The legislative framework for tax geared penalties was intended to provide fixed parameters so that penalties became more standard for all taxpayers i.e. treating taxpayers equally. However, whether a penalty is on equal footing for taxpayers is still at the mercy of discussions between an agent and an HMRC officer (assuming a taxpayer doesn’t undertake their own negotiations).
Clients often believe an HMRC officer has targets that include maximising revenue and charging higher penalties. According to the official voice, that is not the case. So, what motivates an officer to disregard what might appear sensible and reasonable representations and refuse to mitigate a penalty? In this article I consider the mitigation of tax geared penalties and unusual circumstances faced in practice.
Broadly, tax geared penalties can arise for:
- Errors (Finance Act 2007 Sch.24)
- Failure to notify (Finance Act 2008 Sch. 41)
- Failure to make returns (Finance Act 2009 Sch. 55)
- Failure to make payment on time (Finance Act 2009 Sch. 56)
The tax geared penalties for errors and failing to notify are based on the potential lost revenue, whereas those for failure to make returns and make payment on time are on any liability to tax which would have been shown in the return.
Potential Lost Revenue (PLR)
The first area for a disagreement may therefore be what constitutes the potential lost revenue. The normal rule for PLR relating to errors is:
“The potential lost revenue” in respect of an inaccuracy in a document (including an inaccuracy attributable to a supply of false information or withholding of information) or a failure to notify an under-assessment is the additional amount due or payable in respect of tax as a result of correcting the inaccuracy or assessment.
The treatment of an error therefore needs to be ‘agreed’ if the PLR is to be determined. For example, the tax due on a payment to a shareholder/director needs to be agreed as either subject to PAYE or treated as a director’s loan. Both treatments also have an impact for corporation tax and this needs to be considered when arriving at the PLR.
The calculation of PLR is more problematic where there are multiple errors. PLR with respect to each inaccuracy may depend on the order in which they are corrected. The legislation deems the order the inaccuracies are corrected being careless inaccuracies, then deliberate but not concealed inaccuracies and then deliberate and concealed. Overstatements are offset against understatements following the same order.
A penalty can still arise when an inaccuracy results in a loss being wrongly recorded and not wholly used. The PLR is calculated under the normal rule related to the used loss, plus 10% of any unused loss.
The penalty regime applies to the difference between the amount recorded and the true amount. Where an inaccuracy has the effect of creating or increasing an aggregate loss recorded for a group of companies’ group, relief may be taken into account.
In circumstances where there is no prospect of the loss being used to reduce a tax liability, the PLR with respect to a loss is nil.
The PLR where an inaccuracy resulting in tax being declared later than it should have been is 5% of the delayed tax for each year of the delay, or proportionate amount thereon.
The definition of PLR for failures to notify is different than that for errors:
- The PLR for income tax and capital gains tax purposes is that which the individual is liable to and which is unpaid on 31 January following the tax year.
- The PLR for corporation tax purposes is that which the company is liable to in respect of the accounting period and which remains unpaid 12 months after the end of the accounting period.
- The position is similar for VAT.
Prompted or Unprompted Disclosure
HMRC guidance broadly follows the statutory definition of an unprompted disclosure [FA 2007, Sch. 24, para. 9(2)/FA 2008, Sch. 41 para. 12(3)/ FA 2009, Sch. 55 para. 14(3)] and reads:
“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.”
The legislative test is to consider whether the taxpayer has no reason to believe that HMRC have discovered an inaccuracy. It is an objective test – it is not based on or influenced by personal feelings or opinions. The legislation requires consideration where a person has ‘no reason to believe’ rather than their ‘believing’. For example, a person may have received a self-assessment reminder from HMRC, which made them feel that they were being targeted and HMRC knew of their undisclosed income. That belief is irrelevant. The fact a reminder was sent would not give a reason to believe the undisclosed income would be identified by HMRC.
Guidance states that HMRC wants to encourage unprompted disclosures and includes the following advice to HMRC officers:
- A disclosure can be unprompted even if at the time it is made the full extent of the disclosure is not known, as long as the full details are provided within a reasonable time.
- There can be no halfway house between an unprompted and prompted disclosure. It is either one or the other.
- All the facts need to be considered before deciding if a disclosure is unprompted or prompted. A common sense approach is needed. Hasty judgements should be avoided.
- An HMRC campaign highlighting an area of the trading community on which HMRC will be concentrating would not stop a disclosure from being unprompted.
- A disclosure would be prompted if made after specific contact from HMRC to advise of a compliance check or a visit to premises.
- It will be exceptional for a disclosure to be unprompted if a compliance check is in progress. The disclosure will be unprompted only if it is about something the compliance officer has not discovered or is not about to discover.
It is therefore accepted that a disclosure may be unprompted even if a compliance check is in progress. In correspondence with one officer they confirmed that:
“On the balance of probability, I believe Mrs [] did not fulfil the above. Therefore I maintain my consideration that she did not make an unprompted disclosure.
I have carefully considered your hypothesis. I disagree with your conclusion that the test is not what the person believes but what the facts gave them reason to believe…….
…..HMRC’s argument is that the enquiry into her husband requests for records did give reason to believe, as of the date of disclosure, that discovery would come about in the course of the investigation.”
The facts were simply that an enquiry had been opened into the husband’s tax return and no information had at that time been provided to HMRC. The husband had undeclared income although it appeared that the husband and wife were acting in partnership, one being responsible for administration of the business and the other for undertaking services to clients. The husband had received cash payments, which he had not disclosed to HMRC. Did the wife have reason to believe that HMRC were about to discover that she had an inaccuracy?
