FAQ: New penalties for errors in tax returns – updated 28 May 2008

Contents

Questions and answers


Q1. What taxes will be subject to the new penalty regime and when will it start?
Q2. Why does HM Revenue & Customs (HMRC) need to charge penalties?
Q3. Why is HMRC changing its penalties?
Q4. When could a penalty be charged?
Q5. How is the penalty charge calculated?
Q6. What can a customer do to reduce a penalty?
Q7. What should someone do if they discover an inaccuracy in a return or document they’ve already sent to HMRC?
Q8. What is reasonable care?
Q9. What does this mean for customers?
Q10. Can the new penalties be suspended?
Q11. Is the purpose of the new penalties to raise more money?
Q12. Does the new legislation change taxpayers’ record keeping requirements?
Q13. What about the other taxes?
Q14. Who have we consulted about the changes?
Q15. What information is available?
Q16. How can we be sure HMRC officers will apply these penalties properly?
Q17. How will the new penalties affect the voluntary disclosures customers can make for indirect taxes like VAT?

Q1. What taxes will be subject to the new penalty regime and when will it start?

The new penalty regime is for errors on returns and documents, initially for VAT, PAYE (Pay As You Earn), National Insurance, Capital Gains Tax (CGT), Income Tax, Corporation Tax (CT) and the Construction Industry Scheme (CIS). It does not apply to any benefits or credits like Tax Credits, or to the National Minimum Wage (NMW).

For these taxes, it applies to returns or other documents for return periods starting on or after 1 April 2008 that are due to be filed on or after 1 April 2009. The legislation is Schedule 24 of Finance Act 2007.

That means customers who don’t take reasonable care to get their taxes right may incur a penalty for errors made during 2008-09 and later years.

Q2. Why does HM Revenue & Customs (HMRC) need to charge penalties?

Most people pay the right amount of tax and give accurate information and returns to HMRC. However, it is necessary to have the power to charge financial penalties for those who do not, both to deter such behaviour and to ensure fairness to those who do pay the right amount.

Penalties for errors are not new, both the Inland Revenue and Customs and Excise used them. What is new is a single consistent system of penalties that will apply to almost all of the department’s taxes.

Q3. Why is HMRC changing its penalties?

HMRC inherited a variety of penalty charging powers from its two precursor departments. Multiple systems and inconsistency can confuse customers and imposes undue burdens on them and the department alike.

The new penalties are one of the first pieces of cross cutting legislation designed to make the tax system simpler and more consistent. It follows consultation during the Review of Powers, Deterrents and Safeguards.

During the consultation under the Powers Review customers and their agents said they wanted a fair tax system - HMRC should support those who seek to comply, but come down hard on those who seek an unfair advantage through non-compliance. As a result, under the new penalties:

  • if a taxpayer can demonstrate to us they have taken reasonable care to get their tax right they will not be penalised if they make an error
  • if they do not take reasonable care errors will attract penalties and higher penalties if the error is deliberate
  • disclosing errors to us early will substantially reduce any penalty due

Clearer and harmonised penalties which are related to taxpayer behaviours should be an effective deterrent to non-compliance and reassure the compliant that the system is fair.

It is also designed to encourage people to come forward when they think there is a problem with their tax affairs or they have not met a requirement.

Q4. When could a penalty be charged?

Two conditions must be satisfied before we can charge a penalty.

The document given to us contains an inaccuracy that leads to:

  • an understatement of the person’s liability to tax
  • a false or inflated statement of a loss by the person
  • a false or inflated claim to repayment of tax

The inaccuracy must be careless, deliberate, or deliberate and concealed.

A penalty may also be considered where tax has been under-assessed because of the customer’s failure to send us a return, or where the customer has discovered an error in a document but not taken reasonable steps to tell us.

Penalties are chargeable for a tax period, eg a tax year, accounting period or other period for which tax is charged or due.

Q5. How is the penalty charge calculated?

The penalty percentages are applied to the additional tax due as a result of correcting the error (known as the potential lost revenue). There is a different measure of potential lost revenue where the error results in an overstated loss:

  • There is no penalty if a customer can demonstrate to us they have taken reasonable care to get their tax right, but submits an incorrect return. However, if the customer later discovers the error but does not take reasonable steps to tell us about it, the inaccuracy will be treated as careless – see the answer to Q7
  • The penalty is up to 30 per cent of the potential lost revenue if the error is careless
  • The penalty is up to 70 per cent of the potential lost revenue if the error is deliberate
  • The penalty is up to 100 per cent of the potential lost revenue if the error is deliberate and the customer conceals it

The percentages are stepped and are higher the more serious the underlying behaviour causing the inaccuracy. Penalties are significantly higher for those who deliberately try not to pay the right amount of tax, because we want to come down hard on those who seek an unfair advantage through non-compliance.

