Offshore Penalties

By | 27 July 2010

The first Finance Act of 2010 introduced a new penalty regime in respect of undisclosed offshore accounts, from a date to be appointed by Treasury Order. The publicity generated by this legislation resulted from a ‘headline’ maximum penalty rate of 200%. Many individuals, particular those with a foreign connection, have offshore accounts these days. In what circumstances can the enhanced penalty rates apply?

There are 3 categories of penalty under the new regime. Enhanced penalties apply to inaccuracies under categories 2 and 3 (the penalties under category 1 are up to 30% for ‘careless’, 70% for ‘deliberate but not concealed’ and 100% for ‘deliberate and concealed’ defaults).

The penalties for a ‘category 2’ inaccuracy are up to 45%, 105% and 150% respectively. For a ‘category 3’ inaccuracy, the penalties are up to 60%, 140% and 200% of the tax lost. These higher penalty rates depend upon the ‘transparency’ of the offshore jurisdiction concerned. They also reflect the fact that HMRC is less likely to detect non-compliance in those jurisdictions, and that the choice of jurisdictions may have been affected accordingly.

Penalty categories

A ‘category 1’ inaccuracy “involves a domestic matter” or “involves an offshore matter” (as defined) either in a ‘category 1 territory’ (i.e. broadly a territory which automatically exchanges information with the UK), or where the tax at stake is not income tax or CGT. By contrast, a category 2 or 3 inaccuracy involves an offshore matter where the tax at stake is income tax or CGT, and the territory is a category 2 or 3 territory.

Territories are categorised by Treasury Order, broadly according to the following criteria (FA 2007, Sch 24, para 21A):

  • The existence of information exchange arrangements for tax enforcement purposes between the UK and the other territory:
  • The quality of such arrangements (i.e. whether information is exchanged automatically, or upon request); and
  • The benefit to the UK of receiving information from that territory if such arrangements existed.

The penalty regime for failing to make returns etc (FA 2009, Sch 55) is also expanded in respect of the witholding of information, according to whether it is category 1, 2 or 3 information (as defined). In addition, amendments are made to FA 2008, Sch 41 (‘Penalties: failure to notify and certain VAT and excise wrongdoing’) to introduce category 1, 2 and 3 penalties in appropriate circumstances.

Offshore matters are broadly defined in terms of offshore income, assets or activities, or “anything having effect as if it were income, assets or activities” of those kinds. A ‘domestic matter’ is (not surprisingly) everything which is not an offshore matter.

The penalties of up to 200% mentioned above are subject to possible reduction based on the quality of disclosure to HMRC. For a category 3 penalty, where the 200% rate applies, the penalty cannot be reduced below 100% (for a prompted disclosure) or 60% (for an unprompted disclosure).   

Alarm bells

HMRC has pointed out that there is nothing wrong with taxpayers having offshore accounts and sources of income or gains. However, there seems to be an apparent suspicion of offshore evasion on a large scale. There is anecdotal evidence that some UK resident and domiciled taxpayers open accounts in ‘tax havens’ in the mistaken belief that the income generated somehow escapes tax in the UK.

Professional firms preparing tax returns may therefore need to educate some clients about the taxation of foreign income, as well as warning about the potentially high price of non-disclosure in terms of penalties.

 The above article is reproduced from ‘Practice Update’ (July/August 2010), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.