Penalties: Legislation vs HMRC policy

You will probably be aware that penalties for an inaccurate return vary depending on the “behaviour” that led to the tax loss. The “behaviour” is split into three different categories – reasonable care, carelessness, deliberate but not concealed and deliberate and concealed – with all penalties applied to all except those who took reasonable care. This article is similarly relevant to penalties for Failure to Notify, though penalty percentages may differ.
The penalties for careless behaviour range from 0% to 30% of the tax lost, for deliberate behaviour, the penalties are between 20% and 70% of the tax due and for deliberate and concealed, the penalties range from 30% to 100% of the tax due. These are specific to tax arising from UK assets. Penalties in relation to tax due from overseas assets is up to 200% of the tax due (plus other penalties, which I discussed in a previous article).

Those who regularly deal with tax investigations will know that the standard penalty per the legislation is always the higher threshold of the various bands (100%, 70% and 30%) with reductions to be given for making a disclosure (para 9, Sch 24, FA 2007)

According to Sch 24, FA 2007, a disclosure relating to a domestic matter is made when

A person discloses an inaccuracy... by—

(a) telling HMRC about it,

(b) giving HMRC reasonable help in quantifying the inaccuracy[, the inaccuracy attributable to the..., and

(c) allowing HMRC access to records for the purpose of ensuring that the inaccuracy … is fully corrected.

If someone makes a disclosure, HMRC must then reduce the penalties to reflect the quality of the disclosure, providing that the reduction does not go below the minimum stipulated by legislation.

The legislation provides in paragraph 9(3) that “In relation to disclosure “quality” includes timing, nature and extent.”

This is where the legislation hands over to advisers and HMRC to negotiate a penalty percentage in view of the disclosure made. Until September 2016, HMRC used the following structure for calculating the reduction in penalties:

  • 30% deduction for “telling” HMRC about the issue (i.e. making a disclosure);
  • 40% deduction for “helping (aka cooperation);
  • 30% deduction for “giving” information and documents to quantify the tax loss.

So if a person told HMRC about most issues early on and took some time to advise on the remaining issues, but otherwise were fully cooperative and gave all information in their possession relevant to calculating the liability, they may obtain a 95% reduction (25%,40%,30%).

For deliberate behaviour and an unprompted disclosure, the penalty would therefore be 70% - 95% x (70% - 20%) = 70% - 47.5% = 22.5% penalty.

The 30/40/30 structure for reduction in penalties for ‘telling, helping, and giving access’ was HMRC policy. It was not in legislation but the emphasis on cooperation (providing a higher penalty reduction for “helping”) means that taxpayers who were made aware of this early on were likely to do their best to assist.

From September 2016, HMRC’s policy in relation to the penalty calculation changed to also take into account the time lapse between the inaccuracy occurring and the disclosure being made. Essentially, if the disclosure is made more than three years after the inaccuracy, the penalty reductions are restricted by 10%.

Using the example above, the individual may obtain a 95% reduction for telling, helping and giving,   but if the disclosure is made more than three years after the inaccuracy occurred, then the maximum reduction (50%) would be reduced by 10% to 40% and the adjusted penalty would be 70% - 95% x (70%-20%-10%) = 32%.

HMRC’s basis to the change in policy is that the legislation refers to timing as part of the quality of the disclosure. The problem for advisers is that without a specific and clear legislative basis for this policy, it becomes very difficult to argue against it. Three years is arbitrary and arguably a very short time. Individuals who were simply careless are unlikely to go back over previous tax returns to pick up any errors “just in case” and those who deliberately under-declared their income...well, that’s what the extended (20 year) time limits are for, surely.

If parliament had wished to further punish taxpayers for errors, they could have legislated for it as they have with increased penalties in relation to prompted disclosures. In effect, the legislation pushes the onus on to HMRC – if HMRC wishes to levy higher penalties, they must open relevant investigations. HMRC’s new policy however pushes the onus back on the taxpayer – if you don’t want higher penalties, then come forward early.

Parliament has increased the time limits for HMRC to go after those with undeclared income/gains from overseas assets and has also increased the associated penalties. It seems that the reason they gave HMRC discretion over the reduction amounts was so that HMRC and the taxpayer (or the adviser) could discuss appropriate penalties and apply them taking a view of all circumstances in the case. Further, if a taxpayer felt that the penalties still did not reflect the quality of the disclosure, they could – and still can - request an independent review (prior to then going to Tribunal).

HMRC senior management do not wish to enter into negotiation on the restriction in penalty reduction at all. Any independent review therefore considers that the restricted reduction applies if more than three years have elapsed and there is no leeway on this. It is therefore worth making clients aware of what is effectively a new penalty regime, “just in case”.

Crucially, there are a few areas available where an adviser can argue the point:

  • Firstly, you may wish to advise the case worker of any circumstances that mean the three year policy should not apply – extended serious illness for example
  • The manuals also state that where there is a one-off error that the person would never have had reason to reconsider then the restriction may not be appropriate. Arguably, errors that a “person would never have had reason to reconsider” could apply to careless errors as well. After all, why would a person revisit something they had done carelessly?
  • Each error should be considered separately.

For example, a person failed to declare annual income from 2010 onwards and sold a residential property in 2019, the only gain arising in the individual’s taxation history. They then made a disclosure of everything in 2021. In this case, the restriction in reduction should not apply to penalties in relation to the sale of the property.

If the sale was made in 2012, it is arguable that this was a one off and again, the restriction in reduction should not apply.

Finally, it is worth noting that the restriction in reduction does not increase the minimum penalty by 10%, it changes the calculation of the reduction in penalties. It’s a small point but one that could cost taxpayers a lot if the case worker gets it wrong.

The last port of call, should the taxpayer feel that the penalty legislation has been applied incorrectly, is of course Tribunal. In this case, it is useful to ask for a formal independent review from HMRC, as this will give a good understanding of the basis on which the penalties are being applied and is a good start to building the case.

Mala Kapacee is a Chartered Tax Adviser and Director of London Tax Network Ltd, a Tax Investigations Specialist consultancy. Her experience includes resolving tax enquiries, CoP8 and 9 Investigations as well as disclosures for a range of taxes and situations; self-employment, property, owner managed businesses and non-UK domiciled individuals. Mala lectures regularly for professional bodies including the CIOT and the CIMA. She founded the London Tax Society in 2017 and actively encourages networking and technical development for Young Professionals. She was a finalist for Best Rising Star in Tolley’s Taxation Awards 2020. Email or call 07783 236 845.

Mala Kapacee

Written by Mala Kapacee

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