An Employee v Revenue & Customs [2008] UKSPC SPC00673 (19 March 2008) 

Spc00673

SHARE OPTIONS – unapproved scheme - gains by employee – whether charge to income tax arises when options exercised but shares not sold – yes – ICTA 1988 s 135(1)

ASSESSMENT – power to raise assessment - whether loss of tax attributable to negligent conduct on the part of the Appellant or the person acting on his behalf – yes – whether at the relevant time the Revenue could not have been reasonably expected to be aware of the loss of tax – yes – appeal dismissed – TMA 1970 s 29 (4) and (5) 

THE SPECIAL COMMISSIONERS

A N EMPLOYEE
Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY’S
REVENUE AND CUSTOMS
Respondents

Special Commissioner : DR A N BRICE

Sitting in London on 13 to 15 November 2007

Douglas Keel, Counsel, instructed by Bradley Trimmer, Solicitors for the Appellant 

Ms June Kennerley, of the Appeal Unit, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

The appeal 
1.	Mr A N Employee (the Appellant) appeals against a Notice of Assessment dated 23 June 2005 for the year ending on 5 April 2001. The amount of tax charged by the assessment was £490,250. The assessment was issued by the Commissioners of Her Majesty’s Revenue and Customs (the Revenue) because they were of the view that the Appellant, who was an employee of a company, had realised a gain by the exercise of a right to acquire shares and was accordingly chargeable to income tax under Schedule E. The assessment was made out of time because the  Revenue were of the view that the fact that income which ought to have been assessed to income tax had not been assessed was attributable to negligent conduct on the part of the Appellant or the person acting on his behalf and that the Revenue could not have been reasonably expected, on the basis of the information made available to them, to be aware that income which ought to have been assessed had not been assessed. 

2.	The Appellant appealed on the ground that the assessment had been made out of time. He argued that he had not been negligent and, on the basis of the information he had made available to the Revenue with his return, they would have been reasonably expected to be aware that income which ought to have been assessed had not been assessed. Later the Appellant also argued that there was no charge to income tax where share options were exercised but where the shares were retained and not sold. 

The legislation
The legislation relating to share options 
3.	At the relevant time the legislation about income tax on share options was contained in section 135 of the Income and Corporation Taxes Act 1988 (the 1988 Act). The relevant parts of section 135 provided: 

“135(1)	 Subject to section 185, where a person realises a gain by the exercise … of a right to acquire shares in a body corporate obtained by that person as a director or employee of that or any other body corporate, he shall be chargeable to tax under Schedule E on an amount equal to the amount of his gain, as computed in accordance with this section. …

(3)	Subject to section 136(4)-
(a)	the gain realised by the exercise of any such right at any time shall be taken to be the difference between the amount that a person might reasonably expect to obtain from a sale in the open market at that time of the shares acquired and the amount or value of the consideration given whether for them or for the grant of the right; .. “

4.	Section 185 of the 1988 Act contained provisions about approved share option schemes. However, the provisions of section 185 did not apply to unapproved share option schemes and the scheme at issue in this appeal was unapproved. Subject to stated exceptions, section 185(2) provided that income tax was not chargeable in respect of the grant of an option and section 185(3) provided that income tax was not chargeable in respect of the exercise of the option. Special provisions also applied to the calculation of chargeable gains in the context of approved share option schemes. 

The legislation relating to the power to make an assessment
5.	Before self-assessment was introduced a taxpayer made a return and tax was assessed by the Revenue. The taxpayer could challenge the assessment by an appeal. The present scheme is that a taxpayer must include in his return a self-assessment. The return should disclose all the relevant information and correctly assess, on the basis of it, the tax due. The Revenue may then formally enquire into the return and, at the end of any such enquiry, may amend the return and issue a closure notice. If the Revenue make no enquiry the self-assessment return becomes final subject only to the possibility of an assessment under section 29.of the Taxes Management Act 1970 (the 1970 Act).  At the relevant time section 29 provided:

“29(1)	If an officer of the Board or the Board discover, as regards any person (the taxpayer) and a year of assessment-
(a)	that any income which ought to have been assessed to income tax .. have not been assessed, or …
the officer or, as the case may be, the Board may, subject to subsections (2) and (3) below, make an assessment in the amount, or the further amount, which ought in his or their opinion to be charged in order to make good to the Crown the loss of tax. … 

(3)	Where the taxpayer has made and delivered a return under section 8 or 8A of this Act in respect of the relevant year of assessment, he shall not be assessed under subsection (1) above 
(a)	in respect of the year of assessment mentioned in that subsection; and
(b)	in the same capacity as that in which he made and delivered the return,
unless one of the two conditions mentioned below is fulfilled.

(4)	The first condition is that the situation mentioned in subsection (1) above is attributable to fraudulent or negligent conduct on the part of the taxpayer or a person acting on his behalf.

(5)	The second condition is that at the time when an officer of the Board –
(a)	ceased to be entitled to give notice of his intention to enquire into the taxpayer’s return under section 8 or 8A of this Act in respect of the relevant year of assessment; or
(b)	informed the taxpayer that he had completed his enquiries into that return,
the officer could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware of the situation mentioned in subsection (1) above. 

(6)	For the purposes of subsection (5) above, information is made available to an officer of the Board if-
(a)	it is contained in the taxpayer’s return under section 8 or 8A of this Act in respect of the relevant year of assessment (the return) or in any accounts, statements or documents accompanying the return. … or
(d)	it is information the existence of which and the relevance of which as regards the situation mentioned in subsection (1) above-
(i)	could reasonably be expected to be inferred by an officer of the Board from information falling within paragraphs (a) to (c) above; or
(ii)	are notified in writing by the taxpayer to an  officer of the Board. “

Application to hear a preliminary issue  
6.	A hearing for directions under regulation 9 of the Special Commissioners (Jurisdiction and Procedure) Regulations 1994 SI 1994 No.1811 (the Regulations) was held on 12 October 2007 when directions were given leading to the substantive hearing of this appeal on 13 to 15 November 2007. At that time it was understood that the only issue in the appeal was whether the Revenue had power to raise an assessment under section 29 of the 1970 Act. I refer to that issue as the section 29 issue. 

