Do settlement agreements bind HMRC?

In the course of giving oral evidence to the Public Accounts Committee (the "PAC") in relation to the well-publicised settlement agreement concluded with Google, two of HMRC's Commissioners said, essentially, that HMRC can ignore a settlement agreement if new information comes to light which indicates that the settlement was a bad deal for HMRC.

It is concerning that senior HMRC officials hold this view.  It is wrong in most cases, and represents a startlingly novel approach to the law of contract.

Of greater concern is that it appears to be a view held by a large number of HMRC Officers.  With alarming frequency they seek to resile from settlements, and to issue discovery assessments, on grounds that HMRC were unaware of "material" information at the time the settlement was concluded.  Usually, however, those grounds turn out to be unfounded (often because the information relied upon is not at all relevant to the taxpayer's liability for tax).

This article addresses the circumstances in which HMRC are actually entitled to resile from an agreement.  In particular, it considers (i) what the Commissioners actually said to the PAC; (ii) the circumstances, generally, in which a contract can be avoided as a matter of law; and (iii) the application of that general law to HMRC, and whether HMRC is afforded any special treatment.

What did the Commissioners say?

During their oral evidence to the PAC, Dame Lin Homer and Edward Troup (the "Commissioners") said as follows:

"…although it is a settlement, if we found that there was material information unknown to us, we would be able to go back and revisit."¹

"…if we received information in relation to a settlement on any of our taxpayers that gives us facts that we think are relevant to a settlement that we have already made, we can, if those facts are not facts on the basis of which we have settled, go back and reopen."²

[When asked "…you said something very important, which I want to absolutely understand… [y]ou have the legal ability to open up the deal you have done and revisit the assumptions that you have made in the light of those transactions if they turn out to be different."] "This would be if there were material evidence that had not been made available to us and should have been."

In summary, the Commissioners said, without qualification, that HMRC can reopen a settlement agreement in circumstances where material new information comes to light – that is, where they entered into the settlement agreement under a misapprehension as to the true facts.

Avoiding contracts, generally

In general terms, where a party enters into a contract under a misapprehension as to the true facts, that misapprehension may have been caused by the other party, or it may have been self-induced.  The former scenario engages the law of misrepresentation; the latter engages the legal doctrine of mistake.

Misrepresentation

Where a contract is formed following a misrepresentation, the contract will not be treated as a nullity (ie, as never having come into existence), but it may be possible to have it unwound or "rescinded".

In order to successfully rescind a contract on grounds of misrepresentation, a party ("A") must establish that:

• a (substantially) false representation was made to them before, or at the time, the contract was concluded;
• they relied upon that misrepresentation in entering into the contract;
• the other party ("B") can be held responsible for that misrepresentation;³ and
• there are no bars to rescinding the contract.⁴

Precisely what must be established differs depending on whether or not the representation was made fraudulently (ie, without an honest belief in the truth of the representation).⁵  Where "A" can establish fraud:

• it will suffice to identify a false representation of opinion, intention, or law (whereas, ordinarily, the false representation must be one of fact);
• they need not show (as they would in the case of a non-fraudulent misrepresentation) that either (i) the false representation was "material" (ie, that it would influence the judgment of a reasonable person in determining whether to enter into the transaction in question),⁶ or (ii) that "B" knew (or ought to have known) that they would rely on the representation notwithstanding its immateriality; and
• as regards reliance, it will be beyond doubt that all they need show is that the representation was "a" cause that influenced their decision to enter into the relevant transaction.⁷

The failure to disclose a particular matter – even a highly material matter, and even if it would be "morally wrong" not to mention it – will not generally amount to a misrepresentation (whether of fact, opinion, intention or law).  In other words, ordinarily, "A" must bargain for any particular disclosures it requires.  There are, however, exceptions to that general rule – viz:

• where "B" makes a statement which, construed strictly, is true, but which implies some other matter which requires further explanation if it is not to engender some false belief on the part of "A";⁸
• where "B" makes a representation which becomes false before it is relied upon by "A" in concluding the relevant contract (save where it is clear that the representation, when  given, was limited to a statement of the facts as they existed at the time the representation was given); and
• where the law recognises a duty of disclosure – relevantly (in the current context) where, in a settlement agreement, "A" has given "B" a release is respect of claims in general terms but is ignorant of a particular claim they have against "B" (and "B" knows this).

