It is unwise to irritate HMRC and, therefore, vital to know how the tax system works and how to avoid penalties Words Adam Bernstein Illustration Snowdon Fine Animation.
How would you react if the advice, following an HMRC investigation, was to wind up your business to pay a tax bill that, it transpired, was incorrectly levied? With horror no doubt.
That’s what happened in a case sent to the First-tier (tax) tribunal which was ruled upon in May. And when the ruling was handed down, HMRC didn’t come out smelling
The circumstances were grim. A chain of beauty salons – Angel Beauty Parlour Limited – was the victim of excessively demanded tax that was based on a series of wildly incorrect assumptions. Further, HMRC gave such unclear instructions to the taxpayer about an appeal so as to almost deny it justice. Luckily, the tribunal ruled that the PAYE and National Insurance demanded (£528,056) and penalties (£369,639) were “unreasonable, even ludicrous”. Those in need of sleep can read more, searching for case reference TC07093.
For some, HMRC has lost all common sense. As Jason Piper, senior manager, Tax and Business Law at the ACCA, notes, HMRC historically “had a good public record at the tribunals. But alongside HMRC’s restructuring, every appeal decision is now reported, and one particular case hit the national press – a Polish electrician who’d lost his home was pursued by HMRC with penalties for failing to update his address while homeless. The case was thrown out by a judge who branded HMRC’s actions as ‘ridiculous’”.
At issue, says Piper, is that while HMRC’s systems are sensitive to anything out of the ordinary, “the staff actually running the enquires tend to be less experienced than was previously the case, and won’t have ‘local knowledge’ to help guide them to where the money is”. He knows of former tax inspectors who recall being trained by veterans to “recognise when an enquiry should be dropped because there’s either a clear explanation, or because the likelihood of tracking a genuine error is too small”.
But between the reorganisation of HMRC staff into regional hubs and the exodus of experienced investigators, much of that knowledge and pragmatism has been lost. Piper says: “An officer working a case often simply doesn’t have the commercial experience to recognise an unusual, but perfectly legitimate, structure or set of transactions, and being under pressure to maximise yields may be reluctant to drop a line of enquiry.”
This is illustrated by data from law firm Pinsent Masons. It found that HMRC’s tax investigations into large businesses are now taking more than three-and-a-half years to settle, reaching a record 43 months in 2018/19, up 10% from 39 months in 2017/18.
Of course, HMRC needs regimes in place that are backed by penalties.
Whether missing a deadline or deliberately seeking to evade tax, some penalties are automatic – self-assessment returns for example. HMRC issued 1.04 million late filing penalties for returns due for the 2014/15 tax year. There were another one million late filing penalties issued for tax returns due for the 2015/16 tax year. Even worse, it appears that in January (2019), an HMRC technical glitch led to some taxpayers receiving inaccurate payment reminders that led to the wrong amounts of tax being paid and a fine as a result.
Tax investigations start for one of two reasons – targeted intervention or a random enquiry. Piper says that “HMRC are understandably coy about the factors that prompt targeted investigations, but it is clear that they rely on technology and data analysis to select taxpayers for investigation”. He says those selected for enquiry will have triggered a risk flag.
Becky Maguire, corporate tax partner at BPIF partner, Garbutt + Elliott, echoes what Piper says, but adds that HMRC’s enquiries “can be connected to a wide range of factors – they may be specific to a taxpayer, for example a profitable business suddenly makes a large loss, or they may be a result of a wider HMRC industry review”. She can see why HMRC puts a lot of effort into risk-based assessments that are assisted by sophisticated software which pulls in information from a variety of sources – “this means it can target enquiries and investigations more specifically”. She says it is worth remembering, though, “that HMRC carries out a number of compliance checks every year where there isn’t necessarily any suspicion of wrongdoing.”
The natural response when handed a penalty is to offer an excuse. The problem for most is that their excuses just don’t carry any water. HMRC regularly publishes the most “popular” excuses it receives which, in January 2019, included “my mother-in-law was a witch and put a curse on me”, “I’m too short to reach the post box” and “my boiler had broken and my fingers were too cold to type”. None had any application.
HMRC believes that a taxpayer should be “a prudent person, exercising reasonable foresight and due diligence, having proper regard for their responsibilities under the Tax Acts”. It also expects every individual or business “to keep records that allow them to provide a complete and accurate return… and check with their agent, or HMRC, to confirm the correct position.”
Reasonable or not?
