Spreading Out

Mark McLaughlin looks at HMRC’s practice of ‘spreading’ understatements of income into other periods

A TAX RETURN ENQUIRY by HMRC for one period often extends into one or more other periods (e.g. if there is an understated tax liability for the original period).

For example, an HMRC enquiry into the tax return of a self-employed individual with a cash-based business may result in additional profits being assessed on the basis that the taxpayer’s declared income was understated, and/or that expenses claimed as allowable were overstated.

Taxpayers will sometimes accept tax return adjustments proposed by HMRC for an ‘easy life’ in the hope that the enquiry is concluded sooner, even though they do not believe an adjustment is appropriate. However, this can result in a significantly higher tax liability than was anticipated when agreeing to the initial adjustment.

Presumption of continuity

HMRC’s practice of seeking to assess other years in addition to the tax year of enquiry is often referred to as ‘spreading’; it is based on the ‘presumption of continuity’ (see HMRC’s Enquiry manual at EM3309). This principle was expressed (by Judge Walton J) in Jonas v Bamford [1973] STC 519 as follows: “…once the inspector comes to the conclusion that, on the facts which he has discovered, the taxpayer has additional income beyond that which he has so far declared to the inspector, then the usual presumption of continuity will apply. The situation will be presumed to go on until there is some change in the situation, the onus of proof of which is clearly on the taxpayer.”

HMRC’s view

In practice, some adjustments will be ‘one-off’ in nature (e.g. omitted income from a source that only arose in the tax return enquiry year). A ‘spreading’ adjustment by HMRC is clearly not appropriate in those circumstances.What about adjustments in respect of ‘normal’ trading income? HMRC guidance (in its Enquiry manual at EM3309) states that “…in the absence of evidence to the contrary, a ‘presumption of continuity’ can be made and the Inspector can be entitled to conclude that under-declarations in some years can be taken as a pointer to under-declaration in others and make discovery assessments accordingly.”

However, HMRC acknowledges that there are limitations to this principle. It points out: “The ‘presumption of continuity’ alone does not justify increases in assessments, the onus is on HMRC to bring evidence in support of the argument.”

Backwards and forwards

It should be noted that in Jonas v Bamford, the presumption of continuity was expressed by Walton J in terms of spreading adjustments forwards from the year of enquiry (see above). However, in practice HMRC often uses the presumption of continuity as the basis for spreading adjustments backwards instead of (or as well as) forwards. This approach has been met with mixed reactions in tax tribunal cases.

For example, in Chapman v Revenue and Customs [2011] UKFTT 756, the First-tier Tribunal (FTT) commented: “The presumption goes on until there is some change. The presumption as expressed in [Jonas v Bamford] looks to the future and not the past. It is difficult to see how one can apply such a presumption based on the enquiry year to the earlier years.”

On the other hand, in Allan v Revenue and Customs [2016] UKFTT 504 (TC), the FTT stated: “Once the threshold requirement is satisfied for there to be a ‘discovery’ of loss of tax, the presumption of continuity applies in the raising of assessments for earlier years”. However, decisions in FTT cases do not set a binding legal precedent.

Not so fast…

Should HMRC apply the presumption of continuity at all? In Syed v Revenue and Customs [2011] UKFTT 315 (TC), the FTT said: “In our view [Walton J’s judgment in Jonas v Bamford] expresses no legal principle. It seems to us that it would be quite wrong as a matter of law to say that because X happened in Year A it must be assumed that it happened in the prior year.” It added: “This tribunal is not bound to conclude that what happened this year will happen next year.”

Furthermore, in Barkham v Revenue and Customs [2012] UKFTT 499 (TC), the FTT commented: “The presumption of continuity alone does not justify increases in assessments; the initial onus is on HMRC to show evidence in support of the making of the assessments. This would therefore be a limitation on the use of the presumption of continuity where previous year’s accounts are sought to be reopened.”

Conclusion

If HMRC does intend applying the presumption of continuity, it may be possible to resolve the matter without litigation by gathering all available evidence for the tax year of the proposed adjustment, and seeking to persuade HMRC that the evidence supports a lower (or no) adjustment.

Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a tax consultant to professional firms (tax@markmclaughlin. co.uk and mark.mclaughlin@tacs.co.uk), Managing Editor of TaxationWeb (www.taxationweb.co.uk) and Editor of McLaughlin’s Tax Case Review (www. taxinsider.co.uk/mclaughlins-tax-cases. html).