In this article we look at the penalty regime for incorrect tax returns as it applies to direct taxes introduced by HMRC for the 2008/09 tax year and later years, and the predecessor regime. A separate article deals with the penalty regime where there are offshore aspects to the case.
We have not considered the penalty regimes for Failure to Notify cases.
The old penalty regime
The old penalty regime, covering tax years up to and including 2007/08, charged a maximum penalty of 100% of the tax “lost” by HMRC as a result of the underpaid duties (the tax and National Insurance Contributions). This would then be mitigated by applying a percentage reduction in respect of three abatement factors, namely “disclosure”, “co-operation” and “size and gravity” (sometimes referred to as “seriousness”).
A reduction in the penalty percentage charged of up to 20% could be achieved for “disclosure”. However, a further 10% could be obtained if the disclosure of the liability to HMRC was made “without fear of discovery” by HMRC; broadly this means that the taxpayer approached HMRC on a voluntary basis to make a disclosure to HMRC.
Up to 40% abatement could be obtained for full co-operation during the course of the investigation. This factor encompasses assisting HMRC to reach a conclusion to the enquiries. It does not mean that the taxpayer (or their agent) has to agree with everything which HMRC proposes. It is still possible to disagree with HMRC’s methods, information requests and proposals, providing there are grounds to do so.
The final factor to reduce the penalty is “size and gravity” or “seriousness”. This considers both the amount of tax “lost” (the size) both in absolute terms and relative to the amount initially declared and also the nature of the way in which the underpayment of tax arose. For example, at one end could be a simple omission of a few small cash receipts and at the other end could be an organised, large scale, diversion of profits and perhaps a second set of books and records.
The new penalty regime
For the 2008/09 tax year and later years a new penalty regime was introduced. HMRC made it clear at the time that the intention was that penalties would generally be significantly higher than they had been under the “old” penalty regime.
The “new” regime is focussed on the “behaviour” which gave rise to the “error” in the returns. Errors were divided into four categories:
- Errors where the taxpayer had taken reasonable care;
- Where the taxpayer had been careless;
- Where the taxpayer had deliberately under declared the tax due; and
- Where the taxpayer had deliberately under-declared but had also taken steps to conceal this.
Cases were also divided into “prompted” and “unprompted”; the former were cases where HMRC had opened the enquiry, and the latter were cases where the taxpayer came forward voluntarily.
Bands for maximum and minimum penalties are set out for each type of behaviour, with a lower bottom limit where there was an unprompted disclosure. The position within each band is determined by the “quality” of disclosure to HMRC during the course of the enquiry. The factors determining the quality of the disclosure are “telling”, “helping” and “giving”.
This means that under the new regime the penalty is less affected by the conduct of the taxpayer during the investigation. Whereas under the “old” regime, by making a voluntary disclosure and cooperating fully, the maximum penalty would be 30%, and this would commonly usually be reduced to about 15% except in the most serious cases. Under the new penalty regime, the minimum penalty for a prompted deliberate disclosure is 35%.
HMRC have also introduced a new “interpretation” of the penalty regime, which also gives rise to higher penalties in many cases. For disclosures made after 5 September 2016, HMRC have decided that an extra 10% penalty will apply if the disclosure was “delayed”; they interpret this as being more than 3 years after the “offence” which gives rise to the penalty. This change does not reflect a change in the legislation, but merely HMRC’s view/interpretation of the quality of the disclosure. As yet, this new interpretation has not been challenged in the Courts.