7.	On 6 November 2007 the Appellant’s advisers indicated in correspondence that, if the Appellant were unsuccessful on the section 29 issue, they wished to argue that section 135 did not apply where an option was exercised but the shares were not sold. I refer to this issue as the section 135 issue. The Appellant’s advisers suggested that the section 29 issue should be heard as a preliminary issue. The Revenue objected to that proposal and I heard argument about it at the beginning of the hearing of the appeal. At that time five witnesses were present to give evidence about the section 29 issue.   

8.	For the Appellant Mr Keel argued that the Special Commissioners had power to direct the hearing of a preliminary issue. If the section 29 issue were decided in favour of the Appellant that would determine the appeal. He cited Silver v Inspector of Taxes [1997] STC 193. The Revenue argued that it would not be possible to consider the section 135 issue as an issue separate from the section 29 issue. If the Appellant were right about the section 135 issue, and if there were no charge to tax on the exercise of an option if the shares were not sold, then there had been no loss of tax. It followed that the  questions as to whether that loss was attributable to negligent conduct on the part of the Appellant, or whether the officer could have been expected to be aware of the loss of tax, would not arise. The Revenue cited John Andrew Walker v The Commissioners for Her Majesty’s Revenue and Customs  [2007] SPC 00626 at paragraphs 12 and 21. 

9.	In my view the provisions of regulation 9(3)(a) are wide enough to give the Special Commissioners power to direct the hearing of a preliminary issue in an appropriate case. However, an application for such a direction should normally be made well before the substantive hearing. In this appeal it should have been made at the hearing for directions on 12 October 2007 and not a few days before the substantive hearing. Also, the hearing of a preliminary issue should only be directed if it is potentially decisive of the appeal, or saves costs, or will shorten the proceedings. In my view the hearing of the section 29 issue as a preliminary issue was not  appropriate for the reasons given by the Revenue. It would not be desirable to consider the section 29 issue alone, and give a Decision on it, knowing that the section 29 issue might later become hypothetical if the Appellant succeeded on the section 135 issue. 

10.	My decision was that, in all the circumstances, it would not be appropriate to hear the section 29 issue as a preliminary issue. However, I also said that I would hear  argument on the section 135 issue as an additional issue in the appeal and then give one Decision on all issues. The Appellant was not then ready to argue the section 135 issue but assured me that no additional evidence would be required. I accordingly directed that the Appellant should be at liberty to send his representations in writing on the section 135 issue within twenty-eight days of the conclusion of the hearing of the appeal after which the Revenue would be invited to comment. The written arguments of the Appellant on the section 135 issue arrived on 17 December 2007 and the written arguments of the Revenue were dated 16 January 2008. The Appellant replied on 31 January and the Revenue responded on the same date. 

The issues
11.	Thus the issues for determination in the appeal were:

(1)	whether a charge to tax under section 135 arose on the exercise of  share options even though the shares were not sold; and if so

(2)	whether the Revenue were entitled to assess the Appellant under section 29 because either
 
(a)	the fact that income which ought to have been self-assessed to income tax was not assessed was attributable to negligent conduct on the part of the Appellant or his advisers within the meaning of section 29(4) of the 1970 Act; or 

(b)	the Revenue could not have been reasonably expected, on the basis of the information made available to them, to be aware that income which ought to have been self-assessed to income tax was not assessed within the meaning of section 29(5).  

Application for hearing in private
12.	At the commencement of the hearing Mr Keel, on behalf of the Appellant, renewed an application, first made at the hearing for directions, for the hearing of the appeal to be in private or at least for the Decision to be anonymised. He produced a medical certificate. For the Revenue Ms Kennerly argued that as, a general rule, it was in the interests of justice for hearings to be in public. 

13.	Regulation 15 provides that normally hearings are in public. However, regulation 15(2) provides that a Tribunal may direct that all or part of a hearing shall be in private on the application of any party if it is satisfied that a hearing in private is necessary in the interest of morals, public order, national security, juveniles, or for the protection of the private life of the party or if it considered that publicity would prejudice the interests of justice. Rule 20 provides that the Presiding Special Commissioner might make arrangements for the publication of decisions as he considers appropriate. 

14.      I directed that the interests of justice would best be served by holding the hearing in public and by publishing the Decision. However, I also formed the view that in this case the Decision should be anonymised. 

The evidence
15.	A bundle of documents was produced and there was a statement of agreed facts. Oral evidence was given by the Appellant on his own behalf. Oral evidence on behalf of the Appellant was also given by Mr Chartered Accountant. Oral evidence on behalf of the Revenue was given by Mr Neil Jackson, the Inspector of Taxes who considered the Appellant’s tax return when it was received in January 2002; by Mrs Elsie McCann, the Revenue Officer responsible for the Appellant’s tax affairs after October 2002; and by Mr Jonathan Prothero, an officer of the Revenue who was in the Employee Share Schemes Team from November 2000 to September 2004. 

The facts
16.	From the evidence before me I find the following facts. 

The Appellant and his share options
17.	In 1994 the Appellant became an employee of Company Ltd which operated a number of share option schemes, both approved and unapproved, for employees of itself and subsidiary companies. These schemes were dealt with by the Revenue at its Shares and Securities Unit in Somerset House. The Appellant was allocated a number of options in an unapproved scheme both when he joined Company Ltd and also during his employment. The options were exercised at various times. When the Appellant exercised options while he was an employee of Company Ltd he sold the shares on the same day and received the proceeds of sale. 

18.	The Appellant was also a member (although not the nominated partner) of a number of film partnerships. 

19.	In April 2000 the Appellant‘s employment with Company Ltd ceased. One of the terms of the share option scheme was that options had to be exercised within ninety days of the end of the employment. On eight occasions between 6 April 2000 and 3 July 2000 the Appellant exercised his remaining options. On four occasions he immediately sold the shares and the option price was deducted from the sale proceeds. On the other four occasions he paid the option price for the shares and retained them. Some of the retained shares were later sold in the same tax year (that is, the year ending on 5 April 2001). However, about 11,000 shares were retained after the end of the tax year.   

The general correspondence with the Revenue
20.	The Appellant received tax and financial advice from a firm of financial advisers. Mr Chartered Accountant of that firm advised the Appellant about tax matters. The firm also acted for a number of other employees of Company Ltd. The tax affairs of the Appellant were dealt with by the Revenue at London Provincial 34 District which had offices in Sunderland.  