Mistake

In broad terms, there are two types of mistake which, if present, can render a contract a nullity: mistakes as to the terms of a contract, and mistakes as to the underlying facts.⁹  The former is not relevant for present purposes.

A unilateral mistake as to facts cannot render a contract a nullity (even if the other party if fully aware that the first party is mistaken).¹⁰ A mistake as to facts will only render a contract a nullity if the mistake is shared by both contracting parties.

A common mistake will render a contract void only if:

• the parties entered into the contract with (substantially) the same, positive belief in something which is not in fact true;
• the contract does not itself provide for one or other of the parties to bear the risk of the relevant mistake;
• neither party ought to have known the truth; and
• the non-existence of the state of affairs renders in impossible for the parties to perform the contract as originally envisaged.

Application of the ordinary law to HMRC

The position, generally

It is beyond doubt that HMRC's statutory responsibility for the collection and management of revenue,¹¹ confers on it a power to conclude "back duty agreements" with taxpayers (ie, agreements levying tax, or not, in respect of transactions which have already taken place).¹²

Special status is conferred by statute on such agreements where they settle a dispute in respect of a decision by HMRC against which the taxpayer has appealed and certain formalities are met – namely, they are treated as if they were a determination of the First-tier Tribunal (Tax).  (The relevant statutory provisions are (i) section 54 of the Taxes Management Act 1970 ("Section 54") in relation to direct taxes, and section 85 of the Value Added Tax Act 1994 ("Section 85") in relation to VAT.)

However, even in those cases, it is clear that the ordinary law of contract is applicable in determining whether the contract is valid.  Per Popplewell J in Bass Holdings:¹³

"I see no reason why the ordinary law of contract should not apply to this agreement [concluded with HMRC] as to any other agreement.  The effect of a concluded agreement under s54(2) is that it shall be final and conclusive but that does not mean that the Court is not entitled to look and see whether all the ingredients necessary to the formation of a proper contract have been complied with.  Thus capacity, fraud, mistake and such like matters seem to me to be available to a party who seeks to challenge the agreement on one or more grounds.  In the sense that the agreement is res judicata of the issue which it determines it is clearly final and conclusive.  But that does not mean, in my judgment, that the ordinary rules governing the formation of the contract are deemed to have been complied with."

Accordingly, in order to set aside a settlement agreement on the basis that HMRC has misapprehended the true facts, HMRC would have to be able to point to a misrepresentation or to a common and fundamental mistake.  It would not be enough for HMRC to have made a unilateral mistake as to the true factual state of affairs (even if the taxpayer knew of that mistake).

It is inherently unlikely that HMRC could set aside an agreement on grounds of common fundamental mistake since it is inherently unlikely that the taxpayer, in settling the tax treatment of a particular transaction with HMRC, would not know the true state of factual affairs fundamental to the settlement (or, if they genuinely did not know the truth, would nonetheless have a positive but false belief, substantially identical to HMRC's, as to what the fundamental factual state of affairs are).

That leaves only the possibility of HMRC setting aside the agreement on grounds of misrepresentation.  As set out above, that requires more than just HMRC becoming cognisant of some new fact it considers to be relevant or material; it requires the taxpayer to have been responsible for a substantially false representation.  The only exception to that would be if the settlement agreement were drafted in terms that HMRC released the taxpayer from all claims it might have in respect of a particular tax year (a general release), and the taxpayer knew that HMRC had a claim in respect of that year but did not alert them to the facts relevant to that claim.

