What penalties apply for Errors in returns and documents? How are they calculated? When can they be reduced or suspended?
This is a freeview 'At a glance' guide to penalties for errors in returns and documents.
- Subscribers click here for your version of this note which additionally summarises case law and provides guidance on how to appeal suspension conditions.
- There is also a VAT Penalty note for subscribers.
At a glance
A tax-geared penalty will apply in one of three circumstances that result in a potential loss of tax:
- When a taxpayer makes a careless error or mistake in a tax return or document.
- When a third party supplies false information, or deliberately withholds information in connection with another person’s return or document.
- When HMRC raises an assessment for tax and the taxpayer fails to notify HMRC that the assessment is too low.
The measures are set out in S97 and Sch 24 FA 2007.
Further amendments have followed:
- S122 and Sch 40 FA 2008 amend the rules to apply to certain third parties.
- S35 and Sch 10 FA 2010 increases the ranges of penalties in relation to the potential loss of offshore taxes.
- S124 Finance (No 2) Act 2017 inserts provisions applying to errors that are related to avoidance arrangements.
When a taxpayer makes an error in a tax return or document i.e. an inaccuracy, and this amounts to, or leads to:
- An understatement of their liability to tax
- A false or inflated statement of a loss by them or
- A false or inflated claim to repayment of tax
a penalty is charged per error.
- Each error has to be looked at in isolation in order to determine its category and the behaviour that contributed to it.
- There will only be a penalty if the error could have led to a potential loss of revenue.
- Once evaluated, errors may be grouped to simplify calculation.
Penalties are tax-geared. From 1 April 2011, there are different penalty rates depending on whether the error relates to domestic or offshore income and gains.
The rate of penalty that will apply is determined according to the taxpayer’s underlying behaviour, as appraised at various stages between the time of the discovery of the error and its disclosure to HMRC. This may take several steps to calculate and will often require a detailed appraisal of the individual facts of each case combined with judgement as follows:
- The first issue is to decide whether in making the error the taxpayer had been taking reasonable care over their tax affairs.
- Where a taxpayer has made an error despite taking reasonable care it is treated as 'innocent' and no penalty is charged, subject to the new Finance (No.2) Act 2017 changes regarding errors related to avoidance arrangements.
- Where a taxpayer is found not to have taken reasonable care, e.g. they have been negligent, any error will be treated as 'careless' and penalties will apply.
- A higher range of penalties will apply if the taxpayer was found to have made the error deliberately or deliberately and had also made attempts to conceal it.
- Having worked out the maximum penalty according to the taxpayer’s past behaviour, the minimum penalty is calculated on the basis of whether the taxpayer disclosed the error to HMRC or whether disclosure was prompted by HMRC.
- The maximum penalty is then reduced by the taxpayer’s disclosure; whether they were helpful and cooperative in assisting HMRC to quantify and correct the error.
- When a penalty is charged under the provisions of s98 of the 1970 Taxes Management Act (TMA) no penalty is payable under Sch 24 FA 2007: any document that triggers a s98 penalty is automatically excluded from the list of documents for which penalties for inaccuracies may be charged.
- There are special rules dealing with losses and where there is no loss of tax but liability is delayed.
- There are special rules where the taxpayer used a tax avoidance scheme and reliance on a third party may or may not be a defence depending on context, see Penalties: errors in returns and documents (subscriber version).
- A penalty may be charged where an agent has made an error, but only if the taxpayer is found not to have taken reasonable care.
- Company officers may be assessed for penalties where an inaccuracy is made deliberately. The same applies in the case of an LLP and its members.
- HMRC may suspend penalties under ‘careless’ behaviour for a set period.
- The taxpayer may appeal the decision to set a penalty and the rate of penalties charged see How to Appeal a Tax Penalty.
- The taxpayer may appeal any decision not to suspend a penalty or challenge suspension conditions, see Penalties: errors in returns and documents (subscriber version).
A tax penalty regime applies when a taxpayer makes an error or mistake in a tax return or document and this affects their tax charge.
These rules were introduced in the Finance Act 2007. They affect periods from 1 April 2008 for Income Tax, Corporation Tax (CT), Capital Gains Tax (CGT), PAYE, the Construction Industry Scheme (CIS), and VAT.
Transitional rules mean that new penalties will apply to return periods/documents filed and due on or after 1 April 2009. See Penalties: Errors in Returns and Documents (subscriber version)
How does this work?
A penalty is payable by a person where they give HMRC a specified document and it contains an inaccuracy which is careless or deliberate and which amounts to, or leads to:
- an understatement of their liability to tax
- a false or inflated statement of a loss by them, or
- a false or inflated claim to repayment of tax.
