£215,000 tax bill for being generous (and don’t leave it all to your tax software)
By Philip McNeill, Head of Taxation (Tax Practice and Owner Managed Business Taxes)
24 September 2020
How can the tax system turn a £800,000 charitable donation into a £215,000 tax bill? A recent High Court case shows how.
The case of Re Webster (re Webster [2020] EWHC 2275 (Ch)) is cautionary for advisors and philanthropists alike. How could the tax system turn a £800,000 charitable donation in his wife’s memory into a £215,000 tax bill for Mr Webster?
An unusual route
Mr Webster took an unusual legal route. Having made a mistake on his tax return, he appealed to the High Court to correct the return – in legal terms to rectify the return. Ultimately this was something the court declined to do.
The journey through the High Court highlighted an issue with Gift Aid claims which is of wider import: the need for precision over amounts and timing of claims.
Capricious outcomes
Tax advisers are well aware of unexpected outcomes from tax rules. This is part of the job – keeping clients clear of ‘bear traps’ in the legislation. Common sense will not necessarily keep taxpayers clear from unexpected and unwelcome outcomes.
Perhaps Mr Webster’s case brings this to new heights. It is easy to agree with counsel in this case ‘that it is difficult to posit a more striking example of exemplary citizenship – or more illogical and capricious statutory provision’.
So how can a £800,000 charitable gift turn into a £215,000 tax bill for the donor?
Inflexible rules
The warning signs of inflexibility were apparent from the 2010 case of John Cameron (John Cameron TC00415 [2010] UKFTT 104 (TC)). Mr Cameron, a farmer, having made a capital gain, decided to make a substantial Gift Aid donation and elected to carry it back to the previous year (under what is now s426 Income Tax Act 2007 (ITA 2007)).
Being diligent, he had already submitted his tax return before deciding to make the gift and the election. But the legislation requires (under s426 (6) (a) and (b)), that the election must be made: ‘on or before the date on which the individual delivers a return for year’ and, in any event, ‘not later than the normal self-assessment filing date’. Hence once a tax return is filed, the election can no longer be made.
The Tribunal in Cameron commented: ‘the result of this construction is odd but is neither absurd, repugnant, or inconsistent.’ So while it is usually possible to amend a return (within 12 months of filing under section 9ZA Taxes Management Act 1970), such amendment is ineffective for the Gift Aid carry back election as the time limit for making the election will have passed when the return was submitted.
Amending the amount of an election
Moving on to Mr Webster, the situation was different.
Mr Webster had included Gift Aid in his return and made an election to carry it back to the previous year, but the amount included in the tax return differed from the actual payment.
When drafting his tax return, he had entered £400,000 in the software, but the donation he actually made in August 2017 was £800,000. By November 2017, when he submitted the tax return to HMRC, he failed to update the amount recorded in the software.
In line with Cameron, this immediately poses a difficulty as s426 ITA 2007 requires the election to be made ‘on or before the date on which the individual delivers a return’, and the election was for £400,000.
Hence, as the Court in Webster found ‘from the moment the Claimant filed an incorrect tax return on 28 November 2017 he fell foul of S426(6)(a)’ - it is not possible to amend a Gift Aid carry back election after the tax return has been filed.
But surely, Mr Webster had made a valid election, he had simply inserted an incorrect amount. Would not the worst-case outcome be a carry back of £400,000, rather than £800,000?
All or nothing
This is where HMRC’s further interpretation of s426 kicked in.
In Mr Webster’s case, ‘HMRC's position …. was that tax relief was denied entirely unless the amount of the donation and the tax return entry correspond exactly’.
On this approach, if the amounts do not correspond exactly between the tax return and the Gift Aid amount (and declaration) given to the charity, then the s426 election fails completely.
The wording of s426 (1) (a) is: '1) If— (a) an individual makes a gift to a charity that is a qualifying donation.'
Prima facie, HMRC has logic on its side. The qualifying donation was for £800,000. There is no mention in the legislation of partial claims.
Immediate impact
Unfortunately for the taxpayer the full £800,000 donation to charity still stands, but in the following tax year. And for Mr Webster, like Mr Cameron, there was insufficient income and gains in charge to tax in the tax year the gift was actually made, to cover the (basic rate) tax relief claimed by the charity.
S424 ITA 2007 then operates to make the donor taxpayer liable for any shortfall between the tax reclaimed by the charity and that paid by the donor.
Salt in the wound
As if this was not enough, HMRC also considered that making this mistake was careless, and the Court agreed.
In this age of digital tax submissions, it is salutary to read the Court’s comments in full.
‘I have not been provided with the explanation given to HMRC for the error in the tax return.
'I have had the benefit of the Claimant's witness evidence.
'His explanation for the error is that he did not change the figures for the donation to the Charity in the Taxcalc programme. He says that because his personal tax calculation remained unchanged, he did not question the calculation provided by the Taxcalc programme.
'The suggestion appears to be that he printed or otherwise reviewed only the tax liability figure on the tax return prior to filing.
'The Claimant's tax return is exhibited to his witness statement. It is not a particularly long or complex document. The impression given is that he did not check the tax return before filing it.
'Given the Claimant's evidence about the importance of being able to treat the donation as being made in 2016/2017 for tax purposes that is surprising.
'Had he read the tax return before submitting it to ensure that his declaration that it was correct and complete to the best of his knowledge was accurate as required by S8 TMA, it is difficult to imagine he would not have spotted the error in the Gift Aid box where he had included £400,000 not £800,000 given the importance to him.
'It is not a small error.’
The Court then went on to comment:
‘If the Claimant completed his tax return in a way that does not reflect the relief he intended to claim that was his error.
'To my mind an error arising from carelessness in circumstances where the Claimant signed a declaration saying that the tax return was to the best of his knowledge correct and complete is not one that ought to engage the court's sympathy nor the exercise of its discretion.’
Alternative route
Mr Webster’s claim to have his return rectified has been rejected. He has lodged an appeal with the Tax Tribunal, which will have an opportunity to review the election and penalties.
Is it possible that the Tribunal will ease the outcome? Without pre-judging the result, it may be an uphill struggle. The High Court certainly thought that the taxpayer had failed to take reasonable care, and that the time limit in s426 (6) is inflexible.
Pragmatically that means it will be wise to pay attention to the detail now, rather than face tax bills, appeals and uncertainty.
Conclusion
While the minutiae of analysis of the legislation is best left to tax advisers, HMRC and the Courts, some broad principles spring to mind.
It is all too easy to trust the software. The final answer the software gave accorded with the taxpayer’s expectations, so he submitted the return. But a conspicuous entry was incorrect. And this error cost £215,000. Don’t treat the declaration - correct and complete to the best of my knowledge and belief - as a mere tick-box exercise.
More generally, be risk aware. Tax in that sense, has parallels with auditing. A small error in a large figure may be far more significant than a large error in a small figure. And while tax has no de minimis materiality threshold, consequences for the taxpayer are likely to be more serious the bigger the figures. So however straightforward it may seem, if the numbers are large, check and double check.