21.	Between April 2000 and September 2000 Mr Chartered Accountant corresponded with the Revenue about a named client (not the Appellant) who was also an employee of Company Ltd and who had exercised share options in an unapproved scheme but had retained the shares and not sold them. The tax affairs of the named client were dealt with by the Revenue at London Provincial 10 District which had offices in Gateshead. In that correspondence Mr Chartered Accountant argued that, as no gain had been realised by the exercise of the option, section 135 did not apply. The Revenue made it clear that it was their view that the exercise of an option, without any sale of the shares, was the realisation of a gain because, by the exercise of the option, the taxpayer had converted the right given by the option into money’s worth. The Revenue suggested that the difference of opinion might be solved by an appeal. However, Mr Chartered Accountant’s firm and the named client took the view that, as the amount of tax in question was moderate, it was not sensible to spend more time and money arguing with the Revenue. For that reason Mr Chartered Accountant accepted an amended self-assessment in that case.  

22.	On 9 August 2001 Mr Chartered Accountant wrote to the Revenue at their Gateshead offices about the Appellant but did not identify the Appellant by name. The letter said that a client had left the employment of Company Ltd in April 2000 and had then exercised a number of share options. Some of the shares had been sold at the same time but a major proportion of the shares had been retained and had not been sold. Mr Chartered Accountant expressed the view that, as no gains had been realised on the exercise of the options, there should be no liability to tax under section 135 of the 1988 Act.  The letter went on to say that the value of the shares which had been held had since fallen. At the date of the exercise of the option the client had paid $3 for each share and had received shares then valued at $68 each. However, at the date of the later sale each share was only worth $13. Mr Chartered Accountant was of the view that, in those circumstances, no gain had been realised by the client on the exercise of the option and, on the subsequent sale, a gain of only $10 had been realised on the basis that there had been a purchase of a share for $3 and its sale for $13.

23.	The Revenue replied from its Gateshead office on 16 August 2001 and said that they would seek to charge income tax under Schedule E equivalent to $68 per share at the point of the exercise of the option but that there would be an allowable capital gains tax loss when the shares were sold. The letter referred to the fact that Mr Chartered Accountant had corresponded at length in another case where the exercise of options had not been followed immediately by the sale of the option shares and so all the arguments would not be repeated in detail. However, reference was made to the provisions of section 135(3)(a) which, in the view of the Revenue, made it clear how gains realised by the exercise of an option were to be calculated. 

The correspondence leading to the Appellant’s tax return 
24.	On 6 August 2001 the Appellant wrote to his advisers to say that he needed to understand his tax position as soon as possible in order to inform the solicitor acting for him in connection with his matrimonial matters. He had been advised that he should be maximising his debt position. Mr Chartered Accountant replied on 10 August to say that the main point remaining for clarification was the Appellant’s tax exposure from the exercise and holding of option shares. Mr Chartered Accountant stated that he was a lone voice but he was of the view that the mere exercise of an option did not realise a gain; the Revenue’s view was that the acquisition of shares which were worth more than the amount paid for them was the realisation of a gain. Mr Chartered Accountant went on to say that the options exercised and sold produced a tax liability of £181,000 and that the Revenue would seek to collect a further £494,000 from the options exercised where the shares had been retained. 

25.	On 28 September 2001 Mr Chartered Accountant wrote again to the Appellant; he referred to the documentation to complete the return and said that he had “excluded the contentious exercises of options which were held pending a decision on how the matter should be dealt with”. He sent the Appellant copies of the correspondence which he had had with the Gateshead office of the Revenue in August 2001 (which correspondence was about the Appellant but had not identified the Appellant). He concluded: “In the circumstances, I think you should have the opportunity to consider the possibilities – take the easy route and rely on film loss cover to limit liabilities on option “gains” or take further advice (preferably from tax Counsel – which will not be cheap) on the advisability of challenging Revenue views and practice”. No advice from tax counsel was sought.    

26.	On 4 October 2001 Mr Chartered Accountant sent the Appellant his tax return for the year ending on 5 April 2001 with “the share scheme supplementary schedule completed in the way the Revenue would expect to see”. He asked the Appellant to sign and return the form. On 26 October 2001 the Appellant had a meeting with his advisers where tax matters were discussed. As a result of that meeting, Mr Chartered Accountant wrote to the Appellant on 20 November 2001 and sent a summary of options which had been prepared in his firm.

27.	The summary of options dated 20 November 2001 indicated that, if the return were submitted on the Revenue’s basis and income tax was chargeable in respect of options exercised but where the shares were retained and not sold, then the amount of tax due on 31 January 2002 would be £713,000. If the return were submitted on the basis of the interpretation favoured by Mr Chartered Accountant the tax liability would be £393,000; the entire liability would be eliminated by film partnership losses. A compromise might be achievable on the basis that tax would be paid on options exercised and sold in the year but shares not sold in the year would be regarded as purchased at the option amounts actually paid. Tax liability would then be £537,000. The summary concluded that Mr Chartered Accountant’s suggestion would be “to submit your return on the basis of our interpretation of the statutory provisions, argue the merits for a while, then offer the compromise basis (obviously most reluctantly but as a reasonable resolution of a blatantly unfair interpretation of the law as put forward by the Revenue claiming tax on money never received). … As far as your solicitor is concerned it would be entirely accurate to submit that your liability for 2000/1 according to the Revenue should be assessed at £713k”.  

The return 
28.	The Revenue notes with the tax return for the year ending on 5 April 2001 contained a section on share schemes and that, in turn, contained a section on unapproved schemes. This stated that, if the scheme under which share options were granted was not approved, then the taxpayer might be taxable both on the grant of a share option and on the exercise of a share option. It later stated that “you need to include the exercise of any option from unapproved schemes on page 51 of the share scheme pages. In this case you will be taxed on the difference between the market value of the shares at the time you exercised the option and the amount you paid for the shares (including the cost, if any, of the option)”. 