Where a document contains more than one inaccuracy, a penalty is payable for each inaccuracy.
Which documents are covered by these rules?
- Income Tax and CGT returns and claims
- PAYE and CIS returns
- Company tax returns and claims
- VAT returns
- Any document which is likely to be relied upon by HMRC to determine, without further enquiry, a question about:
- Their liability to tax
- Payments by them by way of or in connection with tax
- Any other payment by them (including penalties), or
- Repayments, or any other kind of payment or credit, to them.
Use of the wrong form or return
Use of the wrong form, provided that it was accurately completed will not automatically give rise to a penalty for error provided that it does not contain a false or inflated claim. This kind of error could lead to a late filing penalty.
Rate of penalties
Penalties are set by law as a percentage of lost revenue, according to taxpayer behaviour and degree of culpability or guilt. They are negotiable and the penalties which apply will depend on the facts of each case. They are set as follows:
Genuine mistake: despite taking reasonable care
Deliberate error but not concealed: the inaccuracy is deliberate but no arrangements made to conceal it
Deliberate error and concealed
A further penalty of 30% is triggered if a person fails to notify HMRC of an under assessment of tax, in relation to an assessment made by HMRC.
An inaccuracy in a document given to HMRC, which was neither careless nor deliberate when the document was given, is to be treated as careless if the taxpayer:
(a) discovered the inaccuracy at some later time, and
(b) did not take reasonable steps to inform HMRC.
Potential lost revenue: normal rule
The additional amount due or payable in respect of tax as a result of correcting the inaccuracy or assessment. Ignoring:
- Group relief.
- Close company relief for loans.
Potential lost revenue: multiple errors
If a penalty is due in respect of more than one inaccuracy, and the calculation of potential lost revenue depends on the order in which they are corrected:
- Careless inaccuracies shall be taken to be corrected before deliberate inaccuracies, and
- Deliberate but not concealed inaccuracies shall be taken to be corrected before deliberate and concealed inaccuracies.
Potential lost revenue: losses
If loss is overstated, lost revenue equals extra amount of tax relief received. Where the loss has not been wholly used, lost revenue is increased by 10% of the balance of the loss.
Potential lost revenue: delay
Where tax has been delayed, the lost revenue is 5% of the tax for each year of the delay. This does not apply to losses.
Disclosure can be made to HMRC as follows:
- telling HMRC about it
- giving HMRC reasonable help in quantifying the inaccuracy or under-assessment, and
- allowing HMRC access to records for the purpose of ensuring that the inaccuracy or under-assessment is fully corrected.
Unprompted means made at a time when the person making it has no reason to believe that HMRC have discovered or are about to discover the inaccuracy or under-assessment.
Otherwise, disclosure is 'prompted'.
Discount for quality of disclosure
- Where a person who would otherwise be liable to a 30% penalty has made an unprompted disclosure, HMRC shall reduce the 30% to a percentage, which may be 0%, which reflects the quality of the disclosure.
- Where a person who would otherwise be liable to a 30% penalty has made a prompted disclosure, HMRC shall reduce the 30% to a percentage, not below 15%, which reflects the quality of the disclosure.
HMRC updated a number of compliance check factsheets in December 2017, and included new wording on how the timing of a disclosure will affect the reductions HMRC gives to taxpayers. This is not in accordance with HMRC's manuals and would represent a change in policy. There is some confusion as to whether this is what HMRC actually intends. See New penalty calculation creates confusion.
Special reduction: special circumstances
HMRC may reduce a penalty if there are 'special circumstances'. These do not include:
- ability to pay, or
- the fact that a potential loss of revenue from one taxpayer is balanced by a potential over-payment by another.
See Grounds for appeal: HMRC error or flaw for guidance on what constitutes special circumstances and case law.
- Assess the penalty, notify the taxpayer and state in the notice a tax period in respect of which the penalty is assessed.
- A penalty assessment must be made within the period of 12 months beginning with:
- The end of the appeal period for the decision correcting the inaccuracy, or
- If there is no actual tax assessment the date on which the inaccuracy is corrected.
HMRC may suspend all or part of a penalty for a careless inaccuracy. Notification is in writing and must specify:
- What part of the penalty is to be suspended.
- The period of suspension; not exceeding 2 years.
- The conditions of suspension to be complied with by the taxpayer.
HMRC may suspend all or part of a penalty only if compliance with a condition of suspension would help the taxpayer avoid becoming liable to further penalties for careless inaccuracy.
- At the end of the period of suspension, if HMRC is satisfied that the conditions of suspension have been complied with, the suspended penalty or part is cancelled.
- If not, or the taxpayer becomes liable to another penalty during the period, the suspended penalty or part becomes payable.
