Managing penalties starts before a response to HMRC

With things starting to return to normal, and the end of the 2019/20 enquiry window, we are beginning to see an increase in the number of people receiving enquiry letters form HMRC. Most notably in respect of Code of Practice 9 (hardly surprising given our expertise), but also general enquiries under s9A of the Taxes Management Act 1970.

Under TMA, HMRC have twelve months from the date a tax return was submitted to open an enquiry (if the return was submitted before 31 January). If the return was filed late (and the current extension to 28 February would still be considered late), HMRC have twelve months form the end of the quarter in which the return was submitted. If an error is found, and HMRC have sufficient belief that it is not the first occurrence of an error, they can look into older returns.

Where an enquiry results in the discovery of additional tax liabilities, the taxpayer will have to pay, not only to those liabilities, but also late payment interest, and in many cases penalties.

There are four legislative provisions under which HMRC can charge a penalty:

• Failure to notify HMRC of a charge to tax (i.e. not registering to self-assessment)
• Late submission of a tax return
• Late payment of tax
• Error(s) in a tax return which has resulted in a loss to the Revenue.

The penalties for errors and failing to notify are based on the potential lost revenue (“PLR”), whereas those for lateness are based on any liability which was, or would have been, shown in the return (although these are set to change with effect from January 2023).

Penalties for failing to notify or errors in a return fall to be charged at a percentage with reference to the behaviour of the taxpayer which lead to the error/failure:

• Carelessness
• Deliberate but not concealed
• Deliberate and concealed

Identifying whether a behaviour falls within one of the above categories depends on the circumctances affecting the person or act giving rise to the irregularity. Often, early communications between HMRC and the taxpayer will attempt to identify the behaviour. What may appear simply cooperating with HMRC could inadvertently result in a higher penalty because a wrong statement was made. Preparing to mitigate penalties begins as soon as an enquiry is opened and before a response is made.

Where the behaviour is careless, it is possible to have the penalty suspended it the taxpayer agrees to certain conditions which assure HMRC that they will continue to meet their tax obligations in the future. Where the failure/error has continued for a period in excess of six years, HMRC will likely argue that the behaviour is deliberate. Not only does this open a taxpayer up to harsher penalties, but also extend the enquiry window to twenty years.

The maximum penalties for the above behaviours are 30%/70%/100% of the PLR respectively (where the income/gain is UK-based). Reductions are available where a taxpayer makes an unprompted or prompted disclosure and the value of the reduction is made with reference to the quality of the disclosure and the extent to which the taxpayer tells HMRC about the error/failure, helps HMRC calculate the PLR, and gives access to information which is reasonably requested by HMRC.

The minimum penalty for an error under the above behaviour categories is 0%/20%/30% respectively if the disclosure is unprompted, or 15%/35%/50% for a prompted disclosure.

The minimum penalty for failing to notify under the above categories is 0%/20%/30% if the disclosure is unprompted, or 10%/35%/50% for a prompted disclosure. Where the failure to notify has extended beyond twelve months the minimum penalty for careless behaviour is increased by 10%.

A disclosure is unprompted “if it is made at a time when the person making it has no reason to believe that we have discovered or are about to discover the inaccuracy or under-assessment”. Otherwise, it is a prompted disclosure.

It should be noted that a penalty will only be charged where the taxpayer does not have a reasonable excuse for the error/failure. There is no statutory definition of ‘reasonable excuse’ but HMRC guidance states that it “is something that stopped you meeting a tax obligation that you took reasonable care to meet”. It may include according to HMRC:

• Critical illness or yourself or an unexpected stay in hospital
• Death of a close relative
• Software failure in the course of preparing your return
• HMRC service issues
• Postal delays
• Fire, flood, or theft

Ignorance of the law is not a reasonable excuse. The above is not an exhaustive list and HMRC will be required to look at each case on its individual merits with particular consideration of whether the person’s tax affairs have been brought up to date as soon as practicable after the reasonable excuse has ended. The breadth of what might be a reasonable excuse is much wider than that set out by HMRC!

It is important when discerning the applicable penalty rate that HMRC stand in the shoes of a taxpayer taking into consideration their circumstances and abilities and determining whether the manner in which they acted in light of those circumstances and abilities was reasonable. Herein lies a problem: Will a HMRC officer stand in the shoes of a taxpayer? We often find that any person judging another person does so with predetermined beliefs and values. A professional adviser’s task is therefore to sit in the shoes of a client and articulate the position to HMRC.

We have extensive experience handling HMRC enquiries, and given the favourable penalty position for making an unprompted disclosure, we would encourage anyone who is unsure about their tax obligations, or doesn’t know where to start in making an approach to HMRC, to please contact us for an initial consultation.

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