This article looks at tax penalties that may be charged following an enquiry or investigation – and how they can often be reduced or avoided. Enquiries are often complex and tax adjustments may be required for different reasons. For simplicity, we refer to penalties in the context of ‘errors’ or ‘mistakes’.
It’s a simple fact of life that we all make mistakes. When it comes to tax enquiries, those errors can of course prove very expensive – even more so when penalties and interest are charged on top of the tax itself.
Out of the blue..?
The addition of penalties and interest frequently comes as a surprise to taxpayers. This is perhaps understandable, because while HM Revenue & Customs (HMRC) will almost certainly mention the possibility of penalties, etc., when they first open an enquiry, it may be several months (or even years) before an enquiry is concluded and any penalties are actually calculated. Numerous letters will have passed to and fro in that period, often without referring to penalties at all.
How bad can penalties be?
Basically, penalties can vary from nil to 100% of the tax found to have been underpaid. In fact the penalty can rise to 200% of the tax, if there is an ‘offshore aspect’ to the liability. For the most part, however, penalties tend to fall in a ‘band’ between 15% and 30% of the additional tax charge.
To put things in perspective, under the previous penalty regime it was quite unusual to see a penalty of much more than 10%.
Penalties fall into higher bands if the taxpayer has deliberately understated the liability, and worse, tried to conceal the inaccuracy. For further information on how to reduce a penalty to the bottom of a ‘band’, see “How to reduce the penalty” below.
HMRC says that the current penalty regime is intended to promote full, prompt and accurate disclosure of any mistakes but to discourage delay or incomplete disclosure by the taxpayer (it is a shame that more is not said on delay by HMRC itself – a common cause of frustration for taxpayers and agents).
How to avoid a penalty
No penalty is due if the taxpayer takes “reasonable care” when making the return. The level of care HMRC deems reasonable varies with the person and the circumstances, for instance:
•lower if the taxpayer has no adviser or his business/financial affairs are relatively simple
•higher if the taxpayer has an adviser, or if the matter is so complex or unusual that advice should be sought or better financial systems should be in place
“Reasonable care” covers:
•Adopting a common / reasonable tax treatment which is later found to be wrong (say in a tax tribunal)
•Minor book-keeping errors
•Following advice from HMRC or a competent adviser which was based on full and accurate details given at the time but later found to be incorrect
Referred to as an ‘unprompted disclosure’, this is where the taxpayer makes a complete and accurate disclosure of the error, when he had no reason to expect that HMRC were about to uncover it anyway. While strictly speaking a penalty is due, it can be reduced to nil if the steps below are followed.
How to reduce the penalty
HMRC has the discretion to reduce a penalty from the maximum in the relevant band where the taxpayer:
•Tells HMRC about the mistake, and the details which caused it
•Helps HMRC to quantify the extent of the inaccuracy
•Allows HMRC to see the underlying records to verify the nature and extent of the error
These steps can only reduce the penalty for an unprompted careless error to nil. If the disclosure has been prompted by an enquiry, or relates to the more serious deliberate / concealed inaccuracies, then a minimum penalty remains chargeable – although those steps will help to reduce the penalty to the bottom of the band.