Tax return software gave the wrong answer

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It's important to use the right tool for the job, and this applies to tax software same as anything else. The case of Adam Cooke illustrates why you need to understand what your tax software is doing.

Not tax specialists

Adam Cooke (TC06239) was a client of a small firm of accountants which didn’t have a separate tax department. The accountants and clerical staff prepared the tax returns using PerTAX software, which were then reviewed by a partner of the firm before they were sent to clients for signature. The partner’s review was largely a sanity check for obvious errors and omissions rather than a detailed analysis; essentially the firm relied on the tax software to perform a correct tax calculation.

Foreign income

In 2012/13 and 2013/14, Cooke received dividend income from France and Canada which had tax deducted at source the rates of 30% and 25% respectively. This income was correctly reported on the foreign pages of his tax returns, alongside deductions for the foreign tax already paid. The accountant assumed the PerTAX software would accurately calculate how much foreign tax could be set against Cooke’s UK tax liability.

Foreign tax credit

Unfortunately, the tax software didn’t take account of the 15% cap on foreign tax credit relief set-out in the double taxation treaties between the UK and France, and between UK and Canada. This is a fairly standard rate of tax relief (known as the ‘treaty rate’) for dividends paid to portfolio investors who hold no more than 10% of the company. The PerTAX calculations included all of the foreign tax deducted as credits against the UK tax liabilities for 2012/13 and 2013/14, so the tax relief was overstated and UK tax was underpaid.

HMRC review

In 2015 HMRC conducted a review of all SA tax returns which included claims foreign tax relief and discovered the error on Cooke’s 2013/14 self-assessment. An enquiry was opened into that tax return within time, but the enquiry window for the 2012/13 tax return had already closed.

Discover assessment

As HMRC could not open an enquiry into the 2012/13 tax return, it issued a discovery assessment of £16,560 on 19 January 2016. This was within the four-year limit for such assessments imposed by TMA 1970, s 29. However, for this assessment to stand HMRC needed to prove two things:

  • That the taxpayer (or his agent) had been careless in not spotting there was an error in the tax computation submitted as part of the return
  • HMRC could not have reasonably been expected to have spotted this error because there was insufficient information on the return to alert an HMRC officer.

A “catch-22” problem for HMRC to overcome.

Accountant’s argument

The accountant in this case was very fortunate to be represented by Robert Maas, one of the most experienced tax experts in the UK. His book on Taxpayers’ rights and HMRC powers is a leading work on tax enquiries and penalties, so it fair to say that there is nothing that Maas doesn’t know about discovery assessments.

Maas argued that the accountant was not careless, and that HMRC (or its software) should have been able to spot the problem with the tax computation.

Tribunal ruling

The tribunal judge said “I would expect any HMRC officer of general competence, knowledge or skill to have some understanding of double tax relief, including that there are limitations on the relief that can be claimed.” He added, “The point is not a complex one, and in my view it did not require any ‘white space’ entry or other flagging up.”

The judge concluded that HMRC should have picked up the error, which it did, when the tax return was manually reviewed.

He also ruled that the accountant was not careless, as it was reasonable to assume that the foreign tax credit would be calculated accurately by the tax software, or at least that there would be some warning that it might not be. The fact that the HMRC software did not pick up the computational error when it processed the tax return appeared to influence the judge on this point.

Test and check

It is obviously impractical to check every tax calculation that your tax return software produces. But it is prudent to review a sample of tax computations where unusual categories of income or tax reliefs are reported, and either run the figures though a different firm’s software to check or reperform the calculation by hand. If your tax software doesn’t cater for the complexities of your clients’ tax affairs you are heading for a fall.

About Rebecca Cave

Consulting tax editor for Accountingweb.co.uk. I also co-author several annual tax books for Bloomsbury Professional and write newsletters for other publishers.

Replies

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15th Jan 2018 09:48

we prepare all our tax comps manually on excel and then check these to what the software chucks out

anyone relying solely on software isn't doing the job properly in my opinion

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to ohgoodgodno
15th Jan 2018 10:20

in my opinion that is rubbish

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to ohgoodgodno
15th Jan 2018 10:47

My method is similar. I do my own calculation first, then run it through the HMRC software. I find it invariably helps to locate errors, and I don't submit a return until the two calculations match and I am satisfied in my own mind I have resolved any technical issues.

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to Agutter Accounts
15th Jan 2018 12:03

Me too.

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to Agutter Accounts
15th Jan 2018 12:03

Me too.

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to Agutter Accounts
15th Jan 2018 14:21

Me too

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By chatman
to ohgoodgodno
15th Jan 2018 12:26

I'm the same. Every time Excel adds something up, I check it on a calculator.

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15th Jan 2018 11:14

This is interesting.With identifying the correct foreign tax credit applicable you almost have to start from the finish.I have spent ages on this,often for some very small amounts.Generally however with automated tax comps,remember last years problems with HMRC unable to accept all comps and ran off a long list of possible incompatibility’s .A couple of people last week in my office,doubted the dividend tax result produced in a case as it seemed non sensical.I had actually checked it out with a spreadsheet my software house produced and the HMRC result and everything tallied.The two of them spent about an hour on this (in January) and eventually agreed although the comp was non sensical it was right.Much to my relief.One of the colleagues was about to speak to IT support and said that a (Jan) update was correcting a software computation error !I am glad this is my last January rush.

