They are exciting but nerve-racking, they leave at least one person feeling devastated, and they don't necessarily produce a fair result. However, they are probably the least bad way of resolving things. Yes, of course it's penalty negotiations with HM Revenue & Customs. Why, what did you think I was talking about?
Amidst all the economic doom and gloom, and arguments about the Chancellor's rose-tinted crystal ball, a new tax penalty regime slipped almost unnoticed into out lives for returns filed after 31 March 2009 in respect of tax periods beginning after 31 March 2008. This is a significant event for taxpayers, and is thus probably worth explaining in a little more detail.
The 'old' penalty regime was not particularly prescriptive, and tax inspectors and tax advisors developed a sort of rough modus operandi to cope with that lack of prescription. In general terms, fraudulent or negligent conduct resulting in an underpayment of tax was liabile to a fully mitigable penalty of 100% of the tax underpaid. An inspector would start his penalty calculation at 100%, and would reduce it in respect of three factors specific to the conduct of the enquiry:
Cooperation
Disclosure
Size and Gravity
There were guideline mitigation percentages for the inspector to apply in each case, which at the extreme offered the apparently exciting possibility of 110% mitigation, although I have yet to see a case in which HMRC pay a penalty to an errant taxpayer!
This had the advantage of flexibility, but the disadvantage that there was nothing particularly concrete to hang your hat on in negitiations over penalties, with the result that a degree of horse-trading inevitably occurred and compromise solutions were reached, probably equally unsatisfactory to all concerned. Nonetheless it was a system that just about worked provided all parties were pragmatic in their approach.
Now, however, we have a rather more prescriptive system, which will require the inspector to determine whether an inaccuracy in a tax return arises as a result of one of four types of action and/or state of mind of the taxpayer:
Reasonable
Careless
Deliberate but not concealed
Deliberate and concealed.
There are then maximum and minimum levels of penalty (as a percentage of tax under-stated) which the inspector can apply, as follows:
Type of inaccuracy |
Maximum penalty |
Minimum penalty – unprompted disclosure |
Minimum penalty – prompted disclosure |
|
|
|
|
|
|
Reasonable |
0% |
0% |
0% |
|
Careless |
30% |
0% |
15% |
|
Deliberate but not concealed |
70% |
20% |
35% |
|
Deliberate and concealed |
100% |
30% |
50% |
Now of course all of this begs lots of questions, which are as follows:
What is reasonable?
HMRC gives the following examples of reasonable taxpayer behaviour:
1. Taking a reasonably arguable view of a situation that is not subsequently upheld.
2. An arithmetical or transposition error that is not so large as to produce an obviously odd result in absolute terms or in the context of overall liability.
3. Following HMRC advice, on full discloure of the facts, that later proves to be wrong.
4. Acting on advice from a competent adviser, on full disclosure of the facts, that proves to be wrong.
5. Arrangements or systems exist that could reasonably be expected to produce an accurate calculation of tax due, but inaccuracies arise in processing items through the system which are not significant in relation to the overall tax liability for the period. In the tax context, 'significant' has typically meant not more than 20%.
What is careless?
This is defined as failure to take reasonable care, but I will try to be more helpful than that! It is akin to negligence, which has been defined in judicial terms as follows:
"Negligence is the omission to do something which a reasonable man, guided upon those considerations which ordinarily regulate the conduct of human affairs, would do, or doing something which a prudent and reasonable man would not do."
Careless is not deliberate. Repetition of errors may suggest a lack of care, but not necessarily. HMRC accepts that people make mistakes, even where reasonable care is taken. They will judge reasonable care in the context of the capabilities and circumstances of the particular taxpayer, so I'm not going to get away with any reasonable errors! HMRC will expect sufficient business records and systems to cope with the particular business's transactions.
Where a taxpayer is uncertain how to deal with a transaction, as suggested above they will be deemed to behave reasonably if they seek advice from HMRC or a competent professional and follow that adive, or if they disclose the nature and impact of their uncertainty clearly to HMRC when submitting a tax return.
What is deliberate?
This is not one of the more complex questions on this list, so I will not insult your intelligence by defining what is deliberate. It will be interesting to see in practice whether HMRC seeks to characterise extreme negligence by a taxpayer as deliberate, but I talk in greater detail below about the difficulties of classifying taxpayer behaviour.
What is concealment?
This is a much more interesting question, mianly because HMRC takes a remarkably liberal view of what concealment involves. I would be inclined to say that if someone deliberately submits an inaccurate return, knowing that it understates their liability, they are concealing that understatement simply by not showing the true picture. However, I suppose the problem with that, perhaps simplistic, view is that it does not give HMRC the opportunity to distinguish between the bad and the heinous in penalty terms, and thus concealment is a concept designed to separate those two categories.
