The UK tax legislation is long and complex. It is therefore unsurprising that many taxpayers make mistakes when completing their tax returns. Unfortunately, HM Revenue & Customs (HMRC) will generally consider whether to charge a penalty in respect of an error in a tax return.
Under the current penalty regime for errors etc (FA 2007, Sch 24), the level of penalty broadly depends on the degree of culpability (i.e. ‘careless’, ‘deliberate but not concealed’ or ‘deliberate and concealed’), whether the taxpayer’s disclosure of the error is ‘prompted’ or ‘unprompted’, and on the quality of the disclosure (i.e. broadly telling HMRC, helping HMRC, and giving HMRC access to records so that the accuracy of the disclosure can be checked (FA 2007, Sch 24, para 9(1)).
The maximum penalty for a ‘careless’ error is 30% of the additional tax. By contrast, the maximum penalty is 70% for a ‘deliberate but not concealed’ error, or 100% if the error is ‘deliberate and concealed’ (but note that if the error involves an offshore matter, the penalties are potentially much higher, i.e. up to a statutory maximum of 300%).
Is that reasonable?
However, it is important to note that HMRC cannot impose penalties for errors where the taxpayer has taken reasonable care. There is no statutory definition of ‘reasonable care’. Whether or not reasonable care was taken has therefore been the cause of regular disagreements between taxpayers (or their advisers) and HMRC.
HMRC’s view is that whether a person has taken ‘reasonable care’ depends on the person’s particular abilities and circumstances. For example, a self-employed individual with no tax adviser will generally not be expected to have the same level of knowledge as a person with larger and more complex tax affairs. However, if (say) someone with simple, straightforward tax affairs encounters a transaction or event with which they are unfamiliar, HMRC may argue that the person has not taken reasonable care unless they have carefully researched the correct tax treatment or sought appropriate advice (CH81120).
Very often, HMRC will argue that reasonable care was not taken, and that a tax return error was careless (or sometimes deliberate). ‘Careless’ is defined for penalty purposes as a failure to take reasonable care (FA 2007, Sch 24, para 3).
HMRC’s view (at CH81140) is that ‘failure to take reasonable care’ was best explained by the First-tier Tribunal’s decision in Collis v Revenue & Customs  UKFTT 588 (TC): “That penalty applies if the inaccuracy in the relevant document is due to a failure on the part of the taxpayer (or other person giving the document) to take reasonable care. We consider that the standard by which this falls to be judged is that of a prudent and reasonable taxpayer in the position of the taxpayer in question.” However, the onus of proof is on HMRC to show that the tax return error was careless (or deliberate) on the balance of probabilities.
HMRC’s Compliance Handbook manual includes examples of errors despite reasonable care having been taken, in which no penalty would be due (at CH81131); and also examples of careless errors (at CH81145). However, it must be remembered that HMRC’s guidance does not carry the force of law.
Is ‘negligent’ the same as ‘careless’?
Prior to the current legislation on penalties, the previous regime provided for penalties if a tax return error was negligently (or fraudulently) made. HMRC have sometimes attempted to equate a ‘careless’ error with a ‘negligent’ error, by relying on a case from the 19th century. In that case (Blyth v Birmingham Waterworks  EWHC Exch J65), Alderson B described ‘negligence’ as follows:
“Negligence is the omission to do something which a reasonable man, guided upon those considerations which ordinarily regulate the conduct of human affairs, would do, or doing something which a prudent and reasonable man would not do. The defendants might have been liable for negligence, if, unintentionally, they omitted to do that which a reasonable person would have done, or did that which a person taking reasonable precautions would not have done.”
However, can HMRC reasonably use an 1856 case to equate negligence with carelessness? Not according to the First-tier Tribunal. For example, in Verma v Revenue & Customs  UKFTT 737 (TC), the tribunal commented:
“We have to say that reliance on a 19th century authority on negligence in a civil claim can hardly be regarded as authoritative in the context of the interpretation of a statutory provision for tax penalties enacted by the Finance Act 2007. The Birmingham Waterworks case is not binding on us as it concerns a different legal issue and wholly different factual circumstances.”
