Keystone Law advises on landmark ruling on HMRC abuse of process and fair pleading

Keystone Law’s Tax partner Martin O’Neill has represented Mr Ashley Trees before the Upper Tribunal (Tax and Chancery Chamber) in an important judgment which has set aside a Director’s Liability Notice (“DLN”) issued by HMRC to Mr Trees. This marks a significant victory for taxpayer rights and the integrity of UK tax litigation.

Under a DLN, HMRC can hold directors or senior officers personally liable for tax penalties levied on their company. DLNs are most commonly used in cases where HMRC alleges that the company’s tax defaults are attributable to the dishonesty of a director or a senior officer. They can also be used in cases involving ‘Kittel’ knowledge of a fraud connected to a supply of goods or services. The DLN effectively makes a director liable for the tax liabilities of a limited company after its liquidation, and bypasses the idea of limited liability. The recipient of a DLN risks losing all their savings and assets, including the family home, if not paid or overturned in legal proceedings.

Background to the litigation

Martin has represented Mr Trees in this case during the last 20 years. The case stems from HMRC’s decision to deny CCA Distribution Ltd (in liquidation) (“CCA”), of which Mr Trees was sole director and shareholder, the right to recover nearly £10 million in input VAT relating to trading of mobile phones in the mid-noughties. Following a long series of appeals, the First-tier Tribunal initially concluded, in 2010, that CCA did not and could not have known of a connection to an antecedent fraud. This decision was later overturned following extensive appeals in 2020 with a conclusion that CCA’s transactions were connected with VAT fraud, and that Mr Trees knew or should have known of that connection. Crucially, throughout all these proceedings, HMRC expressly confirmed in writing that it was not alleging dishonesty against either CCA or Mr Trees and did not plead dishonesty as part of its case.

Despite this, in 2021 HMRC served a DLN on Mr Trees, seeking to recover almost £2 million from him personally on the basis of his alleged dishonesty.

The Upper Tribunal’s decision: abuse of process and the requirement to plead dishonesty

In a comprehensive judgment, the Upper Tribunal (Mr Justice Rajah and Judge Guy Brannan) found that HMRC’s conduct was an abuse of process. The Tribunal accepted that:

• HMRC not only could but should have raised any allegation of dishonesty in the original Kittel proceedings if they intended to rely on such findings for the subsequent imposition of a DLN. The Tribunal held that it was inherently unfair for HMRC to proceed on the express basis that dishonesty was not in issue, only to rely on the same evidence and findings to support a later allegation of dishonesty.
• Where allegations of dishonesty or fraud are made, they must be clearly pleaded, with full particulars, and the individual must be given the procedural protections and opportunity to respond that such serious allegations require. The Tribunal reaffirmed that the principles of natural justice and Article 6 of the European Convention on Human Rights (ECHR) require fair notice of the case to answer.
• The “fine line” between knowledge (as required under the Kittel test) and dishonesty for the purpose of section 61 penalties was so slight that, in practice, the findings on knowledge were being used as a proxy for dishonesty without proper procedural safeguards.

The Tribunal also distinguished the case from previous authorities (such as HMRC v Kishore), emphasising that while HMRC has a statutory period post-Kittel to issue penalty assessments, this does not relieve HMRC of the obligation to plead dishonesty initially if it intends to rely on such allegations in the future.

Outcome and significance

The Upper Tribunal allowed Mr Trees’ appeal on the basis of HMRC’s abuse, set aside the earlier Tribunal decision, and quashed the DLN. The Upper Tribunal’s decision makes clear that HMRC – and by extension, all public authorities  must adhere to the highest standards of fairness, transparency, and proper pleading in civil penalty proceedings where dishonesty is alleged.

Martin O’Neill said:

“I have been proud to represent Mr Trees throughout this long and hard-fought litigation. This judgment is an important vindication not only for Mr Trees, but for anyone facing serious allegations from HMRC or other authorities.

“It is nearly ten years since the Court of Appeal clarified that an allegation that a person knew, or should have known, of a connection to fraud is only an allegation of dishonesty if it is specifically pleaded as such in advance by HMRC. Kittel knowledge is not, by itself, dishonest knowledge. It was especially alarming that HMRC sought to dispute this finding by alleging dishonest knowledge against Mr Trees, without pleading it or serving sufficient evidence, and their attempt to introduce the allegation of dishonesty after proceedings had essentially finished was clearly an abuse of process. 

“The Upper Tribunal has made it clear that HMRC cannot shift the goalposts by raising dishonesty after the fact. This is a real boost for procedural fairness and the rule of law in tax litigation.”