As expected, new penalty arrangements for late returns and late payments of tax will be legislated for in Finance Bill 2009. The new penalties have been the subject of extensive consultation, and HMRC even undertook some independent research into taxpayer behaviour with regard to late filing.

The new system will abolish the “capping” process used in relation to late filing penalties for self assessment returns, but will retain the principle of “reasonable excuse”. The initial penalty for most late returns will be set at £100, with a modest daily penalty of £10 per day applying automatically once the return is three months late. Higher penalties, and tax geared penalties will follow if the return remains outstanding for longer than six months.

Concerns about those taxpayers with very low tax liabilities, or those due a refund getting penalised will be addressed by HMRC working with specific groups such as pensioners to try to ensure that they have the support that they need.

There is a separate set of rules proposed for late returns under the construction industry scheme, which will see the rolling £100 per month fine come to an end, replaced by a single fine of £100 followed by a second fine of £200 at the three month point. This means that the very significant penalties which apply when a business has not realised that they fall within the scheme will be a thing of the past. Although the penalties are still quite substantial, given that they will arise on each month’s returns, they are nowhere near the current system of penalties which impose a total penalty of £1,200 on a single return that is 12 months late.

There will also be penalties for late payment of tax liabilities, which will run at the same time as penalties for late filing. These are similar in structure to the current surcharge mechanism used in self assessment for individuals. Penalties will be suspended if the taxpayer has agreed a time to pay arrangement with HMRC – this current practice will be put on a statutory footing.

Quite serious concerns were raised in the last consultation about the intention to raise penalties on businesses paying over PAYE and NIC late during the tax year, for which there is currently no penalty (except for the very largest employers). The mechanism planned to raise penalty charges on these businesses would require additional analysis on the P35 return in order to show the monthly amounts due. HMRC has accepted the concerns, and will first look at imposing penalties on a “risk assessed” basis, rather than asking all employers to undertake additional administrative tasks.

The only surprise is that VAT penalties are not to be legislated for this year. Although VAT obligations have been aligned with the main direct taxes in all of the other powers measures, penalties for late VAT returns and late payment of VAT will not come in the first phase.

More details? See Budget Note 90 [1]