29.	The Appellant’s tax return for the year ending on 5 April 2001 was signed and dated 21 December 2001. It included five pages about share schemes. The first page showed that there was a taxable amount of £465,909 in respect of the exercise of options in the unapproved share option scheme of Company Inc. Each of the other four pages contained details of the exercise of an option as follows:

Date			Number of	Option price	Market value per share at 
shares sold	 per share		date option exercised 

6 April 2000		3,000		£3.755			£47.955
2 May 2000		3,000		£3,492			£47.190
19 June 2000 		3,000		£8.295			£45.078
3 July 2000 		2,605		£8.295			£43.514

30.	These were the four occasions when options had been exercised and the shares sold on the same day. No schedules were included for the four occasions when options had been exercised but the shares had been retained and not sold. 

31.	In the part of the return dealing with capital gains tax liability information was given about twelve separate disposals of shares in Company Ltd. The information given about each disposal included the date of acquisition of the shares, the date of disposal, the disposal proceeds, and the amount of the chargeable gains. Some of these disposals were of shares where options had been exercised after 5 April 2000 and where the shares had been retained but had then been sold later in the tax year. However, no indication of that fact was given. Also, not all the shares where options had been exercised were sold in the same tax year and so about 11,000 shares were omitted from the return altogether. 

32.	At the end of the return was a box for additional information and this had been completed to include information about an election to carry back losses. No reference was made in this box to the fact that the self-assessment did not include income tax under Schedule E in respect of the options exercised but not sold.  

33.	The return was sent to the Revenue in Sunderland with a covering letter dated 27 December 2001 written by the Appellant’s advisers. The letter contained four paragraphs and part of the first paragraph read:

“We would inform you that we have not reported in Share Schemes supplementary schedule exercises of options that our client held instead of selling, on the grounds that no gain was realised at the time of the exercise of the option. Certain of those shares were later sold, and such disposals have been reported in the Capital Gains supplementary schedule, using as cost of acquisition the amount paid when exercising the option.”

The Revenue’s consideration of the return
34.	The return and letter were received by the Revenue on 28 December 2001 and passed to Mr Jackson who received them in January 2002. At that time Mr Jackson had not read the general correspondence between Mr Chartered Accountant and the Revenue’s Gateshead office in 2000 about the named client nor had he read the correspondence with the Gateshead office in 2001 about the Appellant who had not then been named. Mr Jackson looked at the return and read the covering letter and accepted the statements in it at face value. He assumed that it had no implication for the return and that there was no gain and no loss. He concluded that the exercises of the options which were shown in the return had been correctly dealt with. He did not consider that he should open an enquiry under section 9A of the 1970 Act and forwarded the papers to his colleagues to deal with some of the other matters raised. .Thereafter there was correspondence between the Revenue and Mr Chartered Accountant about other matters relating to the return. 

35.	On 3 October 2002 responsibility for the Appellant’s tax matters passed to 
Mrs McCann of the Revenue’s Complex Personal Return Team at Gateshead. She reviewed the Appellant’s return but at that time the covering letter dated 27 December 2001 was not with the return. She formed the view that there was no need to open an enquiry.  

36.	Section 9A of the 1970 Act provides that an officer of the Board may enquire into a self-assessment return if he gives notice in writing of his intention to do so within a stated period. It was agreed that in this appeal the period in which an enquiry could be made into the Appellant’s return under section 9A of the 1970 Act ended on 31 January 2003.

37.	On 13 January 2003 the Revenue wrote to the Appellant to say they intended to make some enquiries into his tax return for the year ending on 5 April 2001 about claims for losses relating to a film partnership. On 17 January 2003 another office of the Revenue set a similar letter to the Appellant about another film partnership. That letter said that until the enquiries were completed the tax return would be treated as being under enquiry. However, if any enquiries were to be made into any other aspects of the return, the Appellant would be informed separately. No further information was sent to the Appellant at that time. 

2003 - The share option returns from Company Ltd 
38.	Company Ltd sent annual returns to the Revenue with details of the share options exercised during the year. Company Ltd corresponded with the Revenue at London Provincial District 34 in Sunderland who forwarded the share option returns to the Employee Share Schemes Team at Somerset House. 

39.	Company Ltd’s share option returns for the tax years ending on 5 April 2000 and 5 April 2001 were both late. Enquiries were made by the Revenue. The return for the year ending on 5 April 2000 was received in August 2001. There was some uncertainty about the date on which the return for the year ending on 5 April 2001 was received by the Revenue. On 24 September 2002 Mr Prothero wrote asking for details of all of the share option schemes operated by Company Ltd and said that the last return received was that for the year ending on 5 April 2000. He telephoned on 15 January 2003 and mentioned the outstanding returns. He telephoned on 28 February 2003 asking for the return for the year ending on 5 April 2001. He was told that the return had been ready for some time but had been held up on the instructions of the parent company. The return was eventually received under cover of a letter marked “Copy” dated 7 January 2003 from Company Ltd. The copy letter received by the Revenue was stamped by London Provincial District 10 as received on 24 July 2003. Having heard the evidence, and seen the witnesses, and considered the documentary evidence I find it most probable that the return was not sent by Company Ltd on 7 January 2003 but was held up at that time and was sent later so as to be first received by the Revenue on 24 July 2003. A copy was sent to the Employee Share Schemes Team and was received by Mr Prothero of that team on 30 July 2003. 

40.	Company Ltd’s share option return for the year ending on 5 April 2001 contained details of the eight exercises of options by the Appellant. These included not only the four occasions when options had been exercised and the shares sold on the same day but also the four occasions when options had been exercised but the shares had been retained and not sold. Mrs McCann received the information in  Company Ltd’s return in 2003 and compared the information given about the Appellant with the information given in the Appellant’s self-assessment return. She then formed the view that income amounting to £1,270,682., which ought to have been self-assessed in the Appellant’s return, had not been assessed. Accordingly, the Appellant’s self-assessment return was passed to a Mrs Mayer for investigation.  

41.	In November 2003 Mrs Mayer sought technical advice as to whether an assessment could be raised under section 29 of the 1970 Act. Internal correspondence continued within the Revenue on this matter with some officers taking one view and some taking another on the questions which are now issues in this appeal.  

42.	On 15 July 2004 Mrs Mayer of the Revenue wrote to the Appellant and his advisers saying that she was enquiring into the Appellant’s 2001 return under section 29 of the 1970 Act. The assessment under appeal was issued on 23 June 2005.  