Concealment involves the taxpayer making arrangements to conceal the inaccuracy which go beyond simply submitting an inaccurate return and hoping not to be investigated. Thus the creation and submission of false evidence in support of an inaccurate figure (e.g. false invoices) would be concealment in this context.
Another way of characterising the distinction might be to say that, typically, HMRC would almost certainly not consider prosecution of the taxpayer as a serious option in a case of deliberate but not concealed inaccuracy, whereas they would probably at least consider the prosecution option in a case of deliberate and concealed inaccuracy.
What is disclosure?
Apart from being a film starring Michael Douglas and Demi Moore, HMRC defines disclosure as having three elements, each of which is taken into account in considering the mitigation of a penalty from the maximum level toward the minimum level. The elements, and the extent to which they are considered in mitigation, are as follows:
Element of disclosure |
Percentage weighting |
|
|
|
|
Telling |
30% |
|
Helping |
40% |
|
Giving access |
30% |
I'll come back to how these are defined in a moment.
What is unprompted disclosure (and, by exclusion, prompted disclosure)?
This is very narrowly defined as disclosure at a time when that taxpayer had no reason to believe that HMRC have discovered or are about to discover an inaccuracy. Any other disclosure is prompted.
This is a tricky area. Under the old regime I have a case where a client voluntarily disclosed an offshore bank account, outside the timeframe for the Offshore Disclosure Facility, but equally at a time when there was no specific reason to believe that HMRC had discovered or were about to discover the account. HMRC are arguing that this is not a voluntary disclosure (for which read unprompted under the new regime) because of the general publicity about their drive on offshore bank accounts and the Offshore Disclosure Facility.
In that case, frankly, their argument is pretty weak, for two reasons. Firstly, all of the Offshore Disclosure Facility cases I saw where disclosures prompted by letters from banks, HMRC or both saying that HMRC had been looking at offshore accounts held by the taxpayer with the specific bank. Nothing of that nature had occurred in my client's case; he simply decided he wished to disclose the account. Secondly, the HMRC argument is akin to the police anouncing that they are having a crackdown on knife crime and then arresting someone who voluntarily brings a flick-knife to a police station on the basis that "you only did it because of our crackdown". But it does illustrate the potential difficulty of establishing unprompted disclosure.
What is telling?
This includes admitting the inaccuracy, disclosing it in full and explaining how it arose. The timing, nature and extent are critical to the mitigation of penalties. Timing involves not the lapse of time since the inaccuracy arose, but the comprehensive nature of the initial disclosure. Nature covers the reasons for the inaccuracy, and requires a degree of volunteering information rather than merely answering HMRC questions. Extent means that the whole of the inaccuracy must be disclosed to obtain full penalty mitigation.
What is helping?
Helping is positive and active assistance, volunteering information and giving reasonable help in quantifying the inaccuracy, by reference to the taxpayer's capabilities and circumstances. Again timing, nature and extent are critical.
Timing relates to timely provision of information. Nature realtes to the usefulness of the help in concluding the enquiry, and extent covers the whole period of the enquiry.
What is giving access?
This is allowing access to relevant documents relating to the inaccuracy. Again timing, nature and extent are important.
As regards timing, prompt provision of documents without recourse to HMRC information powers or reminders is important, as is keeping HMRC informed of the reasons for any unavoidable delays. Nature covers the reasonableness of access to documents and the provision of copies. Extent covers the disclosure of all relevant documents.
There is also the facility for HMRC to suspend penalties for carelessness, on the basis that, provided the taxpayer avoids repeating the errors giving rise to the penalty during the suspension period, it will be waived at the end of that period.
There is an appeal procedure covering all aspects of the regime as a safeguard for taxpayers.
It is also possible for company officers (directors, managers and company secretaries) to be personally penalised for deliberate inaccuracies in company returns where the inaccuracy arose as a result of the deliberate action of the officer concerned.
Thus we have a comprehensive regime, with much better definition of how penalties will be assessed and mitigated in practice. However, the concern I have is about the distinction that inspectors will have to make between the various classes of inaccuracy. It is difficult to impossible to put yourself inside the mind of someone else and decide what motivated them in taking or omitting to take a particular course of action, but that is what we are asking HMRC to do, with some fairly significant consequences at the margin between the categories. In a strange way the very woolly nature of the old regime was helpful in this respect, as it was not necessary to get hung up on taxpayer motivation, but merely to agree a reasonable penalty in the circumstances.
Clearly it will be necessary to see how the regime operates in practice before firming up conclusions about it, but in my view if it is operated sensibly by all concerned it should be a genuine improvement on what went before, and those responsible for devising it are to be commended on their work.
Mark Simpson
27 April 2009
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