Penalties for Tax Return Errors

By | 28 September 2012

Most tax practitioners will be familiar by now with the penalty regime for errors in tax returns and other documents (FA 2007, Sch 24). The level of penalty broadly depends on whether an error was careless, or deliberate but not concealed, or deliberate and concealed. The standard penalty for a careless error is 30% of the potential loss revenue, increasing to 70% if the error is deliberate but not concealed, and 100% if the error is deliberate and concealed. Penalties can be considerably higher if the error involves an ‘offshore matter’.

There are reductions from the standard penalties for disclosure, which are relatively well-known. The level of reduction broadly depends on whether the disclosure is ‘prompted’ or ‘unprompted’, and the various reductions are shown as a table in FA 2007, Sch 24, para 10. For example, suppose that an individual makes a careless error in his tax return by omitting bank interest received and failing to take reasonable care. The standard penalty for a careless error is 30%, but if the error is disclosed to HMRC without prompting, the penalty can be reduced, potentially to zero. If the error is disclosed after prompting by HMRC (e.g. during an enquiry), the standard 30% penalty can potentially be reduced to a minimum of 15%. In those circumstances, can a taxpayer achieve a better result than a 15% penalty? The answer, in many cases, will be ‘yes’.

Firstly, the penalty provisions allow for a special reduction in penalties in appropriate circumstances (FA 2007, Sch 24, para 11).  Secondly, HMRC can suspend penalties in suitable cases involving careless error (Sch 24, para 14).

Special reductions

There have been recent cases before the tax tribunal on whether penalties should be subject to a special reduction, and also on whether penalties should be suspended. One of those cases was Roche v Revenue & Customs [2012] UKFTT 333 (TC). In that case, the taxpayer omitted certain items of income from her tax return, including bank interest and a substantial redundancy payment. HMRC opened an enquiry, and adjusted the return to take account of the omitted items of income. The errors were considered by HMRC to be careless, but the standard 30% penalty was reduced to the minimum of 15% for prompted disclosure. HMRC agreed to suspend the penalties in respect of the bank interest, but not for the other errors including the redundancy payment. The taxpayer appealed against her liability to a penalty, the amount of the penalty, and also HMRC’s decision not to suspend the whole penalty. The tribunal held that some of the errors were careless, including the omitted redundancy payment. However, the tribunal also held that HMRC’s decision not to apply a penalty reduction for special circumstances was flawed. The tribunal found that HMRC had not taken into account certain circumstances in the case, which had contributed to the errors. Because HMRC’s decision was flawed, the tribunal considered that it was appropriate to reduce the penalty attributable to the omitted redundancy payment by 50% to take account of the special circumstances.

The tribunal also considered whether HMRC’s decision not to suspend all the penalties was flawed. The tribunal considered another case, Fane v HMRC [2011] UKFTT 210 (TC), which looked at HMRC guidance indicating that a ‘one-off’ error would not normally be suitable for a suspended penalty. The tribunal in that case held that HMRC’s approach was understandable and justified. For the same reasons, the tribunal in Ms Roche’s case held that HMRC’s decision not to suspend the penalties on the redundancy payment and other omissions was not flawed. However, the end result was that the penalty in respect of the redundancy payment was reduced for special circumstances from 15% to only 7.5%.

Another recent case involving a special reduction in penalties was White v Revenue and Customs [2012] UKFTT 364, which also concerned a termination payment. In that case, the taxpayer omitted to include the taxable element of the termination payment on her tax return. Following an enquiry into her return, HMRC imposed a penalty for a careless error. This penalty was reduced from 30% to 15%, on the basis of a prompted disclosure. However, HMRC would not suspend the penalty, on the grounds that the type of occurrence leading to the error (i.e. redundancy) was unlikely to be repeated, so no measurable conditions for suspension could be set. In addition, HMRC considered that there were no special circumstances allowing for a reduction in penalties. The taxpayer appealed.

The tribunal held that the taxpayer was careless in failing to report the termination payments accurately on her tax return. The tribunal then went on to consider whether the penalty should be suspended, and concluded that HMRC’s decision not to suspend the penalty was not flawed. It agreed that the suspended penalty provisions are not suitable for dealing with ‘one-off’ events such as redundancy. Interestingly, the tribunal also commented: “we do not say that redundancy must always be a ‘one-off’; that is a question of fact which will depend on the circumstances of each case”. However, in this case, the tribunal upheld HMRC’s decision not to suspend the penalty.

