Tax fine!

KEY POINTS

• FA 2007, 2008 and 2009 have changed the penalty regime.
• Is a failure to make a return deliberate?
• There are now three different categories of errors.
• Penalties can be charged on timing errors.
• Close monitoring where penalties exceed £5,000 or more.

Someone complimented me on my driving recently. They put a note on my windscreen that read, ‘Parking fine’. I thought it was very kind of them to say so.

My joke is courtesy of the great Tommy Cooper, but unfortunately the laughs end there.

Avid readers of Finance Acts will know that one of the by-products of the merger of the Inland Revenue with Customs & Excise has been the complete recasting of the penalty regime across all taxes now administered by HMRC.

I fear the real impact of the revised penalty regime has not yet been widely appreciated. This article may, therefore, provide some shock therapy.

Readers will be very familiar with the range of penalties for all kinds of perceived tax misdemeanours, but the changes which commenced in 2007 have in fact changed things radically.

Gone are the days when good negotiation tactics could secure mitigation of a penalty down to levels acceptable to the client, and the degree of co-operation is now irrelevant. The new regime includes statutory minima which will apply no matter what.

Furthermore, most things are tabulated in terms of the degree of culpability, ranging from that which is simply careless, through that which is deliberate and then in the worst category that which is deliberate and concealed and therefore treated as tantamount to fraud.

There is provision to escape under reasonable excuse, but we all know that HMRC’s interpretation of ‘reasonable excuse’ is very different to that of the average taxpayer.

HMRC’s diminishing role

The practical significance of the penalty regime for the taxpayer is that he has to gain an understanding of one of the most complex tax regimes in the world and operate it correctly himself.

HMRC’s role is to ensure that the returns come in on time and to try and catch out the taxpayer if they can, dishing out the prescribed penalty. Yes, of course you can ask HMRC for guidance or assistance, but try it and see the result.

Assistance is often grudgingly given and sometimes they will look for any reason to avoid giving help. Rulings on various issues can be obtained; but if they can, one office will pass the buck to another which will equally deny that the topic is within their remit.

HMRC are not enthusiastic about offering clearances and rulings because they require time and effort, something about which the taxpayer has no choice.

In my view, if the burdens to be shouldered by the taxpayer are as great as they now are, HMRC should be much more proactive in providing help and assistance.

I am not overlooking the vast amount of information available on their website, but its usefulness to the taxpayer in person is very limited.

For example, many non-domiciliaries must have thought that the lunatics had taken over the asylum in 2008 when a tax rate of 300,000% was introduced on £10 of unremitted nominated income, and no amount of explanation on the website could ever provide a rational explanation.

The new legislation

The provisions relating to penalties are spread over three Finance Acts, with some amendments having been made subsequently, and then there are various statutory instruments which have brought the provisions in on a piecemeal basis.

They are still not fully operational for inheritance tax. So even the introduction of the regime has been carried out in a most confusing manner and trying to establish which provision became operative from which date requires considerable research.

Mostly, however, the new rules for errors commenced in April 2009, with some aspects commencing in April 2010, and new rules for offshore matters commencing in April 2011.

The initial tranche of legislation was in FA 2007, Sch 24 and this contained provisions relating to errors in ‘documents’ which includes tax returns and various other statements and declarations. Errors covered might be inadvertent mistakes, ranging in degrees through to deliberate mis-statements.

FA 2008 contained more penalty provisions, these covering failures in connection with HMRC’s information and inspection powers (Sch 36) and failure to notify liability to tax (Sch 41). We have, of course, been familiar with fixed penalties for failure to notify liability, but the new schedule introduces a tax-geared penalty which can produce very unpleasant sums.

These changes brought an end to the £100 penalty for failure notify self-employment within three months of commencement – a sort of tax on ignorance.

Lastly, FA 2009, Sch 55 introduces new penalties for failure to make returns, which is a familiar topic, but Sch 55 carries many new unpleasant implications.

Maria Kitt’s article Bad company looks in detail at some of the implicatiosn for companies. The purpose of my article is not so much to trawl through all the provisions line by line, but rather to sound a note of warning that the world has changed.

Penalties are not only going to be higher and less open to negotiation, but the circumstances giving rise to the issue of a penalty notice will in future be much more common.