Reasons for decision
43.	I have identified the following questions arising out of the issues in the appeal:

(1)	does a charge to income tax arise under section 135 of the 1988 Act on the exercise of share options in an unapproved scheme if the shares are retained but not sold? If it does -
 
(2)	was the fact that income which ought to have been self-assessed to income tax was not assessed attributable to negligent conduct on the part of the Appellant or his advisers within the meaning of section 29(4) of the 1970 Act ? or  

(3)	could the Revenue have been reasonably expected, on the basis of the information made available to them, to be aware that income which ought to have been self-assessed to income tax was not assessed within the meaning of section 29(5)?  

44.	I consider each question separately.

(1)	Does section 135 tax options exercised where the shares are not sold?
45.	The first question is whether a charge to income tax arises under section 135 of the 1988 Act on the exercise of share options in an unapproved scheme if the shares are not sold.

46.	For the Appellant Mr Keel accepted that the word “gain” was defined in section 135(3) but argued that there was no definition of the word “realises”. He argued that the section did not define the transaction it sought to charge but merely assumed that the exercise of a share option realised a gain. He relied upon WT Ramsay Ltd v Inland Revenue Commissioners [1981] STC 174, HL, at 179 for the principle that a subject was only to be taxed on clear words. He cited Black-Clawson International Limited v Papierwerke Waldhof-Aschaffenburg AC [1975] AC 591 at 613 for the principle that it was necessary to ask not what Parliament meant but the true meaning of the words used. He cited Bennion on Statutory Interpretation Fourth Edition at page 1016 for the principle that the words of a statute should be given their primary meaning and argued that the primary meaning of the word “realise” was “to convert cash into money”. Mr Keel went on to argue that the section was incapable of a reasonable construction and so the Appellant should not be charged to tax. He pointed out that similar words were used in section 776 of the 1988 Act and had been considered in Yuill v Wilson [1980] STC 460 and in Yuill v Fletcher  [1984] STC 401 at 410.  

47.	For the Revenue Ms Kennerley argued that section 135 and its predecessors were enacted to reverse the judgment in Abbott v Philbin (1961) 39 TC 82 so that tax would be charged on the exercise of an option. She cited Ball v Phillips (1990) 63 TC 529 at 536 and 538 as authority for the principle that the predecessor of section 135 had been enacted to bring into tax the gain which had been declared in Abbott v Philbin not to be liable to tax. She argued that, on the exercise of an option, the holder of an option became entitled to the issue of shares and that was a gain that was realised by the exercise of the option. Ms Kennerley relied upon the definition of “realise” in the Oxford English Dictionary Second Edition of “to make real, to give reality to …; to convert into real existence or fact …”. She argued that there was a presumption that legislation did not have a futile or pointless result and cited Bennion on Statutory Interpretation Fourth Edition at N24. She distinguished Yuill v Fletcher and argued that in this appeal what was obtained by the exercise of the options were shares which were money’s worth; if the Appellant had been given the shares by his employer there would have been a charge to tax on the money’s worth.  

48.	In considering the arguments of the parties I start with Abbott v Philbin (1961). There a taxpayer was granted share options in October 1954. In 1956 he exercised the options and was allotted shares at the option price. He was assessed to tax for the year 1955-56 on a sum equal to the difference between the market price and the amount he paid for the shares. The House of Lords held that the benefit of the grant of the option in the year 1954-55 was taxable as a perquisite but that the exercise of the option was not taxable. 

49.	Following that decision the provision which is now in section 135 was originally introduced by section 25 of the Finance Act 1966, consolidated in section 186 of the Income and Corporation Taxes Act 1970 and consolidated again as section 135 of the 1988 Act. 

50.	The Appellant accepts that section 135 and its predecessors were enacted to reverse the decision in Abbott v Philbin and clearly the intention of the legislation was to charge tax on the exercise of an option. Section 135 applies “where a person realises a gain by the exercise of a right to acquire shares”. It seems to me that the words of the section are clear and that a gain arises on the exercise of the option even if there is no simultaneous sale of the shares acquired by the exercise. In such a case the realised gain would be more akin to the acquisition of a benefit in kind than to a pecuniary gain. The provisions of section 135(3) reinforce that view because that subsection would be redundant if the section only applied where an option was exercised and the shares were sold at the same time. The provisions of section 185 also tend to support that view because it deals separately with the grant of an option, the exercise of an option and the sale of the shares in an approved scheme.   

51.	In Ball v Phillips  (1990) a taxpayer was granted an option in 1974. The value of the option was £147 and income tax was charged on the grant of the option. The taxpayer appealed and the matter was not pursued. In 1981 the option was exercised and the taxpayer paid £1,756.80 for the shares which were then worth £3,648. Tax was assessed on £1,891 being the difference between the price paid and the value. The taxpayer appealed arguing that, for a charge to tax to arise on the exercise of an option, the option had to have been taxable on its grant. In the Chancery Division Hoffmann J (as he then was) did not agree and held, at 538E, that section 186 of the Taxes Act 1970 (the predecessor of section 135) was an independent charging section. He added:

“Liability to tax under section 186 depends in my judgment solely upon whether the conditions set out in that section have been satisfied. These conditions are, first, that the taxpayer should have acquired a right to buy shares as an employee of a body corporate…. The second condition is that he should have realised a gain within the meaning of the section by the exercise of the right. Again, there is really no dispute that the exercise of the right produced a gain within the meaning of section 186(3).”  

52.	I accept that the issue in Ball v Phillips was not the same as the issue in this appeal but the statement of the law is general and is binding on me. In the light of that authority I must conclude that income tax is chargeable on the exercise of the right to acquire shares even when the shares are retained and not sold. 

53.	The Appellant relied upon Yuill v Wilson (1980) and Yuill v Fletcher (1984). Those authorities concerned the meaning of the phrase “realising a gain” in section  488 of the Income and Corporation Taxes Act 1970. That section was enacted to prevent the avoidance of tax by persons concerned with the development of land and provided that where land was acquired with the sole or main object of realising a gain from disposing of the land the whole of such gain was to be taxed as being income which arose when the gain was realised. I have not found those authorities to be of help as they concern a different legislative provision and very different facts. Ball v Phillips is a later authority and concerns the meaning of the phrase “realises a gain” within the meaning of what is now section 135.   

