Penalties: Concerns and Non-concerns

Penalties for an incorrect return

 

For returns made up to and including 2007/08, penalties could only be charged if the return was made fraudulently or negligently.  The amount of the penalty was decided by HMRC and could be up to 100% of the additional tax due.  Although it has no basis in statute, HMRC decided on how much penalty they charged on the basis of your level of co-operation during the enquiry.  They thus had a means of motivating the tax payer to co-operate.  However, the question of whether the tax payer has been fraudulent or negligent still has to be decided on the merits of each individual case.

 

Fraudulent

 

Here the definition is fairly simple.  If a person makes an incorrect return which contains deliberate errors calculated to deceive HMRC into believing that the person is liable to less tax than is in fact the case, then that return has been made fraudulently.

 

Negligently

 

There is no definition of negligence anywhere in statute but a framework has been established by decided cases over the years.  Negligence really means circumstances where a person realises the consequences of his action or inaction but nevertheless goes ahead with that action, regardless of those consequences.

 

This concept can best be illustrated by an example.  Supposing a man has his car regularly serviced and maintained to a proper standard and he drives it down to his local shop to buy a newspaper.  When he stops the brakes fail and he hits the back of another vehicle.  Unless there are other circumstances, he will not be liable for the other person's damage because he has not been negligent.  He had no reason to believe that there was anything wrong with his brakes and the car was regularly serviced.  He had taken all the steps that a reasonable man would do to ensure that his brakes were working correctly.

 

Now contrast this with a man who knows that he has a problem with his brakes and does not bother to have his car serviced and maintained properly.  He wants to buy a newspaper from his local shop and should really walk.  Nevertheless he decides to take a chance and drive.  The brakes fail and he hits the back of another vehicle.  He is fully liable for the damage because he has been negligent.  He knew what the consequences of his action might be but nevertheless went ahead regardless of those consequences.

 

HMRC's Interpretation

 

The view that HMRC try to put forward is that if a person makes an incorrect return, they have been negligent and are therefore liable to a penalty.  If asked in what way the person has been negligent they answer that the person has made an incorrect return.   We have successfully challenged this somewhat circuitous argument on many occasions.  There can be many reasons why a person has made an incorrect return and yet is not negligent.  Take for example a person who lacks the skill and knowledge of matters of taxation, goes to an accountant to have accounts prepared and the return completed on his behalf.  Supposing that a particular item of expenditure is advised by the accountant to be an allowable expense for tax purposes but subsequently HMRC prove that it is not and that therefore tax has been underpaid.  That person has not been negligent.  He has realised his own lack of knowledge and done what any reasonable person would do by seeking professional help.

 

Now contrast this with the case of a person who is not sure how to properly complete his tax return but has a stab at it anyway and in doing so under declares income.  He then makes the excuse to HMRC that he did not do it deliberately but did not understand how to properly complete the return.  HMRC will rightly argue that he has been negligent and therefore liable to a penalty because if he did not understand how to complete the return, he should have taken professional advice.  A good example of this is a person who did not enter his building society interest on his tax return because he thought that tax had already been deducted, not realising that only basic rate is deducted and that if part of his income for that year falls into the higher rate band, there will still be some tax to pay.

 

The new system for penalties

 

For returns for the tax year 2008/09 and thereafter there has been a change in the law and a new system will be operated.  The words 'fraudulently' and 'negligently' have gone and so has the automatic right for HMRC to charge a 100% penalty.

 

If the error in the return was 'careless', HMRC can charge 30% of the under declared tax.  For a 'deliberate but not concealed' error 70% of the under declared tax and for a 'deliberate and concealed error' 100% of the under declared tax.

 

'Careless' is really another word for 'negligent' and as with 'negligent' there is no definition in statute.  Whether a person has been careless would therefore be decided on the same basis as is whether he has been negligent.

 

If a person makes a deliberate error in order to under declare the amount of tax due then that is fraud.  However, it is difficult to envisage circumstances where this deliberate attempt to defraud the Crown would not be concealed unless of course if a person were to make an entry in the 'Additional Information' section of the return to the effect that a deliberate error has been made in order to pay less tax than is actually due, and what that error is!  It is difficult therefore to know quite what was in the minds of those who drafted the statute when they referred to a 'deliberate but not concealed error' which would attract a lesser penalty of 70% as opposed to a 'deliberate but concealed' error which attracts a penalty of 100%.  However, there have been ambiguities in the drafting of statutes before and it is unlikely that this will be the last time.

 

General Advice

 

If HMRC say that you are to be charged a penalty for an incorrect return, always take professional advice from someone who is an expert in these matters as to whether there are grounds for an appeal.  Many such appeals are settled by agreement without the need for a hearing.