Examples given in HMRC’s Compliance Handbook show penalties for common mistakes. When one takes into account that most penalty notices result in a serious deterioration in the relationship with the client, sometimes coupled with an allegation that the failure is really that of the adviser, I am hoping that readers will soon see that we are now into a whole new ball game.

Failure to make returns

There are many similarities in the rules under this heading which applied up to April 2010 and those which apply under the FA 2009 provisions, but the new rules have much wider application. For self-assessment returns, the initial £100 penalty still remains, but after that things will soon start hotting up.

I can remember a case where a return was deliberately delayed far beyond the due date for a particular purpose, but now after three months, there can be a daily penalty.

The big distinction with the previous daily penalty provisions is that HMRC can simply impose this themselves and they no longer have to apply to the tax tribunal, or the Commissioners as they used to be, for it to be imposed.

After six months, a tax-geared penalty of up to 5% of the tax due under the return becomes payable and at least another 5% once 12 months have elapsed from the due date of the return. I say ‘at least’, because it is 5% for starters.

If there is deliberate failure not to make a return the penalty can range between 70% of the tax due on the return to 200%. The worst penalty is reserved for offshore matters and the introduction date for these is 2011/12 onwards.

The initial £100 penalty is no longer capped at the amount of liability as at the filing date and although the tax-geared penalties can be mitigated, there are statutory limitations on the amount of mitigation which can be applied.

Where a disclosure is prompted by HMRC, the mitigation is a maximum of 50% of the penalty and, in broad terms, it is around 70% of the penalty for unprompted disclosure.

The worst penalties are for cases of deliberate failure. It would be very easy for HMRC to take the view that every failure to make a return is deliberate, because the taxpayer must have known about his obligations to file returns.

As an example, these days it is not unusual for Jersey trustees to be issued with self-assessment returns and they may assume that these need not be dealt with, thinking incorrectly that they have no UK tax liability.

However, even offshore discretionary trustees are liable to UK tax at the trust rates on any UK sources of income, including UK investment income and so one may see penalty notices being issued to them on the footing that they have deliberately failed to make returns.

Onshore, it may be that someone decides not to make a return because any tax due is covered by inclusion on someone else’s return. Unfortunately, Sch 55 specifically states that this cannot be recognised by a reduction in the penalty, and of course it may be said that this failure was deliberate.

So, for example, suppose that a husband and wife jointly own a let property and the one with the lower income declares all the rents on a personal tax return and so the other makes no return, all income being taxed at source.

If HMRC take the view that there is no warrant for only one of them declaring all the rents, the other is liable to a penalty for deliberately not making a return, and this can be applied back over past years to produce a terrifying bill.

What is more, HMRC could claim that the penalty for prompted disclosure cannot be less than 35%, and the fact that the rents are all on the return of the other party cannot be taken into account.

Errors in returns

Whatever horrors may await us in due course in relation to the foregoing penalties, to my mind they will pale into insignificance in comparison with the penalties which are now to be applied for errors.

These mostly had a start date of April 2009, although there were some changes effective from April 2010.

Where tax is underpaid as a result of a careless or deliberate mistake, the penalty provisions will follow, once again with statutory rates applying and minimum levels prescribed along with them.

Gone are the days, therefore, of negotiating the penalty down to something insignificant, unless the error is notified to HMRC by the taxpayer in which case there may be no penalty, but only in the category of careless mistakes.

Once again, there are different categories of errors in relation to offshore matters and onshore. The basic levels of penalty are:

• careless mistakes or omissions;
• deliberate but not concealed mistakes or omissions; and
• deliberate and concealed mistakes or omissions.

A moment’s thought will soon reveal the implications of applying this rigid regime to all the practical aspects of trading accounts and tax returns.

Virtually every tax enquiry will result in HMRC finding something amiss (in their view) because, in the real world, we would never finish anything if we devoted our time to getting every little tiny detail absolutely correct.

Most trading accounts contain certain figures which have to be subject to adjustments, and it can be difficult or unduly time consuming to come up with precise figures.

Many examples immediately spring to mind and private use of car used for the purposes of self-employment is a prime example.

Some people keep detailed mileage records, but in my experience these are in the minority and most people cannot cope with such intricate record keeping.

Nowadays, all trades and professions should carry work in progress figures in their annual accounts. Are these just inspired guesswork or is there some detailed basis for the figures used?

If the former, HMRC can soon allege that the figure used was carelessly wrong and a penalty will soon follow.