54.	My conclusion on the first question is that a charge to income tax arises under section 135 of the 1988 Act on the exercise of share options even if the shares are not sold.

(2)	Was there negligent conduct?
55.	The second question is whether the fact that income which ought to have been self-assessed to income tax was not assessed was attributable to negligent conduct on the part of the Appellant or his advisers within the meaning of section 29(4) of the 1970 Act 

56.	Both parties accepted that the burden of proof lay on the Revenue to prove negligent conduct; that the standard of proof was the balance of probabilities; and that the cogency of the evidence required to meet the standard of proof depended upon the seriousness of the allegations. (See Rochester (UK) Ltd and another v Pickup [1998] STC (SCD) 138 at [89] and [141] to [143]). I also accept that the benefit of the doubt as to whether the Appellant or his advisers were negligent should be given to the Appellant (see King v Walden (No 2) 74 TC 45 at [54]).  

57.	For the Appellant Mr Keel cited AB (a firm) v Revenue and Customs Commissioners [2007] STC (SCD) 99 at [103] to [105] for the principle that negligent conduct was more than just being wrong or taking a different view from the Revenue and that a taxpayer who took proper and appropriate professional advice with a view to ensuring that his tax return was correct, and acted in accordance with that advice (if it was not obviously wrong) would not have engaged in negligent conduct. In a number of recent cases matters which had thought to be settled law had been scrutinised and the accepted interpretations were found not to be correct. Mr Keel went on to argue that the covering letter dated 27 December 2001 sent with the return drew attention in the only way possible to the way in which the return had dealt with the options which had been exercised where the shares had not been sold. An examination of the schedules provided with the return relating to the options exercised and sold showed that there had to be a gain on options exercised. He relied upon SP01/06 at paragraphs 18 and 19 and argued that Mr Chartered Accountant had expected an enquiry to be opened during which a compromise would have been reached. 

58.	For the Revenue Ms Kennerley cited Blyth v Birmingham Waterworks [1856] 11 Ex 781 at 1049 for the principle that negligence was the omission to do something which a reasonable man would do or doing something which a prudent and reasonable man would not do. She also cited King v Walden 74 TC 45 at 76 [147] for the principle that neglect exists where inadequate returns are made by a taxpayer of matters within his own knowledge. She argued that the understatement in the return of income of £1.2M chargeable to tax under Schedule E amounted to neglect and the failure to disclose in the return or accompanying documents the full information about the treatment of the options exercised where the shares were not sold amounted to negligent conduct. It was clear both from the provisions of section 135(3) and from Ball v Phillips that tax was chargeable on the exercise of an option even if the shares were not sold. The Appellant and his advisers were fully aware of the Revenue’s views and the level of information referred to in Code of Practice 10 had not been provided. Mr Chartered Accountant knew that his was a “lone voice”. 

59.	In considering the arguments of the parties I first note that, in the context of section 29(4), there has to be negligent conduct either by the taxpayer or by a person acting on his behalf. That means that negligent conduct by the Appellant’s advisers would be sufficient. 

60.	I have considered the authorities cited to me about the meaning of negligent conduct within the context of section 29(4). Blyth (1856) contained a definition of negligence within the context of tortious liability. King v Walden (2001) is a more recent case and concerned the meaning of the word “neglect” in the context of  section 88 of the 1970 Act which provided for interest to be charged on an assessment  if there had been a loss of tax attributable to fraud, wilful default or neglect. The authorities were reviewed and at [103] the Special Commissioners expressed the view that “neglect” existed where there was a failure to give any notice, or to make any return, or to produce or furnish any document or other information required by or under the Taxes Acts. Neglect also existed where inadequate returns were made by a taxpayer of matters within his own knowledge unless the taxpayer showed that his inadequate return was due to some reason other than neglect. AB (a firm) (2007) concerned the meaning of the words “fraudulent or negligent conduct” in section 30B of the 1970 Act which dealt with the amendment of a partnership return where a loss of tax was discovered. At [105] the Special Commissioners concluded that the question whether a taxpayer had engaged in negligent conduct was a question of fact in each case; one should take the words of the statute as one finds them and not try to articulate principles which could restrict the application of the statutory words.   

61.	As AB (a firm) is most recent, and as it considered statutory provisions very similar to those in section 29(4), I adopt the same principle and conclude that the question whether the Appellant or his advisers engaged in negligent conduct is a question of fact having regard to all the circumstances and the facts of this appeal. 

62.	I therefore turn to consider the facts and circumstances. I first note that Mr Chartered Accountant was fully aware of the views of the Revenue. In his correspondence with the Revenue in 2000 about the named client, and in his correspondence in 2001 about the Appellant (who was not identified), Mr Chartered Accountant had not only ventilated his own views but had also learnt the views of the Revenue. This is not a case where it could be said that there was any misunderstanding at all about the Revenue’s view of the law. 

63.	I next note that a deliberate decision was made, by the Appellant or his advisers, to submit the self-assessment return on the incorrect basis. It was known that this basis would substantially reduce the Appellant’s tax liability.  

64.	I have considered whether the relevant paragraph of the covering letter of 27 December 2001 could adequately compensate for the incorrect return. I find the  wording of the paragraph far from clear. The words used refer to “exercises of options that our client held” whereas, of course, after the exercises of the options it was the shares that the client held, not the options. There is a statement that “no gain was realised at the time of the exercise of the option” where the writer of the letter clearly knew that the Revenue were of the view that a gain was realised by the exercise of an option. Also, Mr Chartered Accountant was a Chartered Accountant and should have been aware of the decision in Ball v Phillips. The paragraph in the covering letter does not make it clear that the exercise of options amounting to £1.2M had been omitted from the return. No indication was given of the number of shares referred to, or the option price paid, or the market value at the date of the exercise of the options. No indication was given that the shares referred to were part of an unapproved share option scheme rather than an approved scheme. No reference was made to the previous correspondence or to the known views of the Revenue or to the fact that it was known that the Revenue would not agree with the way in which the return had been completed. No attempt was made to give reasons for what had been done. 

