AccountingWeb

Zero penalties – a thing of the future. By Rebecca Benneyworth

The new penalty regime allows HMRC to levy zero penalties in a number of circumstances when an error results in an underpayment of tax, some of which are quite surprising.

Reasonable care

The first area to be aware of is when reasonable care has been taken. Where a taxpayer (be it individual, partnership, company or trustee) has taken reasonable care over their tax affairs, then even where there is a mistake on a return or other document which results in an underpayment of tax, no penalty will be due. This is a major change for VAT, where the current legislation allows a penalty to be charge when there is an error – even an innocent one – of a particular magnitude. The triggers to Serious Misdeclaration Penalty do not take behaviour into account, and are merely centred on the magnitude of the error in relation to the return.

So taxpayers who take reasonable care in relation to their tax affairs will never be liable to a penalty in respect of errors on returns or documents. HMRC guidance sets a minimum of proper records in pursuit of reasonable care, and there is some evidence from senior HMRC people that they realise that these may comprise 'a shoebox' rather than full ledgers. For larger companies, more sophisticated tax-geared systems would be needed, but provided the company has systems in place, which if adhered to would produce the correct tax liability, then if errors arise in processing, no error would be due. This carries the proviso that the size of the error is not of such significance that it would be obvious. Part of the systems one might expect would include a 'reasonableness' check, so this should be sufficient to identify errors of sufficient magnitude to compromise reasonable care.

Lack of reasonable care

The second situation is where an error has been made which has resulted from lack of reasonable care. Normally this would result in a penalty of 30% of the tax underpaid as a result. However, where the taxpayer makes full disclosure of the inaccuracy before HMRC start to enquire into the taxpayer’s affairs, the discounts for disclosure allow the penalty to be reduced to zero. Disclosure is covered by the legislation at para 9 of Finance Act 2007 Sch 24. Rather than just identifying an error to HMRC the law provides that disclosure includes three steps:

• Telling HMRC about the inaccuracy
  
• Giving HMRC reasonable help in quantifying the inaccuracy, and
  
• Allowing HMRC access to records for the purpose of ensuring that the inaccuracy is fully corrected

When disclosure is made, the law provides for the 'quality' of the disclosure to be measured in relation to the timing, nature and extent of the disclosure. So if an inaccuracy which has arisen from a failure to take sufficient care is discovered fully and promptly to HMRC (disclosure including all of the steps above), then the penalty will be mitigated to zero.

Mitigation is present under the current system of penalties, but how it is applied and in respect of what is much more carefully set out in the legislation, leaving little room for individual officers to vary the penalty, leading to more consistency.

Suspension of penalties

Finally, and the most surprising aspect of the new regime is the suspension of penalties. This applies only to failure to take reasonable care, and would not be appropriate in every case, but it is considered that a significant number of penalties could be suspended once the new regime commences. The principle is the same as suspended sentences in criminal cases. The penalty that would otherwise apply is set, but not levied. Conditions are set, and if these are met during the period of suspension (up to two years), the penalty is cancelled. The UK is the first tax authority in the world to explore suspended penalties in this way, and this is an essential part of the new regime which is designed to increase voluntary compliance from honest taxpayers, and divert resource to dealing with dishonest taxpayers. The suspension of penalties will apply where the cause of the error is systems related, and allows HMRC to set conditions to ensure that errors of this type do not arise again. The view is that money spent on penalties is wasted, and much better spent improving systems to ensure future compliance – again meeting the objectives of the powers review by promoting voluntary compliance.

The expectation is that many inaccuracies will not lead to penalties in the future, which is probably going to be a shock to compliance staff, who are currently being trained on the high level issues in relation to the new penalty regime. The detailed operational guidance for this new regime is still being written, but once that is available we shall be better able to judge the detailed impact on our clients and be ready to advise accordingly. HMRC are also introducing new internal management information systems to monitor the penalty regime to ensure that the application of the rules is consistent from tax to tax and across the country. Hotspots where 'too many' penalties are being charged can then be identified and additional training given as necessary.