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Cotting your losses: carry-back claims

The fact that the recent case of HMRC v Cotter [2011] EWHC 896 (Ch) was taken at all is evidence of a hardening of HMRC attitudes to avoidance schemes and a willingness to deploy all possible weaponry against them. The fact that judgement was given in favour of HMRC removes at a stroke one of the key attractions of a wide range of schemes.

Mr Cotter entered into a tax scheme which purported to create in 2008/9 a tax loss which could be set against general income either of 2008/9 or 2007/8. The scheme may or may not ultimately prove successful: but its effectiveness in creating a tax loss was not the issue before the Court. Rather, the case was about the cash-flow effect of making a claim to relief of this kind. In Mr Cotter's case the tax loss happens to have been an employment income loss: but the case is significant because many tax schemes purport to create losses which are likely to governed by the same general principles as are set out in this case.

Mr Cotter claimed that, as a matter of procedure, relief for the loss was properly claimable in his 2007/8 tax return and therefore reduced the tax payable under his self-assessment for that year. If that were so, any enquiry into the effectiveness of the scheme could only be by way of enquiry into the 2007/8 tax return; and, crucially, any additional tax resulting from a successful HMRC challenge to the scheme would (except in very special circumstances) be payable only when the enquiry into the return was closed.

HMRC on the other hand considered that the carrying back of a loss in this way does not operate to alter the amount of the tax self-assessed for the earlier year, but creates a "free-standing" claim. On that analysis, any enquiry is into the claim itself and, once an enquiry is under way, HMRC are not required to give effect to the claim (and in particular not required to make any repayment) until the enquiry is concluded.

Hence the nub of the argument was that if Mr Cotter was right, a participant in a tax scheme of this kind defers payment of the tax in question until the Courts decide (often after many years) that the scheme doesn't work: if HMRC were right, schemes of this kind, once challenged, deliver no benefit (not even a cash-flow benefit) until the Courts have finally ruled in the taxpayer's favour. The distinction is crucial: the attractiveness of many tax avoidance schemes lies partly in the fact that they offer - at worst - the opportunity to defer payment of tax, perhaps for many years (albeit at an interest cost) and partly in the fact that the promoter's fee is offset (in cash-flow terms) by the deferral of tax. If a scheme removes the immediate need to pay a £50,000 tax bill, finding the money to pay a promoter's £10,000 fee is not likely to be a problem: but paying £10,000 on top of the £50,000 tax bill in order to get a refund at some indeterminate point in the future is a rather different proposition.

The case may yet proceed to the Court of Appeal. Meanwhile, we think this will change the landscape in a significant part of the tax avoidance industry.

For more on this (and to know why we have always preferred bespoke planning to off-the-shelf schemes) contact help@bkltax.co.uk