When the tax affairs of a drainage treatment business came before the first tier tribunal (FTT), the judge discovered that the waters had been well and truly muddied by the actions of a former adviser.
Rota Rod was a partnership established in 1993 by two couples, the Kingdons and the Steads (“the partners”) (TC08633), which engaged in the investigation, clearance, repair and installation of commercial and domestic drainage systems. In the early 2000s, it was decided to incorporate, and Rota Environmental Service Ltd was formed.
During 2005, the business was transferred from the partnership to the company. But exactly when in 2005? That was the most important – and difficult – question before Judge Popplewell. If, as the partners alleged, it was 31 March or 1 April, then the partnership had no income for the 2005/2006 tax year and HMRC’s assessments on its partners were wrong. If, however, it was 2 August, as HMRC alleged, then a substantial part of the income earned by the business up to that date was properly taxable on the partners rather than the company.
Two Questions Arise:
- Why is there any confusion over the date at which the business transferred?
- Why has it taken until 2022 for this issue to be concluded?
Both questions are in part answered by noting that, until January 2009, the business had, in the words of the judge, “the misfortune of initially instructing the firm of Christopher Lunn & Co (“Lunn”). Its principal, Christopher Lunn, was found guilty of four counts of cheating the public revenue in December 2015. He received a custodial sentence.”
Lunn Muddies The Waters
The partners, being experts in drainage systems, had no knowledge of tax or accounting, and no real interest in how their business was structured for tax purposes. They merely wanted to concentrate on “getting in new work and servicing it”. Lunn had been the one to suggest incorporation, and the structuring and method of operation of the two entities was left entirely to Lunn.
Following a General Commissioners hearing in 2009 regarding the partnership’s 2004/2005 return, the partners came to the conclusion that Lunn was more interested in conducting an argument with HMRC than in representing their best interests, and dismissed him as their adviser.
Their new adviser, Pearlman Rose, struggled to obtain handover documents from Lunn. It appears that Pearlman Rose also struggled to obtain from HMRC any of the Lunn documentation that HMRC had seized at his arrest in June 2010. Pearlman Rose asked HMRC for access to the paperwork relating to their client in November 2011, but this had still not been shared by February 2018 when HMRC wrote setting out the discovery assessments which it proposed to raise.
Down The Drain
The partners appointed Doodney Tax Consulting Ltd (“DTC”) as successors to Pearlman Rose in May 2018. DTC, like its predecessor, was faced with the fact that the details of exactly what had been in the working papers for the relevant periods had vanished into the black hole of Lunn’s seized files.
DTC appealed against the assessments, and made a formal complaint to HMRC about the delay in progressing matters and the manner in which it had conducted its enquiry. In response, HMRC accepted it was responsible for some delay and that things had not been managed well. The complaint was upheld in part.
Plumbing The Depths
The FTT was asked to determine several things. For the first two, the burden of proof lay with HMRC.
- Did the partnership actually continue to trade in the 2005/2006 tax year?
- Were the assessments made in time? Given the delay, HMRC would need to show that the partners had been negligent or had deliberately prepared and submitted incorrect returns.
If HMRC succeeded in making these two points, the burden of proof would shift to the partners, who would need to show either:
- that the extent of the profits that had been attributed to the partnership is incorrect
- that the passage of time has rendered it impossible for them to have a fair hearing, or
- that HMRC had made an undertaking not to assess the partnership or the appellants to additional profit for the year 2005/2006.
In all these cases, the standard of proof required is the civil standard of “the balance of probabilities” or “more likely than not”.
Water Under The Bridge
The first problem was that – after such a long time had elapsed – the memories of the individuals involved could not be relied on to have any probative effect. The date when the business was transferred from the partnership to the company would have to be determined from the available documentary evidence. This consisted of:
- a letter of 13 July 2007 from Ms Struys of HMRC, which notes that “the business activities (primarily drain clearance) of the partnership were invoiced by the company from around March 2005, and this is borne out by the VAT returns.”
- a letter of 30 October 2009 from Pearlman Rose that noted that, during 2005/2006, “the partnership did not generate any income in its own right and that all sales were actually invoiced by [the company]”.
- a letter of 25 February 2011 from Pearlman Rose that stated (without explanation) that the company “took over the entire business of the partnership as from 2 August 2005”.
- the tax returns, which had been prepared by Lunn and which – as was broadly accepted by all parties – bore no relation to the commercial realities of the business.
Treating Lunn’s input with the appropriate pinch of salt, the judge concluded, left us with “a choice between the July letter and the October letter on the one hand and the February letter on the other”.
He found it significant that the October letter explicitly stated that the source of its information was the partners, while the February letter (which contradicts it) is silent as to the basis on which it was written.
“The importance of the partners being the source of information is clear. It is they who
were carrying on the real business, irrespective of how Lunn divided up the income and
expenditure between the partnership and the company.” While memories of what took place in 2005 are vague today, they would not have been so vague in 2009.
The fact that the July letter (and the associated VAT returns) reinforces the likelihood that March 2005 was the true date when the company took over can also not be ignored.
The burden of proof lay with HMRC to show that its preferred date (August 2005) was more likely, and HMRC had failed to do that. There was no 2005/2006 partnership income, and the assessments fail.
The judge went on to consider some of the other arguments raised, of which the most interesting was whether HMRC’s inordinate delays had prevented the partners obtaining a fair hearing. In his view, it had not, because the most important issue was that the partners never had a clue what Lunn was doing.
“This lack of understanding would not have been cured had the trial proceeded in, say, 2014. Whilst [their] memories might have been clearer, they would have had no greater insight into what Lunn was doing”.
On negligence, the judge felt that the partners had not acted negligently: “They put their financial and tax affairs in the hands of an ostensibly competent firm. They cannot be impugned for what essentially amounts to a fiscal frolic by Lunn.”