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KEY POINTS
- Will 50,000 annual checks improve recordkeeping?
- Incentive carrot equals penalty stick.
- No provision for suspended penalty in new proposals.
- Legislative anomaly will weaken the new measures.
- Readers should respond by 28 February 2011.
The consultation period on business records checks closes on 28 February 2011. HMRC’s proposals are based on the premise that two million UK businesses have poor business records which is leading to an under-assessment of tax. If that is correct, it obviously calls for a well-considered and targeted strategy from HMRC. So is that what is proposed?
The Business Records Check: Consultation Document emphasises: ‘Tax agents tell us that while they advise clients on what records to keep and how to keep them, many do not follow the advice given. This causes additional unnecessary work for those agents who have no way of enforcing the standards that they think necessary.’
While some agents may resent being used like a dummy to say what is convenient for the ventriloquist, it is not an unreasonable starting point. It recognises the tension between running any business and accepting a counsel of perfection from professional advisers.
So the logic is to harness the resources of the professional advisers to achieve the required improvement in business records and the resulting tax yield.
At first glance, HMRC’s proposal to make 50,000 business records checks annually seems to fit the strategy. Get the troops out in the field, make sure that they know what they are looking for, draw attention to identified weaknesses in record keeping, and give business owners a compelling incentive to obtain professional advice.
A strategic flaw?
The weakness in this strategy hinges on the ‘compelling incentive’ element. Within taxation, that translates as ‘penalty’. On page 13 of the consultation document, question 4 asks the following question:
‘In relation to direct taxes, what amount of penalty is needed at a minimum (within the £3,000 maximum) to encourage those with significantly poor records to bring their record keeping up to standard, and to deter a potential “for £X it is worth not having to bother” mentality?’
The question is difficult to answer in such terms and much depends on individual attitudes. But as generalisations go, one answer might be that the penalty should be sufficiently high to make the alternative cost of advice on record keeping look like a sound investment.
From HMRC’s perspective, setting penalties in that way should achieve either the intended improvement in records or the extraction of substantial penalties from those who still choose not to play by the rules. Such a win-win outcome for HMRC is, however, prevented by a legislative anomaly.
The legislative anomaly
Penalties for record-keeping failures are imposed under TMA 1970, s 12B(5). The section contains no provision for suspended penalties. So we have the following contrasting situation.
- Jack keeps poor business records and in consequence under-declares the income in his tax return. The HMRC officer concludes that the under-declaration amounts to carelessness, but after looking at Compliance Manual CH83250 decides to suspend the resulting FA 2007, Sch 24 penalty using the paragraph 14 provision. Jack knows that he can avoid the penalty only by getting things right. The officer (or the First-tier Tax Tribunal on appeal), knows that it is within Jack’s power to satisfy the suspension conditions and is therefore much more likely to impose a tough suspended penalty.
- Jill’s record keeping is much the same as Jack’s. Jill gets a business records check and the officer (quite properly) concludes that her records are unsatisfactory. The officer imposes a penalty. As the law stands, that penalty cannot be suspended.
So, paradoxically, we have the situation that Jack, who has submitted an inaccurate tax return which (but for HMRC’s enquiry into Jack’s return) would definitely have resulted in a loss of tax, has the opportunity to avoid any sanction, but Jill – who has not yet submitted her return – has none.
Surely this calls for a simple amendment to s 12B(5) to permit an officer to suspend a s 12B(5) penalty? FA 2007, Sch 24 para 14(3) provides a model that could readily be adapted.
An effective strategy?
Unless addressed, this legislative anomaly threatens the effectiveness of the business records checks strategy. Let’s suppose that Jill speaks to her advisers who assure her that they have always worked around her record weaknesses to make sure that her returns were correct.
If Jill appealed against her s 12B(5) penalty to the First-tier Tribunal and called her advisers as witnesses, they could confirm that the (admitted) failure in her business records would not have resulted in any loss of tax.
Given their inability to suspend the penalty, a reasonable tribunal might well conclude that it should either cancel the penalty or reduce it to a level that reflected the risk to the Exchequer.
Only if the penalty for a record-keeping failure can be set at a sufficiently high level to make its avoidance an economic necessity for a business is it likely to lead to the desired improvement in the records.
Only if the penalty can be suspended, is it likely to be pitched by the officer (or confirmed by a tribunal) at such a level to ensure that the taxpayer involves their advisers in achieving the required improvement.
There is otherwise a real risk that HMRC’s (minimum) penalty will indeed prompt the response identified in question 4 that ‘for £X it is worth not having to bother’.
The Institute of Financial Accountants is highlighting the anomaly in its response to the consultation document. Readers have until 28 February to do likewise.
Responses should be emailed to Fraser Fairlie, or posted to Christabel Cofie, HMRC, Room G5, West Wing, Somerset House, Strand, London WC2R 1LB.
Will Silsby is a director at Rabjohns LLP and can be contacted on 01905 732131 or via email.
