Judicial review and HMRC ESCs

The Court of Appeal has provided guidance on characteristics to be attributed to the “ordinarily sophisticated taxpayer” for the test applied in claims based on legitimate expectation in the case Murphy v HMRC [2023] EWCA Civ 497. The decision, concerning the application of an extra statutory concession (ESC), highlights that HMRC’s long-standing practice on the application of the concession will not be relevant to its correct interpretation where that practice was not visible to the general body of taxpayers. The decision also indicates that other factors, such as incompatibility of HMRC’s interpretation with EU law, may be relevant to the interpretation of a concession.

Background

The case concerns the proper application of ESC B18 concerning the availability of credit for tax paid by a non-resident trust in relation to distributions made by the trust to a UK beneficiary. The taxpayers were UK resident beneficiaries of a Guernsey FURBS. In 2019, the FURBS made distributions to the UK beneficiaries who claimed credit against their UK tax liability for payments of UK tax made by the trustees of the FURBS on the income received by the trust and which was distributed to the taxpayers.

The taxpayers relied in particular on the terms of ESC B18. ESC B18 contained three concessions. The first served to enlarge the ability of a beneficiary of a UK resident trust to claim to “look through” the trust and was subject to a six year time limit which was consistent with the legislation on which it was based.

There were then two concessions in a paragraph dealing with non-resident trusts. Concession 2 applied where a non-resident beneficiary receives a payment out of income of the trustees in respect of which, had it been received directly, it would have been chargeable to UK tax. Concession 3 allowed a UK beneficiary of a non-resident trust to claim appropriate credit for tax actually paid by the trustees on the income out of which the payment to the beneficiary is made. The section on non-resident trusts started with the words “a similar concession will operate” and HMRC took this to mean that the six year time limit in Concession 1 also applied to Concession 2 and 3.

The taxpayers, who relied on Concession 3, argued that the concession should not be read in that way and brought a claim for judicial review based on legitimate expectation. In particular, they pointed out that whilst the legislation on which Concessions 1 and 2 were based included a sxi year limitation, the legislation on which Concession 3 was based did not include any such limitation. As such, the words “similar concession” should not be read so as to add a six year limitation to Concession 3. The High Court dismissed their argument, considering that there were two ways to read the concession but considered that the better view was that the concession was restricted.

Decision of the Court of Appeal

The Court of Appeal has upheld the taxpayers’ appeal. The Court reiterated that the meaning of an ESC published by HMRC is to be assessed by reference to how it would “reasonably have been understood by those to whom it was directed” and in this case, this meant the “ordinarily sophisticated taxpayer”. On that basis, the Court considered that, read naturally, the text of ESC B18 strongly supported the taxpayers’ interpretation. However, apart from determining the case on a natural reading of the language of the concession, the Court’s decision also contains a number of interesting aspects of broader importance in the context of judicial review.

Firstly, the Court considered the argument that the taxpayers’ argument should be preferred since HMRC’s interpretation was, arguably, contrary to EU law principles. HMRC’s interpretation would have meant that a UK beneficiary of a non-resident trust would have been denied a credit in circumstances where a UK beneficiary of a UK trust would benefited from a credit. The taxpayer argued that EU law considerations were relevant to how an “ordinarily sophisticated taxpayer” would understand the concession in that they would assume it should be read in a way that would avoid illegal discrimination. The Court of Appeal agreed with this analysis.

Secondly, ESC B18 had existed in a number of forms. The High Court had used the previous versions (dating from as early as 1978) as an aid to construction of the most recent one issued in 1999. However, the Court of Appeal doubted whether it was right to have regard to earlier versions. “An “ordinarily sophisticated taxpayer” would not expect to have to research earlier versions of ESC B18 in order to understand ESC B18 (1999), especially when ESC B18 (1978) and ESC B18 (1994) are not readily available.”

The Court also went on to discuss the significance of practice, manuals and commentaries when considering what the “ordinary sophisticated taxpayer” would understand an ESC to mean. The Court indicated that whilst HMRC long-standing practice would not be relevant simply on the basis of HMRC’s consistent application of the ESC in relation to individual taxpayers where evidence of that practice is only visible to HMRC, the position might be otherwise where that practice is public.

“On the other hand, there may be cases in which the “ordinarily sophisticated taxpayer” would have been alerted to a settled practice of HMRC through, say, HMRC manuals, guidance published by HMRC or commentaries in practitioner texts. In such a situation, HMRC practice may be of relevance. In a sense, that might be said to result in the meaning attributed to an extra-statutory concession changing over time despite its wording remaining the same. As, however, Sales J explained in Accenture, a claim by a taxpayer to take advantage of an extra-statutory concession is “in the nature of a claim to benefit from an enforceable substantive legitimate expectation”. Materials revealing a settled practice on the part of HMRC may bear on whether a taxpayer had such an expectation.”

Comment

The decision of the Court of Appeal is important in highlighting that an ESC and other HMRC publications should not be interpreted in the same way as a piece of legislation. What is important is the understanding that would be placed on them by the ““ordinarily sophisticated taxpayer”. As such, HMRC’s long-standing practice of limiting a concession in a particular way could not be determinative if that practice was not visible to the ordinarily sophisticated taxpayer who’s legitimate expectation could not be affected by that practice.