The tribunal then considered whether the 15% penalty should be reduced for special circumstances. It held that HMRC’s decision that there were no special circumstances was flawed. Looking at the particular facts and circumstances, the tribunal identified that there were factors which took this case out of the ordinary. The tribunal therefore decided that the 15% penalty in respect of the omitted termination payment should be reduced by 60%, i.e. the 15% penalty was reduced to only 6%.

Suspended penalties

The taxpayers in the cases mentioned managed to obtain a special reduction in penalties, but were unable to get the penalties suspended. However, there has been a recent case in which penalties were suspended. It is interesting to note that this case, Boughey v Revenue & Customs [2012] UKFTT 398 (TC), also concerned an appeal against a redundancy payment. The taxpayer claimed exemption from tax on his self-assessment return in respect of a redundancy payment. However, relief had already been given through the PAYE system. The error was discovered, and HMRC imposed a 15% penalty. HMRC would not suspend the penalty, on the basis that a condition needed to be set that was specific to the careless inaccuracy (i.e. claiming the £30,000 relief for a redundancy payment in error). HMRC broadly decided that such a condition could not be set in respect of a redundancy payment.

However, the tribunal considered that HMRC’s decision was flawed. It referred to the Fane case mentioned earlier, in which the judge pointed out that on the face of the provisions on suspended penalties there was no restriction in respect of a ‘one-off event’ that was unlikely to be repeated. The tribunal noted that Mr Boughey had proposed his own suspension condition, which was that during any period of suspension his tax returns should be prepared by a qualified accountant. The tribunal considered that this was a “borderline” case but agreed that there was a basis on which the penalty could be suspended. The tribunal therefore decided to suspend the penalty for two years. It is interesting to note that the suspension condition was that the taxpayer’s returns must be prepared during that period on his behalf by a chartered or certified accountant. Members of those professional bodies will no doubt be delighted at this condition, although members of other professional bodies may be less than impressed by the tribunal’s decision!

A final point on penalties in respect of redundancy payments and whether they are suitable for suspension is that in another case, Cobb v Revenue & Customs [2012] UKFTT 40 (TC), the tribunal said that HMRC should be able to suspend all or part of the penalty for a careless error by an individual who is made redundant, particularly in relation to more complex redundancy settlements, and that being made redundant may not be a ‘one-off’ event.

There is some fairly detailed guidance on penalties for errors and whether penalties should be suspended in HMRC’s Compliance Handbook Manual. Of course, the guidance only provides HMRC’s view on the subject, and does not carry the force of law. For example, there are illustrations in the Compliance Handbook at CH83143 of circumstances where HMRC will not suspend penalties. One of those illustrations involves an error in respect of a termination payment, in which HMRC states that there are no suspension conditions that can be set to avoid the taxpayer making a careless error in the future. However, as already noted, HMRC’s approach may not necessarily be in accordance with the tribunal’s view. A useful point that HMRC does make in its guidance is that they must consider suspension for every penalty involving a careless error (CH83131).

Similarly, there is guidance on the provisions allowing for a special reduction in penalties in the Compliance Handbook. It may be helpful in cases involving a potential special reduction or suspension of penalties to at least be aware of HMRC’s approach, even if it may be called into question.

Practical points

Finally, there are one or two practical points arising from the penalty cases mentioned. Firstly, remember the old adage that “if you don’t ask, you don’t get”, and if necessary ask HMRC for penalties to be suspended in cases of careless error, where the circumstances seem appropriate. In addition, check whether HMRC has considered the special reduction in penalties. In the White case, the tribunal indicated that HMRC should consider any special reduction before issuing a penalty determination. In each case, be prepared to argue for a reduction and/or a suspension in penalties if it appears justified. Also be prepared to lodge an appeal if the outcome of discussions with HMRC is unsatisfactory.

Secondly, in the White case, the tribunal agreed with the comments in another case, Collis v HMRC Commissioners [2011] UKFTT 588 (TC), in which the judge said that if the tribunal affirms HMRC’s decision that a penalty is payable, it should normally go on to consider the amount of that penalty, the existence or effect of any special circumstances, and also whether or not to suspend the penalty and any conditions of suspension. However, in the Cobb case mentioned earlier, the tribunal would not make any decision on the suspension of the penalty because it had not been given as grounds for appeal. If appealing against a penalty, including HMRC’s decisions regarding suspension and the special reduction, it would therefore seem prudent to mention all of the grounds for appeal.