The facts for the wife were that HMRC did not have information nor were in possession of information for the husband’s tax affairs. Would HMRC, during their enquiries, have identified that the spouse had undeclared income? The officer had assumed that husband and wife communicate openly although as many married couples will know, communication between them is a belief and not a fact. It is acknowledged that the situation is a difficult one although given HMRC want to encourage unprompted disclosure, it would appear counterproductive to penalise in these circumstances.
The officer however seemed intent to treat the wife’s disclosure as unprompted indicating inconsistency of treatment between taxpayers. Assume the situation of friends, one of which has received an enquiry letter and one that has not. Both have undisclosed rental income from flats within the same block. Following a conversation in the pub, the friend without an enquiry approached HMRC to disclose irregularities. This is an unprompted disclosure, is it not? Would the position be different if the two friends owned one rental flat between them and divided the income?
HMRC guidance clearly states that ‘a disclosure can be unprompted even if at the time it is made the full extent of the disclosure is not known, as long as the full details are provided within a reasonable time’. The disclosure is of the facts and not necessarily quantifying the tax liabilities. Often during an enquiry, an officer and adviser will debate whether an irregularity is taxed one way or another. It is therefore surprising that in one case, the difference of technical standing was utilised to contend the disclosure was prompted:
“We do not agree with the abatement set out for the years 2006/07, 2007/08 and 2008/09. We consider that….and……made a spontaneous and complete disclosure to the best of their knowledge and belief. The revision from partnership to company was provided by us based on facts that our clients told us. Those facts were shared with you and related to whether the items disclosed were taxable as a partnership or as a company. There was evidence identifying either treatment as set out to you in correspondence. We advised our client not to pursue the position for the desire of settling the position with HMRC as opposed to considering HMRC’s position was necessarily correct. We do not consider the disclosure was in anyway inaccurate but instead due to the way the business operated, it was not clear whether the company or a partnership traded. The correct mitigation category with which to deal with the operational side of the business is “seriousness”. We kindly suggest that the disclosure was factually accurate and therefore it was spontaneous and complete attracting the full mitigation. “
Again, we are reminded that whilst HMRC pertain to encourage unprompted disclosures, officers may act contrary:
“We have taken time to consider the comments in your letter of 2 October 2018. HMRC’s views on the appropriate penalties have been made clear. We are not persuaded to deviate from those views which were arrived at after careful consideration of the facts and the penalty loadings have been authorised at the appropriate level.”
Tax Geared Penalties and Behaviours
For tax geared penalties arising under FA 2007, Sch. 24, the three ‘behaviours’ to which standard levels of penalty are set are:
- careless action
- deliberate but not concealed action
- deliberate and concealed action
For tax geared penalties arising under FA 2008, Sch. 41, the three ‘behaviours’ to which standard levels of penalty are set are:
- non-deliberate failures
- deliberate but not concealed failure
- deliberate and concealed failure
Assuming the PLR can be agreed, the behaviour of the taxpayer needs to be considered. This is where it is more likely that an officer’s view will differ. Maybe one officer will hold a belief that any taxpayer who has made an error has done so deliberately whereas another may empathise with the personal circumstances of the taxpayer.
The personal circumstances of the taxpayer are important when considering behaviour because when determining the type of behaviour, it is necessary to sit in the shoes of the taxpayer. A simple illustration is that of a practicing accountant who continually under declares income or overstates expenses. An accountant is considered more knowledgeable than someone who is not trained to complete accounts and prepare tax returns. Therefore, to demonstrate a behaviour of a knowledgeable person is careless has a much higher benchmark.
However, a HMRC officer may not consider a person’s lack of ability to warrant a lower benchmark:
“We note that during your recap of events and the subsequent deliberations you assert in relation to penalties, you have not taken into consideration the academic ability of our clients.
We understand that HMRC should view a taxpayer’s actions in light of their abilities and circumstances. This is reflected in the interpretation of reasonable care test to impose the same test of reasonableness on all taxpayers. The department’s Compliance Handbook clarifies the point as follows:
‘Every person must take reasonable care, but reasonable care cannot be identified without consideration of the particular person’s abilities and circumstances. HMRC recognises the wide range of abilities and circumstances of those persons completing returns or claims.
So whilst each person has a responsibility to take reasonable care, what is necessary for each person to discharge that responsibility has to be viewed in light of that person’s abilities and circumstances.
For example, we do not expect the same level of knowledge or expertise from a self-employed un-represented individual as we do from a large multinational company. We would expect a higher degree of care to be taken over large and complex matters than simple straightforward ones.’
Our client is not particularly well educated. Furthermore, and as clearly stated in the disclosure report, our client has dyslexia. Dyslexia may affect both literacy and numeracy depending on how severe. Our client is severely dyslexic. To assist your further understanding of the condition, symptoms include (but are not limited to) the following:
- unpredictable spelling
- confusion over word and/or number order
- slow at reading
- visual disturbances when reading (letters move across the page)
- difficulty answering questions orally as well as writing
- slow writing speeds
- poor handwriting
- poor phonological awareness
- poorly organised written work
- try to avoid reading and writing
- poor spelling
- struggling to remember things
- struggling to meet deadlines
… We note that you consider the behaviour in respect of the partnership self-employment income as deliberate. We do however consider the behaviour may be attributable in part to the fact that our client is dyslexic. The condition would gravely inhibit a person not only keeping and maintaining records but also collating records to provide to an accountant with which to prepare year end accounts. It would be unreasonable for HMRC to penalise a taxpayer for an inaccuracy brought about by their medical condition.”
Conclusions
No one penalty negotiation is the same and that is probably because no one officer is the same. They are all quite different. Maybe there is a motivation to penalise but not driven from an official source. I think the reality is no one knows what motivates the inconsistencies applied by different officers and maybe HMRC should work on being consistent to remain fair to all taxpayers.
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