65.	Mr Keel, for the Appellant, argued that the covering letter drew attention in the only way possible to the way in which the return had dealt with the options which had been exercised where the shares had not been sold. Ms Kennerley, for the Revenue, drew attention to the Revenue’s Code of Practice 10 – Information and Advice. This describes the way in which a ruling can be requested from the Revenue on the application of tax law to a specific transaction after it has taken place. It states that the request should be sent to the tax office dealing with the taxpayers’ affairs and should include full particulars of the transaction, the taxpayer’s opinion of the tax consequences, details of the sections of the Taxes Acts considered to be relevant, particulars of any relevant case law and the reasons for the taxpayer’s opinion of the tax consequences. 

66.	In my view the standards of compliance shown by the Appellant and his advisers fell below the standards reasonably expected of the competent taxpayer and adviser and such conduct amounted to negligent conduct. The Revenue must be entitled to assume that a professionally prepared tax return has been prepared competently. 

67.	In the light of all the facts and circumstances I conclude that there was a loss of tax attributable to negligent conduct on the part of the Appellant or his advisers within the meaning of section 29(4) of the 1970 Act. That conclusion means that the Revenue were entitled to make an out of time assessment and I do not need to consider the next question but as arguments were put I express my views. 

(3)	Should the Revenue have been aware of the loss of tax?
68.	The third question is whether the Revenue officer could have been reasonably expected, on the basis of the information made available to him, to be aware that income which ought to have been self-assessed to income tax was not assessed within the meaning of section 29(5). 

69.	For the Appellant Mr Keel cited Langham v Veltema [2004] STC 544 at [35] for the principle that the test is one of objective awareness of an actual insufficiency. He accepted that the Court of Appeal had held that, for the purposes of section 29(5), the information available to the Revenue was information supplied by the taxpayer but argued that that did not exclude additional information which was in fact available. He argued that there was a reasonable doubt as to whether Company Ltd’s returns with all the information which had been used for the discovery assessment could have been received in mid-September 2001. He argued that SP 01/06 indicated that a self-assessment return could indicate that a different view had been adopted but that it was not necessary to provide all the information needed to quantify the insufficiency. It followed that the Appellant had not been obliged to state the number of shares or the value of the options exercised. The covering letter sent with the return had been sufficient.    

70.	For the Revenue Ms Kennerley argued that, at the time that the Appellant’s return was received with the covering letter of 27 December 2001, the officer considering the return and the letter (Mr Jackson) did not know of the previous correspondence with another office about the named client; nor did he know about the previous correspondence about the Appellant who had not been named. Neither did that officer have the information contained in Company Ltd’s return (which had not then been received). Also, the covering letter did not state that the share options referred to were in respect of an unapproved scheme. If they had been granted under an approved scheme then the exemption given by section 185 of the 1970 Act could have applied. In addition the parts of the return which dealt with the options which had been exercised and the shares sold were correctly completed. Finally, there was no mention in the space for additional information of the options exercised but not sold. She argued that the return and the documents sent with it did not disclose all the relevant facts and did not disclose full details of the extent of the disagreement between the Appellant’s advisers and the Revenue about the treatment of options exercised and not sold. Neither did the return or the covering letter disclose any actual insufficiency. She relied upon Nicholson v Morris  (1977) 51 TC 95 at 110F for the principle that the obligation was on the taxpayer to provide full information to the Revenue and not for the Revenue to have to search for it. 

71.	Of the authorities cited to me I have been most assisted by Langham v Veltema.  There a company controlled by Mr Veltema owned the house in which he lived. In 1998 it transferred the house to him for no consideration. Mr Veltema, therefore, became liable to income tax under Schedule E on the market value of the house at the date of transfer. The house was valued at £100,000. The company sent the Revenue at Leicester a P11D form showing the transfer of the house. Mr Veltema’s self-assessment tax return was later sent to the Revenue at King’s Lynn and it declared that assets valued at £100,000 had been transferred. In 1999 the company sent its corporation tax return to the Revenue at Leicester and that included a chargeable gain computation relating to the house with a value of £100,000. The matter was referred to the District Valuer who valued the house at £160,000 but a value of  £145,000 was eventually agreed   By this time the power to enquire into Mr Veltema’s return had expired and so the King’s Lynn inspector made an assessment on Mr Veltema for the extra £45,000 under section 29(5) of the 1970 Act.

72.	At [11] Auld LJ identified the issues. The first concerned the circumstances when the Revenue became disentitled from making a section 29 assessment. Was this when (as argued by the Revenue) there was an awareness of an actual insufficiency? Or was it when (as argued by Mr Veltema) there was an awareness of circumstances suggesting a possible insufficiency and the need for basic checks? The second issue was whether the state of mind mentioned in section 29(5) was (as argued by the Revenue) derived from the information provided by the taxpayer, or whether (as argued by Mr Veltema) it should take into account all the information before the inspector from other sources?

73.	From [31] onwards Auld LJ held that the self-assessment scheme was based on an assumption of an honest and accurate return and accompanying documentation by the taxpayer. The Revenue were not obliged to conduct an intermediate scrutiny of self-assessment returns when they did not disclose insufficiency but only circumstances where further investigation might show insufficiency. There was nothing in the statute which obliged the Inland Revenue to enquire into a return. The test in section 29(5) was concerned with what an inspector could have been reasonably expected to be aware of, not what he could reasonably have been expected to do. The section referred to the inspector’s objective awareness, from the information supplied by the taxpayer, of an actual insufficiency. The Revenue was only shut out from making an assessment under section 29(5) when a taxpayer, in making an honest and accurate return, or in responding to an inquiry under section 9A, had clearly alerted them to the insufficiency of the self–assessment. The Revenue was not shut out if they had some other information, not normally part of their checks, that put the sufficiency of the assessment in question. That conclusion was supported by the provisions of section 29(6) which identified only categories of information which emanated from the taxpayer. 

74.	Applying the principles in Langham v Veltema to the facts of the present appeal I do not consider that that the Appellant’s return and the accompanying documentation were accurate and complete. They did not unambiguously disclose any actual insufficiency in the self-assessment. The relevant officer of the Board for the purposes of section 29(5) was Mr Jackson before October 2002 and Mrs McCann thereafter. The only information  provided to them by the Appellant and his advisers about the tax on the shares where options had been exercised and the shares not sold was contained in the paragraph in the covering letter. The information provided did not clearly alert the officers to the insufficiency of the self-assessment nor could they infer an insufficiency. It is not relevant that the officers could have made enquiries. 

