If an error is made in a tax return, it does not necessarily follow that a penalty will be incurred if additional tax becomes due as a result of that error being corrected. For example, HM Revenue and Customs (HMRC) cannot charge a penalty if the error has arisen despite reasonable care having been taken.
Suspending the penalty
Many tax return errors seem to be ‘careless’ for penalty purposes. The maximum penalty for a careless error in most cases is 30% of the additional tax (although higher penalties can be charged if the error involves an offshore matter or offshore transfer). However, HMRC has the power to suspend penalties in cases involving careless (but not ‘deliberate’) errors (FA 2007, Sch 24, para 14). HMRC guidance (in the Compliance Handbook manual) instructs its officers to consider the suspension of every penalty for a careless error (CH83132).
If HMRC decides to suspend all or part of a penalty for a careless tax return error, it must specify a period of suspension, which cannot exceed two years. HMRC will set conditions of suspension (e.g. action to be taken, and a timeframe for taking it), which the taxpayer must comply with throughout the relevant period. HMRC may suspend a penalty only if compliance with a suspension condition would help the person to avoid becoming liable to further penalties for careless errors. At the end of the suspension period, if HMRC is satisfied that the conditions of suspension have been satisfied, the suspended penalty (or part) is cancelled. Otherwise, the relevant penalty becomes payable.
However, even if HMRC offers to suspend a penalty, the taxpayer might decide to contest it (e.g. on the basis that reasonable care was taken). There is a statutory right of appeal against (among other things) HMRC’s decision to impose a penalty, or the amount of the penalty (Sch 24, para 15). If the appeal cannot be settled by agreement, the taxpayer may notify their appeal to the tribunal. What if the tribunal affirms HMRC’s decision to charge a penalty for a careless error – will HMRC still suspend the penalty? Unfortunately, a recent tribunal case suggests not.
In M Najib and Sons Ltd v Revenue and Customs  UKFTT 147 (TC), on checking the appellant’s employer records in February 2012, HMRC identified that, from the tax year 2009/10, the appellant paid a mileage allowance of 40 pence per mile to each of its two directors, but no mileage logs had been kept to indicate the business mileage the directors had undertaken. HMRC also identified that, from the tax year 2006/07, the appellant had paid the premiums for the directors’ private health insurance, but those payments had not been debited to the directors’ loan account.
In HMRC’s view, both categories of payment constituted earnings of the directors, and Class 1 National Insurance contributions (NICs) should have been paid by the appellant in respect of those earnings. HMRC subsequently raised assessments of Class 1 NICs for the tax years 2006/07, 2008/09, 2009/10 and 2010/11, and also charged penalties for those tax years. The appellant appealed. The First-tier Tribunal agreed with HMRC that the appellant was liable to pay Class 1 NICs for the relevant tax years. The tribunal also concluded that the appellant had not taken reasonable care to avoid the inaccuracies in question, and was satisfied that HMRC was entitled to raise penalties for those years. The appellant’s appeal was dismissed.
The tribunal in Najib noted that HMRC had been willing to suspend the penalties; however, this required the appellant to accept liability. The appellant was unwilling to do so, and the penalties remained unsuspended; one can only speculate what might have happened if the appeal had been extended to HMRC’s decision to make the penalty suspension conditional in this way. An unfortunate effect of the appellant’s unsuccessful appeal was that (in addition to the Class 1 NIC liabilities) the company became liable to penalties that would otherwise have been suspended. This seems (to me at least) rather harsh; if the conditions to suspend a penalty existed before the tribunal hearing, they must have existed after it.
When considering an appeal against an HMRC tax return enquiry closure notice or assessment of additional tax liabilities, also take into consideration the penalty position. This includes cases where HMRC considers that the liability has arisen due to a careless error but has offered to suspend the penalty, particularly if (as in Najib) HMRC’s offer to suspend the penalty is subject to the taxpayer’s acceptance of the penalty. For example, consider the prospects of the appeal against the tax liabilities succeeding, and whether there is a good ‘reasonable care’ argument if the tax appeal is unsuccessful.
The above article was first published in Business Tax Insider (August 2017) (www.taxinsider.co.uk).