So, what is a “reasonable excuse”? Guidance from HMRC allows for a number, including a taxpayer’s close relative or domestic partner passing away or falling ill around the time they should have filed their return or paid tax; and unforeseen events which can include delays due to industrial action or returns and payments being lost in the post.
As to what might not, or will rarely, be considered reasonable, HMRC says these include a deliberate failure to submit a tax return on time; insufficient funds – but not if the shortage could not have been reasonably foreseen by the taxpayer, or the lack of funds is down to something outside of their control – the lockdown at TSB bank in April 2018 would probably count; or reliance on someone else unless it can be shown that the taxpayer took “reasonable care” to avoid the compliance failure – hiring a professional accountant as opposed to a family friend, for example.
Pre-empt an inquiry
Where intervention is likely, Piper’s suggestion is to “always take advice before engaging with HMRC as there have been too many reported cases where taxpayers would have been wrong to rely on HMRC’s interpretation or application of the law.” He adds that a firm’s accountant “may have the detailed knowledge of tax enquiries to assist directly, or they might want to refer the case to a specialist firm; either way, talk to them first and don’t hold anything back”.
Maguire takes a similar tack. She says: “It is never worth burying your head in the sand about errors. Apart from getting peace of mind, HMRC also takes into account that taxpayers have voluntarily come forward when it considers penalty calculations.”
Alex Millar, a senior VAT consultant and one of Maguire’s colleagues, explains that “the current penalty regime is designed to encourage businesses to disclose errors to HMRC before it discovers them.” He says that the process requires telling HMRC about the errors, helping it quantify the tax relating to the errors, and allowing HMRC to access records for the purpose of ensuring the errors have been corrected. Millar continues: “But in order to benefit from full penalty mitigation, the disclosure must be unprompted, which means it must be made at a time when there is no reason to believe that HMRC has discovered the errors or is about to discover them.”
Clearly, a voluntary disclosure will always be better than waiting for HMRC to find the problem – but it must be done carefully and correctly. Again, Piper says that expert advice is critical to make sure that “the declaration doesn’t prompt more questions than you’ve answered, while being ready to head off any other enquiries HMRC might think are linked to the initial disclosure”.
Maguire also says to involve an adviser early on: “They will be able to help you consider your case, build supporting evidence for the position you’ve taken and help you understand the strength of HMRC’s position.” She adds that the BPIF has a financial support partner that offers advice, support and solutions (via firstname.lastname@example.org).
But advice costs and the smallest businesses may not be able to afford professional fees. Here, Piper says to consider tax charities such as LITRG, TaxAid, or Citizens Advice “who should be able to point you in the right direction”.
However, Piper says companies can also insure against investigation risk with fee protection insurance. In his view, “it should be considered as part of the suite of legal protection insurance that every business should invest in, alongside products such as directors’ and officers’ liability insurance.”
He’s seen the costs of defending against an HMRC enquiry, even where no tax is due, easily run into thousands, and tens of thousands if a complex appeal arises and says that “having that covered by insurance will make a huge difference to the stress of dealing with the investigation”.
But as Maguire says, this form of insurance is very much an individual decision for each taxpayer or business owner to make – its value “will depend on a number of factors including the frequency and length of tax enquiries, the complexity of the business, the overall risk and control environment within the business, and whether or not an adviser is being used”.
The harsh reality
It is absolutely key to remember that the word “reasonable” can mean different things to HMRC and taxpayer; those in doubt should consider taking expert advice before fighting a losing case that will both drag out the inevitable and cause stress at the same time.
But to Maguire goes the last word. She reiterates that “HMRC is under increasing pressure to get results from investigations and enquiries to justify the resource it has committed. This, combined with an environment where HMRC is under increasing scrutiny, means that it is unlikely to be a soft touch when it comes to applying penalties to tax errors”.
Worryingly, she’s seen an increasing trend for HMRC to raise penalties where there are tax adjustments.
You have been warned.
Boxout: Avoid planning to fail
Tax compliance failures are easy to list and include late filing of tax returns, failure to submit a tax return, late payment of tax, failure to notify HMRC of a tax liability, and a failure to provide information and documents.
The actual penalty will depend on how convincing an excuse is and whether the taxpayer can show that “reasonable care” had been taken in complying with their obligations.
If errors arise with a tax return, HMRC will decide whether to impose a penalty, but they tend to follow on automatically precisely because the error was made. The penalty will be graded according to the degree of blame that lies with the taxpayer. HMRC uses three categories: “careless” – a maximum penalty of 30% of the missing tax; “deliberate but not concealed” – a maximum penalty of 70%; or “deliberate and concealed” – a penalty of 100% of the missing tax, more if the error is serious.