In other words, the ability of HMRC to revisit a contract is much more restricted than the Commissioners suggested to the PAC, and is (in practice) limited to situations where there has been a misrepresentation. That is very much the position that was envisaged by Lord Keith in Scorer:¹⁴

"Subject to the question, which I mention later, as to whether the taxpayer has provided misleading information, I do not see why the circumstances that the inspector has made a mistake either of law or fact should [vitiate the contract]. Essentially, the question is not why [the inspector] agreed but whether he agreed. The purpose of [Section 54] must be to protect the taxpayer by producing finality, and Parliament, I would suppose, must have contemplated that the taxpayer would be protected, even though the inspector made some error in his view of the facts or the law. That is a likely, if not the most likely, event in which the question of going back on the agreement would ever arise at all."

Point of departure from the general position

There is, however, a point of difference not yet addressed.   HMRC, like other public bodies, cannot be held to a contract which is made in excess of its statutory powers.  That is, where

• it had no statutory power to enter into a contract of the type in question; or
• the contract, though of a permissible type, was entered into improperly – ie, inconsistently with the general principles of public law governing the exercise of public powers (for example, the requirement to have regard to all relevant matters and no irrelevant matters; not to exercise powers for a collateral purpose; and not to exercise powers irrationally).

A clear example of a contract which is ultra vires because it is not of a type that HMRC may conclude is a "forward tax agreement" – that is, an agreement which purports to levy tax, or not, in respect of transactions which have not yet, and may never, occur.¹⁵  That is a logical application of the principle that a public body cannot fetter its ability to exercise its statutory powers in the future.  But this has nothing to do with misapprehensions of fact.

More problematic is the question of whether a misapprehension as to a matter of fact can result in a contract being concluded improperly, hence rendered void.  Theoretically, at least, the misapprehension of some material fact could give rise to a contract being irrationally generous to the taxpayer (when considered in light of the true facts), or being entered into without the consideration of all relevant matters.

There are, however, at least two reasons why that theoretical position is unlikely to arise in practice (or, at least, is only likely to arise in a very narrow category of cases).

• First, there is dicta in a recent Court of Appeal decision that, where the issue is whether the contract was concluded improperly (as opposed to whether the contract is of an impermissible type), it will only be set aside where the other party had notice that the transaction was in excess or an abuse of the powers of the authority.¹⁶  On that basis, the taxpayer would have to have known that (i) HMRC had failed to appreciate a fact when concluding the relevant settlement agreement; and (ii) the relevant fact was so material that it rendered the contract irrationally generous or flawed.  In essence, therefore, HMRC could only avoid the agreement if the taxpayer had engaged in sharp practice and knowingly failed to disclose a truly material fact.
• Second, it is clear that whilst HMRC is required to settle with a view to reaching a genuine and realistic approximation of the amount due (indeed, that is what is required by HMRC's published litigation and settlement strategy):

• • it can do so on a basis which represents the most purposive application of the relevant law which the most pro-active judge might arrive at;¹⁷ and
  • it is only required to do so based on the facts known to it, and it is permitted to take a view as to the extent of information it can reasonably expect to obtain.¹⁸

Given that latitude, it would have to be a fairly extreme case in which a Court would set aside a settlement agreement as having been concluded improperly.

Discovery assessments

Another distinguishing feature between HMRC and private citizens is that HMRC has a statutory power to issue assessments after the usual enquiry window has closed if, among other things, it "discovers" that tax has be under-assessed and certain conditions are satisfied.  In some quarters (especially within HMRC) it seems there is held a belief that this power cannot be curtailed by a settlement agreement, and a discovery assessment may be issued even if doing so would plainly be contrary to the terms of an agreement (because the assessment purports to assess a liability which has been settled).