75.	Langham v Veltema makes it clear that section 29(5) refers to an inspector’s objective awareness but for good measure I also record that both Mr Jackson and Mrs McCann gave evidence that they were not aware, or could infer, the insufficiency of the self-assessment from the information provided. Mrs McCann, of course, did not see the covering letter of 21 December when she examined the return in 2002 but I accept her evidence that, if she had seen the covering letter, she would not have opened an enquiry as the information could have related to an approved share option scheme where there was an exemption from income tax on the exercise of an option although capital gains tax was charged when the shares were sold. 

76.	Following the judgment of the Court of Appeal in Langham v Veltema the Revenue published Statement of Practice SP 01/06 entitled “Self-assessment: Finality and Discovery” and Mr Keel, for the Appellant, argued the return complied with the Statement of Practice. The Statement of Practice, of course, does not have the force of law. The introductory part contains the following paragraph:

“Taxpayers who adopt a different view of the law from that published as the Revenue’s view can protect against a discovery assessment after the enquiry period. The return would have to indicate that a different view had been adopted by entering in the Additional Information space comments to the effect that they have not followed Revenue guidance on this issue or that no adjustment has been made to take account of it.” 

77.	Paragraphs 9 and 10 of SP 01/06 are headed “Discovery in Practice” and paragraph 9 states:

“9.	A taxpayer can further restrict the opportunity for discovery by providing enough information for an HMRC Officer to realise within the enquiry period that the self assessment is insufficient. However, taxpayers are encouraged to submit the minimum necessary to make disclosure of an insufficiency. The Veltema judgment does not require the provision of enough information to quantify the effect on the assessment.”

78.	Paragraphs 18 and 19 of SP 01/06 are headed “Taking a Different View” and read:

“18.	It is open to a taxpayer properly informed or advised to adopt a different view of the law from that published as HMRC’s view. To protect against a discovery assessment after the enquiry period, the return or accompanying documents would have to indicate that a different view had been adopted. This might be done by comments to the effect that the taxpayer has not followed HMRC guidance on the issue or that no adjustment has been made to take account of it. This would offer an opportunity to HMRC to take up the return for enquiry. It is not necessary to provide all the documentation that HMRC might need to quantify that insufficiency if an enquiry into the Return is made. 

19.	Provided the point at issue is clearly identified and the stance adopted is not wholly unreasonable, the existence of an under-assessment or insufficiency is demonstrated by the statement that a different view of the law has been followed. In these circumstances the taxpayer achieves finality if no enquiry is opened within the statutory time limit.”

79.	As mentioned, the Statement of Practice does not have the force of law. Also, it was published five years after the submission of the return at issue in this appeal. Also, in my view, the Appellant and his advisers did not comply with the guidance given. Neither the return nor the covering letter stated that the Appellant took a different view from the Revenue, nor did they state that the guidance given in the previous correspondence had not been followed. In my view the point at issue was not clearly identified. I am also of the view that the stance adopted by the Appellant or his advisers was wholly unreasonable bearing in mind the clear words of  section 135, the judgment of Hoffmann J in Ball v Phillips, the lack of any authority cited at the time to support the view taken, the known views of the Revenue, and the fact that Mr Chartered Accountant knew that he was “a lone voice”. 

80.	My conclusion on the third question is that the Revenue officer could not have been reasonably expected, on the basis of the information made available to him, to be aware that income which ought to have been self-assessed to income tax was not assessed within the meaning of section 29(5). 

Decision

81.	My decisions on the issues for determination in the appeal are:

(1)	that a charge to tax under section 135 arose on the exercise of  the share options even though the shares were not sold; and 

(2)	that the Revenue were entitled to assess the Appellant under section 29 because either 
(a)	the fact that income which ought to have been self-assessed to income tax was not assessed was attributable to negligent conduct on the part of the Appellant or his advisers within the meaning of section 29(4) of the 1970 Act; or 

(b)	the Revenue officers could not have been reasonably expected, on the basis of the information made available to them, to be aware that income which ought to have been self-assessed to income tax was not assessed within the meaning of section 29(5).  

82	That means that the appeal is dismissed.

DR NUALA BRICE

SPECIAL COMMISSIONER

RELEASE DATE:
SC 3073/2007
15.02.08
The original version of this Decision was released to the parties
on 19 February 2008.  This version has been anonymised. 

DR NUALA BRICE

SPECIAL COMMISSIONER 

RELEASE DATE: 19 March 2008

SC 3073/2007 
19.03..08 

Authorities referred to in argument but not mentioned in the Decision

R v Income Tax Commissioners [1988] 22 QBD 296 at 309
Cenlon Finance Co Ltd v Ellwood  (1962) 40 TC 176 
Varty v British South Africa Company (1965) 42 TC 406
Clixby v Pountney (1967) 44 TC 515 at 519H and 522E-G
Customs and Excise Commissioners v Top Ten Productions Limited [1969] 3 All ER 39 at 93 and 95
Thurgoode v Starke (1971) 47 TC 130 
R v Special Commissioners of Income Tax (ex parte Martin) (1971) 48 TC 1 at 11C-E 
Vickerman v Mason’s Personal Representatives (1984) 58 TC 39 
Pleasants v Atkinson (1987) 60 TC 228 at 234H and 236B
 Nunn v Gray [1997] STC (SCD) 175 at [11]
Hurley v Taylor (1998)  71 TC 268 
Imperial Chemical Industries plc  v Colmer [1998] STC 874 and [1999] STC 1089 
Rowland v Boyle [2003] STC 855 
Hancock v The Commissioners of Inland Revenue (1999) STC (SCD) 287
Billows v Hammond [2000} STC (SCD) 430
Hoechst AG and Metallgesellschaft Ltd v Inland Revenue Commissioners [2001] STC 452  
Mansworth v Jelley [2003] STC 53. 
MacEwan v Martin [2005] STC 993 at [25]. 
Marks & Spencer plc v Halsey [2006] STC 237 and 1235  
D’Arcy v The Commissioners for Her Majesty’s Revenue and Customs  [2006] STC (SCD) 543
The Commissioners for Her Majesty’s Revenue and Customs v Household Estate Agents Ltd [2007] EWHC 1684 (Ch) at [48]
Johnston Publishing (North) Limited v Revenue and Customs Commissioners [2007] STC 1481