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If you are a subscriber click here for your version of this note which additionally summarises case law and provides guidance on appealling 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:

  1. When a taxpayer makes a careless error or mistake in a tax return or document.
  2. When a third party supplies false information, or deliberately withholds information in connection with another person’s return or document.
  3. 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:

When a taxpayer makes an error in a tax return or document (an inaccuracy) and this amounts to, or leads to:

A penalty is charged per error.

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:

Overview & FAQs

A tax penalty regime applies when a taxpayer makes an error or mistake in a tax return or document and this affects his tax charge.

When?

These rules were introduced in the Finance Act 2007. They affect periods from 1 April 2008 for Income Tax, Company Tax, CGT, PAYE, CIS, and VAT.

Transitional rules mean that new penalties will apply to return periods/documents filed and due on or after 1 April 2009. This covers returns: periods starting:

How does this work?

A penalty is payable by a person where he gives HMRC a specified document and it contains an inaccuracy which is careless or deliberate and which amounts to, or leads to:

Where a document contains more than one inaccuracy, a penalty is payable for each inaccuracy.

Which documents are covered by these rules?

Documents include:

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:

Culpability

Maximum

Unprompted (minimum)

Prompted (minimum)

Genuine mistake: despite taking reasonable care 0% 0% 0%

Careless error:
if the inaccuracy is due to failure to take reasonable care

30%

0%

15%

Deliberate error but not concealed: the inaccuracy is deliberate but no arrangements made to conceal it

70%

20%

35%

Deliberate error and concealed

100%

30%

50%

 

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:

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:

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

Disclosure can be made to HMRC as follows:

Disclosure: “unprompted”

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”.

Tax trap: a disclosure is "prompted" if it is made after HMRC has notified of its intention to make a compliance visit covering the specific area of tax to which the disclosure relates. Most compliance visits are now cross-tax, and so this means that compliance visits may cover all the taxes which affect that business, in which case it will be difficult to claim a penalty discount for an unprompted disclosure.

Tax planning: if a business is judged to be high risk, a regular tax heath check will minimise the risk of prompted disclosures. As these penalties could mount up this may be most cost effective. As this regime is new, initial penalties will in many cases (at least for the early years) be suspended. A regular tax health check may be something that is required as a consequence, at least until the suspension period ends.

Discount for quality of 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 give to taxpayers.

The new wording suggests that a disclosure more than 3 years after the error was made will not be entitled to the full reduction. In delayed cases, the minimum penalty will be limited to 10 percentage points above the statutory minimum.

This is not in accordance with HMRCs 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:

Planning point: the Tribunal will be the final arbitrator as to what is meant by special circumstances; each case will be decided on its merits.

See Grounds for appeal: HMRC error or flaw for guidance on what constitutes special circumstances and case law.

Assessment

HMRC will:

Suspension

HMRC may suspend all or part of a penalty for a careless inaccuracy. Notification is in writing and must specify:

HMRC may suspend all or part of a penalty only if compliance with a condition of suspension would help him to avoid becoming liable to further penalties for careless inaccuracy.

Suspended penalties can apply jointly in the case of partnerships.

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 in order for penalties for errors to be suspended.

Paragraph 14 Schedule 24 FA 2007 says that a condition of suspension may specify:

a) action to be taken, and 

b) a period within which it must be taken.

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.  

The condition of suspension must contain a more practical and measurable condition (e.g. improvement to systems) which would help the taxpayer to achieve the statutory objective that tax returns should be free from errors caused by a failure to exercise reasonable care.

 Cases on suspension:

Can we appeal against penalties?

The taxpayer may appeal against a decision of HMRC:

See How to Appeal a Tax 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

Error involving tax agents

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:

“Officer” includes:

(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 him, so that he can prove that he has taken reasonable care.

Double jeopardy

A taxpayer is not liable to a penalty in respect of an inaccuracy or failure in respect of which he has been convicted of an offence.

Carelessness

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.

HMRC provides us with these examples

Example 1 Paul, a self-employed plumber:

Verdict: his attitude indicates a lack of reasonable care.

Example 2 Chandra, a shopkeeper.

Verdict: this indicates at least a lack of reasonable care.

Example 3 A&B Ltd, a large company.

Verdict: a failure to take reasonable care and could be shown to be deliberate.

Example 4 Able Ltd

Verdict: this indicates failure to take reasonable care because it has ignored the advice given by HMRC.

Example 5 Whizz Ltd

Example 6 Susan the personal representative of her late mother’s estate.

When she is completing the IHT account Susan does not check the balances on bank accounts at the date of death with her mother’s bank. Instead she estimates the amounts.

Verdict: this shows a lack of reasonable care.

Example 7 Rainyday Insurance Ltd IPT

A mislaid bank statement and a failure to take reasonable care by the bookkeeper. Adjusting the error on the later return is a disclosure of the inaccuracy for the purposes of the penalty regime because the IPT return shows the under-declaration in a separate box, see CH81141.

Taxpayers and reasonable care

What is reasonable depends on the individual and the nature of the issue at stake.

See reasonable care and tax penalties.

Time limits

Normal Enquiry window

For:
Individual and partnership returns 2007/08 on, and company accounting periods ending after 31 March 2008.

Amendment window

Individual and partnership returns: 12 months from 31 January following the year of assessment, and company returns: 12 months after the filing due date.

Amendment 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.

Discovery assessments

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 and up to 20 years in cases of fraud.

Small print and links

Links:

Tax compliance: powers to inspect businesses.
Client guide to reasonable care and tax penalties

How to appeal a tax penalty

Legislation
Penalties for errors in returns and documents are found in S97 and Schedule 24 of the 2007 Finance Act, as modified by s35 and Schedule 10 FA 2010.

HMRC's Compliance Handbook is provides a summary of its internal guidance.