Conditions for suspension
HMRC current practice is that penalties for inaccuracies may only be suspended if the suspension condition is SMART, that is 'Specific, Measurable, Achievable, Realistic and Time' bound.
Taxpayers may be asked to sign a Specific Measurable Achievable Realistic Time Bond.
A taxpayer may appeal against a decision of HMRC setting out suspension conditions. If for example, the conditions attaching to your SMART Bond are unreasonable or over onerous.
Cases on suspension:
Can we appeal against penalties?
The taxpayer may appeal against a decision of HMRC:
- That a penalty is payable
- The amount of a penalty.
- Not to suspend a penalty payable.
- Setting conditions of suspension of a penalty.
see Penalties: errors in returns and documents (subscriber version) for recent developments and guidance on how to appeal against a lack of suspension or suspension conditions.
An appeal may be brought to the First-tier Tribunal (FTT):
- The Tribunal may affirm, substitute or cancel HMRC’s decision if it thinks it flawed.
- 'Flawed' means flawed when considered in the light of the principles applicable in proceedings for judicial review.
- The taxpayer may appeal any decision not to suspend a penalty or challenge suspension conditions,
Error involving tax agents
- The taxpayer is liable to be penalised where a document which contains a careless inaccuracy is given to HMRC, even if transmitted via an agent.
- Reliance on the work or advice of a qualified tax agent may amount to a reasonable excuse, if the tax is complicated, it is not VAT, or the taxpayer was not participating in a tax avoidance scheme (FA (No2) 2017 rules) see Penalties: errors in returns and documents (subscriber version).
Companies: officer's liability
Where a penalty is payable by a company for a deliberate inaccuracy which was attributable to an officer of the company:
- the officer as well as the company shall be liable to pay the penalty, and
- HMRC may pursue the officer for such portion of the penalty (which may be 100%) as they may specify by written notice to the officer.
(a) a director including a shadow director within the meaning of section 251 of the Companies Act 2006 (c. 46), or
(b) a secretary.
It is essential that a director knows what is expected of them, so that they can prove that they have taken Reasonable care.
A taxpayer is not liable to a penalty in respect of an inaccuracy or failure in respect of which they have been convicted of an offence.
Carelessness = failure to take reasonable care
HMRC links this to “negligence”. It uses a quote as follows:
In the 1856 case of Blyth v Birmingham Waterworks Co, Baron Alderman said: “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. The defendants might be liable for negligence, if, unintentionally, they omitted to do that which a prudent and reasonable person would have done, or did that which a person taking reasonable care would not have done.”
HMRC's guidance (abridged from the Compliance Handbook)
How to work out if someone is careless
It is simply a question of examining what the person did or failed to do and asking whether a prudent and reasonable person would have done that or failed to do that in those circumstances.
Repeated inaccuracies may form part of a pattern of behaviour which suggests a lack of care. Keep a sense of proportion; repetition will not always indicate a failure to take reasonable care. People do make mistakes. Perfection is not expected.
See Penalties: errors in returns and documents (subscriber version) for HMRC provided examples
Taxpayers and reasonable care
What is reasonable depends on the individual and the nature of the issue at stake.
- Sch 36 Finance Act 2008 gives HMRC wide powers to inspect business records and premises so discovery which allows the re-visiting of periods outside the enquiry window into a tax return is potentially more likely.
- HMRC has limits on its use of Schedule 36: information must be "reasonably required" as well as being in a taxpayer's power or possession.
- HMRC may not insist on a blanket trawl of non-business records or business records outside the period under enquiry, without good reason.
- Whether Sch 36 will affect the timescale in which HMRC can investigate past and closed period returns really seems to depend on the circumstances of each case.
Normal enquiry window
For individual and partnership returns 2007-08 on, and company accounting periods ending after 31 March 2008.
- Twelve months after the date that the return was delivered.
- Exception for groups (other than small groups, as defined by the 2006 Companies Act): enquiry window runs from due filing date. Further advice on medium and large groups at http://www.hmrc.gov.uk/ctsa/enq-window.htm
Individual and partnership returns: 12 months from 31 January following the year of assessment, and company returns: 12 months after the filing due date.
Amendments and the new tax penalty regime
An amendment to correct an error or mistake in a return within the amendment window will not be subject to tax penalties if the taxpayer makes it without prompting from HMRC.
- There may be penalties if HMRC find that the error or mistake was deliberate (see table of penalties in Overview).
HMRC will go back 4 years if on finding an error there is the presumption of continuity. This will extend to 6 if there is suspected negligence or dishonesty, 12 if it involves an offshore matter from April 2019, and up to 20 years in cases of fraud.