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Is your client a Damien, an Attila, a Desmond or a Douglas? By Will Heard

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2nd Feb 2007
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HMRC’s proposed tax geared penalties regime is scrutinised in the second of Will Heard’s three articles.

In my last article, I briefly considered the main changes that will affect the calculation of tax geared penalties both for direct and indirect taxes. I also noted that we are going to have to take account of the fact that the new structure incorporates subjective concepts into tax law far more than hitherto such that HMRC officers will have a near monopoly on what is or is not considered to be reasonable behaviour in a given circumstance.

The officer’s viewpoint is always important in tax investigation negotiations but now it will be crucial in that it will determine the base position from which the final penalty can be negotiated. That base position will not be the difference between a few percentages of tax. It could be the difference between a starting point of somewhere between 0% and 50% of the outstanding tax (see below).

In this article I do not propose to compare and contrast the old and proposed new systems but more to expand on the contents of the consultative document based on information supplied to delegates at a workshop recently held by HMRC to discuss the proposed new penalty powers.

Let me first explain the foundations of the proposed penalty determination structure.

Section 3 of the proposed Act defines three degrees of culpability as follows:

Inaccuracy in a document given by P to HMRC is –

  • a) “careless” if the inaccuracy is due to failure by P to take reasonable care,
  • b) “deliberate but not concealed” if the inaccuracy is deliberate but P does not make arrangements to conceal it, and
  • c) “deliberate and concealed” if the inaccuracy is deliberate and P makes arrangements to conceal it (for example by submitting false evidence in support of an inaccurate figure).

Section 4 states that the penalty for careless action is A% of the potential lost revenue. It is B% for deliberate but not concealed action and C% for deliberate and concealed action.

However, under Section 7 there is mitigation for different gradations of disclosure so that under section 7(3) “where HMRC think that a person who would otherwise be liable for a penalty of A% has made an unprompted disclosure, HMRC shall reduce the A% to a percentage (which may be 0%) which HMRC think reflects the quality of the disclosure”

There are similarly worded subsections to cover the other degrees of culpability but they define vastly different results in terms of the minimum and maximum levels of penalty that will apply under various types of disclosure.

Let us call cases that attract an A% penalty a Class A case, B% a Class B case and C% a Class C case.

We have seen that the penalty range for a Class A case is between 0% and A% but only where the person has made an “unprompted disclosure”.

Section 7 goes on to define penalty ranges depending on whether there has been an unprompted or a prompted disclosure in all classes of case.

A Class A case exhibiting a “prompted disclosure” will attract a penalty in the range E% (which must be higher than 0% by definition) to A%.

The full matrix is as follows:

DISCLOSURE CLASS A CLASS B CLASS C
Unprompted 0% to A% F% to B% H% to C%
Prompted E% to A% G% to B% I% to C%

So in all cases the minimum penalty for a prompted disclosure will be higher than the minimum penalty for an unprompted disclosure and the maximum penalty in each succeeding class will be higher than the maximum penalty in the preceding class.

The consultative document does not define these penalty levels. This is understandable because, in my view, these levels are just about the only area in the document that are still not yet fully decided.

However HMRC were not so coy in the consultative workshop on the new penalty regime when certain percentages were discussed in detail. Whilst the following figures are not cast in stone nevertheless the general level of penalty range from each case can be gauged from the discussed levels.

These were as follows:

DISCLOSURE CLASS A CLASS B CLASS C
Unprompted 0% to 30% 20% to 70% 30% to 100%
Prompted 15% to 30% 35% to 70% 50% to 100%

One does not have to be too awake to realise that these proposals represent a massive hike in the potential penalty for a many different gradations of tax offence.

On a simplistic level if we assume that over time the statistical average for each range of penalties will be achieved in practice then the average unprompted disclosure penalty levels will be 15%, 45% and 65% for the three classes respectively and the average percentages for prompted cases will be 22.5%, 52.5% and 75%.

Contrast this with the average level of penalties for all classes that has prevailed in recent years of about 25% (see my first article) and you can see that the tax investigation scene is due for a dramatic change.

The forthcoming “amnesty” for people disclosing tax evasion will, apparently, involve sweeteners in the form of maximum tax geared penalties of maybe 10% or 20%. In my view the time horizon for such disclosures will be from now until FA 2007 comes into force. Any recalcitrant clients should get their disclosures in while stocks of HMRC good will last.

By the way – a Damien (Hirst) is a first class honours degree, an Attila (the Hun) is a 2:1 degree, a Desmond (Tutu) is a 2:2 and a Douglas (Hird) is a 3rd so which class of disclosure will your client be awarded by HMRC when the taxman next calls?

Readers should not forget that these proposals cover both direct and indirect taxes.