That belief is erroneous.  It was made clear by the Court of Appeal in Nuttall that even an "informal compromise" (which term they used to signify a settlement agreement which did not enjoy the special status conferred by Section 54) would prevent HMRC from taking steps to collect and recover the tax, interest and penalties settled by the agreement.¹⁹

However, one cannot take the point too far, since it is clear that the issue of a discovery assessment is not precluded in so far as the assessment is founded upon a point other than the particular matter which was the subject of the settlement agreement.²⁰  It is, therefore, important to consider carefully the precise scope of the release clause (that is, the clause by which HMRC releases its claim(s) against the taxpayer) to understand precisely what claims were contemplated (and released) by HMRC, and whether the claim made by the discovery assessment trespasses into those that were settled.

 

 

 

 

 

 

 

 

 

¹ Public Accounts Committee, Oral evidence, Corporate tax deals, HC 788, 11 February 2016: Dame Lin Homer's response to question 247.
² Edward Troupe's response to question 251.
³ This will usually only be where "B", or their agent, made the false representation.  However, it may also be the case (but is not beyond doubt) that "B" may be held responsible for a representation made by a third party to "A" if "B" had notice of the misrepresentation and knew it to be false.
⁴ Principally, that (i) "A" has in fact affirmed the contract (that is, where at a time they had sufficient knowledge of their right to elect to rescind, they have shown clearly by their words or conduct that they have elected to uphold the contract); (ii) "A" has delayed too long (see further footnote 7 below); or (iii) it is impossible to restore the parties to the status quo before the contract was made (because, for example, third parties have acquired rights in good faith and for value).
⁵ Further distinctions can be drawn between non-fraudulent misrepresentations that a negligent (that is, made carelessly or without reasonable grounds for believing its truth) and those that are wholly innocent.  However, that distinction is only relevant in circumstances where the remedy sought it damages as opposed to rescission (section 2 of the Misrepresentation Act 1967).
⁶ Though establishing materiality is still helpful, as it creates a rebuttable presumption that the party relied upon the representation.
⁷ Whether or not a misrepresentation was fraudulent is relevant to whether a Court would decline to set aside a contract due to the effluxion of time.  Ordinarily, the Court (in determining whether to set aside a contract for misrepresentation) will consider whether too much time has elapsed since the contract was concluded.  However, where the misrepresentation was fraudulent, the Court will instead consider whether too much time has elapsed since the injured party discovered (or could with reasonable diligence have discovered) that they had been defrauded (which will often be a later date).
⁸ For example, if "A" asks "B" whether they received a payment from X, and "B" responds by stating that they received a payment from Y, there is an implicit representation (made by "B") that they did not receive a payment from X.  If that is not correct (because they did receive a payment for X), there would be a misrepresentation.
⁹ It is also possible, generally, for a contract to be avoided on grounds that there has been a common mistake of law.  However, in the case of settlement agreements, both parties are treated as accepting the risk that their view of the law might subsequently turn out to have been mistaken, hence common mistakes of law are not relevant in the present context.
¹⁰ It is possible for unilateral mistakes of fact to vitiate other, non-contractual arrangements (such as gratuitous dispositions), but that is outside the scope of this article.
¹¹ Section 5 of the Commissioners for Revenue and Customs Act 2005.
¹² See, for example, IRC v Nuttall [1990] STC 194 at 203 and 205.
¹³ R v Inspector of Taxes ex parte Bass Holdings [1993] STC 122.
¹⁴ Scorer v Olin Energy [1985] STC 218 at 223-4.
¹⁵ See, for example, Al Fayed v A-G for Scotland [2004] STC 1703.
¹⁶ Charles Terence Estates Ltd v Cornwall Council [2012] EWCA Civ 1439.
¹⁷ R (oao Wilkinson) v IRC [2003] EWCA Civ 814 at [45].
¹⁸ See Nuttall, per Ralph Gibson LJ at 203.
¹⁹ See Nuttall, per Bingham LJ at 203.
²⁰ See, for example, Lord Keith in Scorer [1985] AC 645 at 656.