The tribunal in Verma considered that Collis v Revenue and Customs Commissioners (see above) was more relevant, in which the tribunal found that the standard by which reasonable care fell to be judged is that of a prudent and reasonable taxpayer in the position of the taxpayer in question. Similarly, in Seacourt Developments Ltd v Revenue & Customs  UKFTT 522 (TC), the tribunal abandoned the Blyth case in favour of the ‘more modern and, with respect, more apposite approach’ in Anderson (deceased) v Revenue and Customs Commissioners  UKFTT (TC) (see below).
Reliance on agents
What if an error is made in the taxpayer’s return by an agent? The penalty legislation concerning agents broadly provides that the taxpayer is liable to a penalty if the return contains a careless error and is given to HMRC on the taxpayer’s behalf. However, the taxpayer is not liable to a penalty for an error by the agent if HMRC is satisfied that the taxpayer took reasonable care to avoid that error (FA 2007, Sch 24, para 18).
The question therefore arises whether reliance on an agent is taking reasonable care. A number of cases have considered this issue. For example, in AB Ltd v Revenue and Customs  STC (SCD) 99, it was held that a taxpayer who takes proper and appropriate professional advice with a view to ensuring that his tax return is correct, and acts in accordance with that advice (if it is not obviously wrong), would not have engaged in negligent conduct.
subsequently, in Hanson v Revenue and Customs ([2012 UKFTT 314 (TC)), the taxpayer disposed of some loan notes during 2008/09, resulting in chargeable gains for capital gains tax (CGT) purposes. His accountants advised that a form of holdover relief would be available to mitigate the CGT charge on the disposal. When preparing their client’s tax return, the accountants indicated on the return that a relief claim was being made. HMRC subsequently opened an enquiry into the return, and pointed out that the relief was not available because the loan notes were not qualifying assets. The accountants accepted that the relief did not apply. An additional CGT charge therefore arose due to the invalid relief claim.
Fortunately, the First-tier Tribunal held that the taxpayer had taken reasonable care to avoid the error. He had instructed an ostensibly reputable firm of accountants, who had acted for him for many years. The advice given was seemingly within their expertise, and there was no reason to doubt their competence or their advice that the relief was available. In the circumstances, the taxpayer was entitled to rely on the accountants’ advice without himself consulting the legislation or any HMRC guidance. His appeal was therefore allowed.
By contrast, in Shakoor v Revenue & Customs  UKFTT 532 (TC), the taxpayer disposed of two flats in July 2003. The disposals were not included in his tax return for 2003/04. HMRC subsequently raised a discovery assessment charging CGT on the disposals, and also imposed a penalty. The taxpayer appealed against the penalty. His accountant’s advice had been that the disposal of the flats would not result in a CGT liability. The taxpayer had not resided in either of the two flats at any time during his period of ownership. However, his accountant considered that private residence relief applied due to an extra-statutory concession. The taxpayer noticed that his tax return contained no reference to his disposal of the flats, and he questioned this with his accountant, who told him that as the disposal was exempt, there was no requirement to disclose it in the tax return.
Unfortunately, the First-tier Tribunal found that the accountant’s advice was obviously wrong, and that the taxpayer realised, or ought to have realised, that it was obviously wrong or so potentially wrong that it called for further explanation or justification. The tribunal therefore concluded that the penalty was properly due.
HMRC’s view is that a person would have taken reasonable care in acting on advice from any competent adviser which proved to be wrong despite the fact that the adviser was given a full set of accurate facts (CH81130). On the other hand, HMRC considers that a person cannot simply appoint an agent and delegate responsibility for their tax affairs, as that is not taking ‘reasonable care’ (see HMRC’s Compliance Handbook manual, at CH84540).
HMRC also considers that a person has an obligation to choose an adviser who is trained and competent for the task in hand, and that they should check the adviser’s work or advice to the best of their ability and competence. Nevertheless, the burden of proof is on HMRC to prove that there has been careless behaviour by the taxpayer before charging a penalty.
