Watch out for the tax penalty area!

28 April 2009

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Most of us take care to get our tax returns right. But to err is human and with the best will in the world things occasionally go wrong or get left out.

When the error comes to light, in addition to the extra tax, HM Revenue & Customs can charge interest (this is not a surprise; after all we've had use of the money) and also penalties, a form of fine to discourage other taxpayers who might be tempted to similar carelessness.

Until 6 April, HMRC had considerable discretion in the way that they applied their own guidelines on penalties, so there was enormous scope for negotiations and bargaining in reaching a final settlement. For returns due in after 6 April 2009 that discretion is consigned to history and is replaced by a more rigid statutory system. The result is almost certainly going to be higher penalties.

Where an innocent mistake has happened and the taxpayer has taken "reasonable care" to get things right then there should be no penalty, provided that he owns up to the mistake before HMRC prompt him to do so. This is more difficult than it sounds because disclosure is prompted unless HMRC

did not know about the error and
were unlikely to find out.

Consequently, as soon as HMRC announce that they plan to make a compliance check on a taxpayer's records, any disclosure he makes is treated as prompted: the result is that the minimum penalty jumps from nil to 15% of the tax due.

The new rules set out penalties based on a percentage of the additional tax due which escalates according to the gravity of the error:

	Penalty	Penalty Possible mitigation
The mildest form of error is carelessness – tax return errors due to a failure to take reasonable care	30% of additional tax due	To nil with full unprompted disclosure, otherwise 15%
Errors due to deliberate but unconcealed inaccuracy	70% of additional tax due	To 20% for full unprompted disclosure, 35% for prompted disclosure
The worst form of error – where the taxpayer has deliberately been inaccurate and has taken pains to conceal the inaccuracy	100% of additional tax due	To 30% for full unprompted disclosure, 50% for prompted disclosure

How might this work?

Suppose that Basil, a hotelier, submits his business tax return for 2008-9 in January 2010. His expenses erroneously include private expenditure, £1000 for his wife's hairdressing costs.

Basil's local tax district announces in September 2010 that they intend to make a compliance check on Basil's tax position. Having received the Revenue letter Basil checks his files and realizes his error. He informs the inspector and pays the £410 additional tax due.

Basil's disclosure of the overclaimed expenses earns him some relief, but it is "prompted" for the purposes of the new penalty regime. He is ineligible for the nil penalty and receives a bill for £61.50, 15% of the additional tax due.

Needless to say Basil feels outraged, but the situation could have been a whole lot worse. What if he had deliberately posted his wife's hairdressing costs as a business expense, disguised as consultancy say? Then the error would have been concealed and so fallen into the third category. The fine could then have been up to 100% of the £410 tax due.

What can taxpayers do to ensure that they keep out of the penalty area?

The main message here is that the new penalties are non-negotiable and potentially very costly, just at a time when taxpayers and their businesses can least afford them.

So it will be worth taking extra care to make sure that all the entries on your returns can be justified. Moreover, not every difference of opinion between taxpayers and HMRC constitutes carelessness, so if a particular claim or relief is likely to be controversial it would be as well to keep documents that support the treatment adopted.

For returns that have already been submitted, the old discretionary penalty regime applies. As the new statutory fines are likely to be a good deal higher than the settlements of 10-25% regarded as normal under the old guidelines, it may be prudent to disclose any indiscretions now before the penalty stakes are raised.

About the author

This article was contributed by Clare Munro who is a partner at Haslers Chartered Accountants and a member of the UK200 Tax Panel. She advises on all tax related matters including investigations and has been in practice since 1982, serving a vast range of clients, from individuals to FTSE100 companies Clare.Munro@Haslers.com

UK200Group is an association of separate and independently owned and managed accountancy and lawyer firms, and as such each has no responsibility or liability for the acts or omissions of other members. UK200Group does not provide client services and it does not accept responsibility or liability for the acts or omissions of its members. www.uk200group.co.uk

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