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By kattony
15th Jan 2018 11:48

This case is noted.
However,I have just had a similar experience with a current well known Tax Software problem and the Dividend Tax for 2016/17.

This tax was worked by me longhand using the HMRC Dividend Allowance Factsheet: Example 6. It told me that the Dividend Allowance was used first against any balance of the Basic Rate Income Tax band. In my case there was still some Basic Rate Income Tax Band not used. I charged the part of the dividend balance up to £32,000 at the lower Dividend Rate of 7.5% and the remainder at 32.5%. These figures were in excess of the amount of tax payable shown by my software.

When I queried this with the software company I was told that their programme had been made to access the HMRC Tax Return site so that the Tax Return files could be submitted via the Internet.

Was my calculation wrong and if so where?

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By kattony
15th Jan 2018 11:49

This case is noted.
However,I have just had a similar experience with a current well known Tax Software problem and the Dividend Tax for 2016/17.

This tax was worked by me longhand using the HMRC Dividend Allowance Factsheet: Example 6. It told me that the Dividend Allowance was used first against any balance of the Basic Rate Income Tax band. In my case there was still some Basic Rate Income Tax Band not used. I charged the part of the dividend balance up to £32,000 at the lower Dividend Rate of 7.5% and the remainder at 32.5%. These figures were in excess of the amount of tax payable shown by my software.

When I queried this with the software company I was told that their programme had been made to access the HMRC Tax Return site so that the Tax Return files could be submitted via the Internet.

Was my calculation wrong and if so where?

Thanks (0)
to kattony
15th Jan 2018 13:30

kattony wrote:

This tax was worked by me longhand using the HMRC Dividend Allowance Factsheet: Example 6.

Was my calculation wrong and if so where?

Example 6 in the HMRC dividend fact sheet is incorrect.
I suspect that your calculation is also wrong. You have likely made the same mistake as HMRC by not allocating the PA in the most efficient manner.

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By mabzden
16th Jan 2018 15:34

TBH, I would agree with HMRC that its system shouldn't have to check whether entries an accountant has entered in a tax return are consistent with tax treaties.

It feels like the rules are badly drafted. As a result this individual taxpayer got off paying 16k that everyone seems to agree they should have paid at the time. Presumably they cracked open the champagne when they heard the result.

The law, sometimes, is a bit of an [***].

(PS. The accountingweb bad language filter obviously finds donkies offensive.)

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15th Jan 2018 12:06

Interesting that this case seems to have hinged about comparative lack of software quality.

Grim!

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15th Jan 2018 12:26

Should the taxpayer have suffered the 30% and 25% deductions in the first place? Sadly probably.

As he did, then overall result is fair (HMRC are always banging on about 'fairness'...).

The 'treaty rate' seems to be another tax grab by HMRC which causes income to be taxed twice or a higher effective rate paid on certain income.

This is a fine example of how the tax system doesn't work properly and HMRC seeking to exploit it.

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to Ian McTernan CTA
15th Jan 2018 13:27

Ian McTernan CTA wrote:

Should the taxpayer have suffered the 30% and 25% deductions in the first place? Sadly probably.

The taxpayer should have informed the payer of the residence status and the wht would have been reduced accordingly.

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15th Jan 2018 12:41

Perhaps the wider issue is that if software approved by HMRC means that less tax is collected that HMRC are going to have a harder task in collecting the extra.

HMRC is now on notice to make the tax code simpler....

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15th Jan 2018 12:47

I have just been speaking to an accountant who has used HMRC's online system to file a client's return. The details (simplified) are £39,000 salary, £2,400 interest and £6,400 dividends. Pension contributions of £1,750 gross.
HMRC make the tax £6,435 but the correct figure is £6,260. Take out the pension contribution and then HMRC will get the correct figure of £6,260. (In other words the HMRC system increases the tax by £175 if you have a penson contribution!)
The HMRC response dated 10 January 2018 was "I have sought advice from our Technical Support who have advised that we cannot comment on the software that you use and that the calculation we issued stands".
Oh dear ...

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15th Jan 2018 12:54

Nobody comes out of this looking good.

PerTax software, for not recognising the problem. Our own well known software provider is equally deficient in this regard and always has been!

HMRC software, ditto. I wonder what HMRC's own
software does with this, and what the input screen requests/advises, anybody know? Clearly the one that checks the third party software filing hasn't a clue.

The accountant, for getting involved with the taxation of substantial foreign dividends whilst clearly lacking the required skills.

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15th Jan 2018 13:08

"As HMRC could not open an enquiry into the 2012/13 tax return, it issued a discovery assessment of £16,560 on 19 January 2016. This was within the four-year limit for such assessments imposed by TMA 1970, s 29. However, for this assessment to stand HMRC needed to prove two things:"

Its not "needed to prove two things". It's "needed prove one of of two things". Proving A or B is easier than proving both A and B. But in fact its prove one of three things. The criterion you omitted was that the loss of tax was brought about deliberately by the taxpayer or someone acting on his behalf (ie fraudulently).

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15th Jan 2018 18:30

I can’t recommend the Taxpert tax calculator app enough for a sense check against tax software calculations. Tim sends regular updates through the course of the year and for about £95 it’s worth every penny to give that peace of mind that the software is doing what it’s supposed to!

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