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.
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.
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.
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.
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.
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.