Penalties can be suspended by HMRC, in total or in part, for up to two years. This doesn’t happen often, and a taxpayer has to request it.
Where “deliberate” errors have been found, penalties cannot be suspended. What happens next depends on whether the error was disclosed by the taxpayer to HMRC and whether the disclosure was “prompted” (by, say, a visit) or “unprompted” (the taxpayer’s own accord).
In circumstances when taxpayers have taken “reasonable care” and have a “reasonable excuse”, HMRC may not impose penalties, but it will be up to the taxpayer to prove their case. “Reasonable care” and “reasonable excuse” are not defined by HMRC.
HMRC has the power, in certain circumstances, to provide a “special reduction” to remove a penalty entirely. These situations are considered on a case-by-case basis, and HMRC offers no real definition of what constitutes “special circumstances”. Another option open to HMRC is to “stay” a penalty – this effectively delays enforcement of a penalty.
Boxout: How to appeal a penalty
Appeal first to HMRC
For direct taxes such as Income Tax, Corporation Tax or National Insurance, an appeal will be handled by an HMRC officer not previously involved with the penalty decision. However, those wanting to appeal a penalty about “indirect tax” such as VAT or customs duty can either request a review by HMRC or appeal straight to the tax tribunal (also known as the First-tier Tribunal).
Penalties sent by post include an appeal form that should be completed and returned within 30 days. If no form was included, the taxpayer should write to their tax officer with their details, tax reference and an explanation for the error.
To appeal a Self-Assessment penalty, the tax return must have been submitted (or HMRC told it was not needed). An appeal must note the date the penalty was issued, date the tax return was filed and the excuse for the delay. Appeals for tax years from 2016 can be made online (but will need a Government Gateway account). Postal appeals require form SA370 (SA371 for partnerships).
A PAYE penalty is appealed online through HMRC’s PAYE for employers service, selecting “Appeal a penalty”.
Appeals involving a late VAT or Corporation Tax return require specific forms - WT2 for VAT if there’s a reasonable excuse, and Corporation Tax WT1 if the issue arose because of a computer problem (note the date of the failure and any system error messages).
It is important to appeal within 30 days of the date of the penalty notice, otherwise an explanation of why the deadline was missed will be required.
Disagreeing with HMRC’s review
There are two options for those wanting to take the matter further – refer the case to the tax tribunal within 30 days or send the case to alternative dispute resolution (ADR). ADR does not remove the right to take the matter through to appeal and can only be used when matters relating to information are involved. Disputes over the penalties themselves are outside of the ADR process.
Tax tribunals can hear appeals and are independent of government. It will hear direct tax appeals (such as Income Tax, PAYE, Corporation Tax, Sick Pay and Inheritance Tax), but only after HMRC has reviewed the penalty first. Indirect taxes such as VAT can be sent straight to the tribunal. There will be a time limit for the appeal which will be noted on the decision letter from HMRC. The tax will usually have to be paid before the appeal, but penalties can be paid after a hearing. It’s possible to seek a “closure notice” in relation to direct taxes to halt HMRC investigations.
The actual appeal to the tax tribunal is made online or by post using form T240.
Not all cases involve a hearing, but 14 days’ notice will be given if one is to be held. The hearing is public and requires all papers including letters, invoices, accounts, HMRC decision letter and response. Each side may receive a bundle of documents from the other, and each can take representation and witnesses.
A taxpayer who loses at the tax tribunal may seek to appeal further if there was an error in the law being applied or can have the decision “set aside” (cancelled) if there was a procedural error. There are time limits – 28 days to seek full written reasons for the decision and 56 days to ask to appeal further. If permission to appeal has been refused, it is still possible to appeal to the Upper Tribunal (but only be granted on limited grounds).
More details are available on the gov.uk website.
Boxout: Deliberate tax defaulters
Once a quarter, HMRC publishes a list of those taxpayers who have been caught out deliberately defaulting on their tax paying obligations .
On a previous list, published mid-March, is Prism Perceptions Ltd, formerly of Bromsgrove, who between May 2012 and July 2015 defaulted on £69,660 and was given a penalty of £30,476; and Harun Miah – a print and copy shop – formerly of Northampton, who was given a penalty of £54,373 for defaulting on £74,997 between August 2010 and January 2015.
On the list published in June was Sterte Print Limited of Wimbourne and formerly Poole, an online printer, which was handed a penalty of £18,721 on tax defaulted of £39,622. The default occurred between May and November 2017.