If you have clients with furnished holiday lets, have you asked whether they use the property themselves, and if so for how long so that expenditure can be apportioned between private use and commercial use?

If you have not asked, HMRC will if they open an enquiry and if there is no private-use adjustment this will at best be a careless error and at worst a deliberate one.

Gains and trusts

The context of capital gains can also give rise to a variety of situations where HMRC commonly pick up errors. A typical example is the valuation of a jointly held second home as at March 1982 to establish the base cost on disposal.

The one half shares are not valued at one half of full market value but each must be discounted, normally by 10% but sometimes by a greater figure.

Taxpayers see this as an artificial exercise designed simply to inflate the tax liability, but HMRC may see it as a correction of a careless error in the return which will be met with a 15% penalty.

Another fruitful area for HMRC as regards capital gains are foreign currency accounts. At present, withdrawals from foreign currency accounts give rise to a capital gains tax position and the relevant calculations can be never ending.

However, not all accounts are within the capital gains tax regime, but HMRC may not agree with your analysis of which are and which are not.

Even if they do agree, will your capital gains tax calculations for those within the scope of charge stand up to scrutiny. Sometimes it is tempting to cut a few corners in the interests of not spending the rest of one’s life on the project! Thankfully this whole area is set to go away, but it has not yet.

With rental accounts, are you sure that you understand the distinction between repairs allowable for income tax purposes and improvements deductible only for capital gains tax purposes? What if the expenditure is partly repair and partly improvement? Expect HMRC to say that any error is a careless error, because you have not studied and digested their published statements on the point.

Is there an offshore family trust from which your client has received a benefit? If so, are you certain of the tax treatment of the benefit? If you are, maybe you should not be because some of the rules are vague and usually there is no certainty about the tax treatment.

HMRC will tell you that the transfer of assets abroad provisions (ITA 2007, s 720 and s 732) apply in every case, unless you satisfy them that they are excluded by the motive test and in practice you will never satisfy them if you cannot tell them every detail of history about the case concerned.

Accordingly, any return prepared on the assumption that this legislation does not apply may well be regarded as carelessly, or even deliberately, incorrect.

There is a box to tick on the self-assessment foreign pages to indicate that the motive test is considered to apply, but in penalty terms that simply means that the careless or deliberate mistake is not concealed; if it were concealed the penalty would be in an even higher bracket.

Timing errors

Timing mistakes are easily made in trading accounts; for example, where a deduction for an expense is claimed in the wrong year.

A separate rule in the new penalty provisions deals with this situation. The penalty, say 30% for prompted disclosure of careless mistake, is applied to the total of the overall tax lost as a result of the timing error (that is, the first year of underpayment, less the later years of consequent overpayment) plus 5% of the ‘delayed tax’ for each year of the delay; see Tommy’s Mistake.

The delayed tax is the amount of over declaration in subsequent years. So to summarise, it is no defence to say that all the tax has been paid, and there is just a timing error.

The new rules will collect a penalty on the net overall underpayment to date plus 5% of the over payments in the years to date. A penalty on overpaid tax is completely novel.

More bad news

If there is a deliberate inaccuracy in a company’s tax return, HMRC can specify that any company officer responsible for it is liable to pay all or part of the penalty. Officers include directors, shadow directors, managers or the company secretary.

It has been announced that HMRC intend to closely monitor for a five-year period anyone who incurs a penalty of £5,000 or more for deliberate understatement of tax. We can be sure that the five-year period will not be enjoyable one.

It is not only the taxpayer who might declare a tax liability at a figure which is too low, but HMRC make under-assessments as well.

In this case, however, there is no penalty on HMRC for its undercharge, but instead the penalty is on the taxpayer for not telling HMRC. They must be notified within 30 days of the date of the assessment so there is not much time to avoid the penalty.

When this penalty was introduced, it was stated that it would be applied only where HMRC make an assessment in the absence of a return. It will be interesting to see how long that holds good, or whether in due course, HMRC will expand the scope of this penalty, with or without notice.

Summary

Overall, the new penalty provisions may herald a new more aggressive era. This article has not by any means been a complete summary of all the provisions but what I have really wanted to do is show just how far they have the potential to reach into the ordinary everyday life of the practitioner and client.

Malcolm Gunn CTA (Fellow) TEP is a consultant with Squire, Sanders & Dempsey. He can be contacted by email

Issue: 4333 / Categories: Comment & Analysis , Admin