Failed avoidance schemes
HMRC regularly challenges tax avoidance schemes before the courts and tribunals, and have succeeded on a number of occasions. If a tax avoidance scheme fails, does that mean that taxpayers were careless (or negligent) in having used the scheme and incorrectly completed their tax returns on the basis that the scheme works? A test to be applied in determining whether a taxpayer has been careless was set out in Anderson (Deceased) v Revenue & Customs  UKFTT 258 (TC):
“The test to be applied…is to consider what a reasonable taxpayer, exercising reasonable diligence in the completion and submission of the return, would have done.”
There have been several cases in the area of failed avoidance schemes.
For example, in Litman & Anor v Revenue & Customs  UKFTT 89 (TC), the taxpayers realised capital gains during 2004/05 on the disposal of company shares and land and buildings. Both individuals participated in a ‘capital redemption policy scheme’ marketed by a firm of tax consultants, with the aim of generating a capital loss to offset against their capital gains. However, following a decision in another case (Drummond v Revenue & Customs  EWCA Civ 608) it was accepted that the capital redemption policy scheme was not effective, and the taxpayers subsequently paid the full amount of capital gains tax in respect of their disposals. HMRC subsequently charged penalties, and the taxpayers appealed.
The taxpayers argued that the capital losses were claimed on the basis of advice from their professional advisers, and could not be treated as negligent for properly relying on that advice. The First-tier Tribunal considered how much enquiry a sophisticated taxpayer should be expected to make in respect of a packaged scheme in which advice was provided by professional advisers and all documents had been drafted by them. The tribunal noted that the taxpayers were in a similar position to the taxpayer in another case (Bingham v Revenue & Customs  UKFTT 110 (TC)), where it was held that ignorance of technical aspects of the ‘settlements’ legislation did not amount to negligence.
However, the tribunal concluded that the failure to enquire into the basic commercial reality of the scheme transactions entered into by the taxpayers amounted to negligence. A reasonable taxpayer would have ensured that the commercial elements of the transaction stood up to commercial scrutiny and had been properly implemented. The taxpayers should not have claimed the capital losses without at least understanding that an actual transaction had been entered into, that some money had moved, and that the transactions were not a sham. The taxpayers’ appeal was dismissed.
By contrast, in Herefordshire Property Company v Revenue & Customs  UKFTT 79 (TC), a controlling director shareholder decided that the company should sell its investment property, and sought advice from a firm of tax consultants as to whether the tax arising could be mitigated. They suggested a scheme (a capital redemption policy scheme, as in the Litman case above) that it believed should create an allowable capital loss, which the company could offset against the gain on the property. The controlling director’s research suggested that the scheme was a ‘widely used tax planning tool’ (KPMG and Grant Thornton were marketing similar schemes). However, after the scheme was implemented, it was held in Drummond v Revenue & Customs (see above) that the type of scheme undertaken failed. The company therefore withdrew its capital loss claim, and the tax resulting from the property disposal was paid. HMRC subsequently decided to charge the company a 25% penalty for negligently submitting its tax return. HMRC considered that the scheme would have failed because of ‘implementation defects’ or possibly because ‘nothing happened at all’ and scheme users ought to have appreciated this. The appellant appealed.
The First-tier Tribunal commented that the scheme was implemented in a ‘manifestly artificial’ way, and criticised the scheme documentation as having been very badly prepared. However, this did not mean that the documentation was necessarily ineffective. The company’s controlling director had no belief or concern that he was dealing with a tax consultancy firm of poor repute. He had used the firm before, and found them to be highly satisfactory. The director had read counsel’s opinion of the scheme, and also researched the financial press and the internet. He had concluded that the scheme was regarded as a widely-used planning tool, with similar arrangements marketed by highly reputable firms. The tribunal considered that the director was entitled to think that the scheme would operate as expected, and held that the company had not been negligent in submitting its tax return as it did. The appeal was therefore allowed.
Taxpayers (and their advisers) who genuinely consider that a tax return error has arisen despite reasonable care having been taken should be prepared to stand their ground as far as possible, if HMRC attempts to argue that the error was careless (or worse, deliberate).
Doing so could be the difference between a significant penalty being incurred, and no penalty at all.
The above article was first published by Tax Insider (July 2015) (www.taxinsider.co.uk).