If we take an overview for the moment it seems that the basic structure echoes the current direct tax penalty regime more closely than the indirect tax regime.

The two principal differences in the direct tax area are that the gradations of tax “offence” have been more rigorously defined (albeit with ample scope for argument about the meaning of various words and phrases) but still remain in principle and secondly that minimum tax geared penalty levels will apply in law to these various gradations as opposed to the current operating parameters laid down within the manuals of instruction.

The indirect tax position is somewhat different. The concepts of misdeclaration, repeated misdeclaration, reasonable excuse and dishonest conduct disappear to be replaced by the Class A, Class B and Class C offences.

Moreover, the minimum level of penalty in each class is likely to be far higher than the current levels applied to all but the most heinous of VAT offences.

In my experience, for example, a well prepared, complete and timeous disclosure of a major VAT fraud involving understated VAT of nearly £70,000 dealt with on civil lines lead to a penalty of 20% (it would have been 15% for a voluntary disclosure) whereas the direct tax penalty consequences in the same case gave rise to a 40% penalty. Admittedly the amount of income tax involved was much higher than the VAT but the absolute amount of VAT and income tax in money terms is only one part of the driver determining the percentage level of penalty.

Under the proposed regime the minimum direct tax penalty would be 50% (on my understanding of the proposed rules) and so would the minimum percentage penalty for the VAT offence.

So what practical effects are likely to flow if these proposals are put into law or, perhaps, the question should be what practical effects does HMRC hope will flow from them.

This question cannot be answered in isolation from other events which may well occur alongside the introduction of the proposed legislation. I have in mind two recent phenomena.

Firstly the unlocking of a massive amount of information about UK residents with offshore bank accounts and trusts that is currently underway as high street and other banks yield up their secrets under current information gathering procedures.

Secondly the increasing intensity of inter government intelligence about the financial activities of UK residents abroad through more comprehensive adherence to international anti money laundering rules as well as the likes of Spain and France giving detailed information to our government about UK residents who own and rent out many thousands of properties in these countries.

Not only will such information give rise to new techniques to increase the government’s cash flow such as the imminent so called “amnesty” but HMRC will have available to it much better quality information about potential tax evasion.

Together with the increased penalty base for all types of tax evasion this should encourage a far higher take from tax investigation work as a whole as well as encouraging those tempted to evade taxes to think twice before they do so on the basis that they are more likely to be detected so increasing the average tax take from the population as a whole without putting increased pressure on basic and higher rates.

Time will tell on that one but with the freedom of information powers now available to check how well the proposed system is working perhaps we will be able to monitor results more closely than hitherto.

In my next article I will pick up some of the other changes promised in the consultative document for exploration and comment.

Will Heard is a tax investigation specialist working in Chartered Tax Advisers Shaw & Co in Edgbaston, Birmingham (www.shawtax.co.uk). He may be contacted on 0121 452 1515 or [email protected]

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By User deleted
05th Feb 2007 15:24

Penalties for timing errors?
A lot of VAT errors arise through timing errors but there is no overall loss to HMRC as they are corrected in the following return (possibly through not being aware of the error at all). Does HMRC really intend to impose these kinds of percentages for a 3 month timing error?

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By deanshepherd
05th Feb 2007 18:51

Slightly off topic but..

..surely everyone knows it's a Geoff rather than a Damien?!

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Richard Murphy
By Richard Murphy
05th Feb 2007 17:31

Let's just worry about case 1
Situations 2 and 3 noted by Will involve fraud - deliberate tax error is that, no more or less. I remain astonished that the penalty isn't 100% PLUS a fine in these cases. Why not? Isn't corruption worth that much?

Let's then turn to case 1. This is where the real problem lies with these proposals. This situation assumes at least carelessness. It should not. It should allow for mistake i.e. genuine error in fact or in interpretation. This should carry no penalty at all.

I know this is possible under the rules - but the assumtpion will be that 10% will be due as a minimum. That's not acceptable. Mistake is a fact of life. It need not carry penalty if innocent.

In summary, this proposal gets it wrong at both extremes: the crooks will be winning and the innocent will be penalised. That's not good enough.

Richard Murphy
http://www.taxresearch.org.uk/blog/.


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By specialtax
06th Feb 2007 08:14

They think it's all over.............................

........................it is now!

Dean,

Sir Geoff will always live in my memory as the greatest goal scorer the World Cup FINAL (a hatrick) has ever seen but Damiens now loom large in the academic lexicon though, unfortunately my lads had to think in terms of Dezzys and Duggies

Andrew B and Richard Murphy -

the consultative document does have a lot to say about the Class A cases and the various VAT penalty situations but space did not permit a more in depth examination of either. However my planned three articles have already spilled over into a proposed fourth article so I may be able to deal with some of these issues in that one (assuming Accounting Web are happy that I do a fouth one).

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