The penalty payable where tax has been under-assessed because of the customer’s failure to send us a return is 30 per cent of the potential lost revenue.

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Q6. What can a customer do to reduce a penalty?

There can be a substantial reduction in the level of penalty charged for unprompted disclosure of errors. A disclosure is unprompted if it is made at a time when the person making it has no reason to believe that we have discovered or are about to discover the inaccuracy or under-assessment.

Further reductions can be given based on the quality of the disclosure. To calculate the reduction we need to consider three elements of disclosure. Is the customer:

  • telling us about their error
  • helping us work out what extra tax is due
  • giving us access to their records to check their figures

The new penalties should encourage people to come forward when they think there is a problem with their tax affairs, or they have not met a requirement.

Q7. What should someone do if they discover an inaccuracy in a return or document they’ve already sent to HMRC?

Please contact us about the error, with full details, as soon as possible.

If the inaccuracy was neither careless nor deliberate at the time the document was sent to us it will be treated as careless if you do not take reasonable steps to inform us, after you have discovered the error.

Reasonable steps include, for example:

  • consulting with an accountant or agent to discuss the position so they can inform us
  • ringing us to discuss it
  • discussing it with one of our officers if there is an ongoing compliance check
  • emailing, faxing or writing to an HMRC office with details

Q8. What is reasonable care?

Each person has a responsibility to take reasonable care. But what is necessary for each person to meet that responsibility has to be viewed in the light of their abilities and circumstances.

For example, we would not expect the same level of knowledge or expertise from a self-employed and unrepresented individual as from a large multi-national company. We expect a higher degree of care to be taken over large and complex matters than simple straightforward ones.

Every person is expected to make and keep sufficient records for them to provide a complete and accurate return. A person with straightforward tax affairs may only need to keep a simple system of records, which are followed and regularly updated. A person with larger and more complex tax affairs may need to put in place more sophisticated systems and maintain them equally carefully.

We believe it is reasonable to expect a person who doesn’t understand a tax issue to take care to check the correct tax treatment or to seek suitable advice from HMRC or a tax professional. We expect people to take their tax seriously.

Q9. What does this mean for customers?

To take reasonable care customers should make sure that:

  • their accounting records, systems are documented and all in place from 1 April 2008
  • systems and processes are being followed
  • they look across all the taxes they pay when filing returns
  • they can show their decision making processes in relation to the returns submitted
  • they find out the correct tax treatment in relation to their circumstances or seek advice from a tax professional or HMRC

Q10. Can the new penalties be suspended?

Suspension is a new concept. It is intended to support those who try to meet their obligations by giving them time to improve their systems, which helps them to avoid penalties for inaccuracies in the future.

Only a penalty arising from failure to take reasonable care can be considered for suspension. Suspension conditions will be agreed and set and if they are met the penalty will be cancelled. If they are not met the penalty becomes payable. The period of suspension can be up to two years.

For example, if a careless inaccuracy is due to poor record-keeping one of the conditions of suspension could be that specified improvements are made to the way records are kept. This will help the customer avoid future errors.

We will consider the taxpayer’s general compliance behaviour, the level of disclosure and the nature of the inaccuracy before deciding whether to suspend the penalty.

Penalties charged for deliberate errors cannot be suspended.

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Q11. Is the purpose of the new penalties to raise more money?

No. The new penalties are to encourage people to comply with their legal obligations and improve their compliance.

Q12. Does the new legislation change taxpayers’ record keeping requirements?

No. Business and individual record keeping requirements remain the same. Records should be kept that are adequate to provide us with correct tax returns and other documents.

Q13. What about the other taxes?

It is expected that the 2008 Finance Bill will create a single penalty regime for incorrect returns across most of the Department’s taxes, levies and duties. This includes Environmental Taxes, Excise Duties, Stamp Duties, accounting for recovery of student loans by employers, Inheritance Tax, Insurance Premium Tax, Pension Schemes and Petroleum Revenue Tax.

It is expected that the new provisions will cover incorrect returns for periods commencing on or after 1 April 2009, where the return is due to be filed on or after 1 April 2010.

For more information see Budget Notice 96.

Q14. Who have we consulted about the changes?

The Powers Review consulted a wide range of taxpayers, representative bodies, accountants, HMRC staff and others during the development of the new penalties.

HMRC staff, accountants and representative bodies have also been engaged in the development of the technical guidance will continue to be given the opportunity to input into any changes in guidance that HMRC produces, including the operational and process guidance.

The consultation on the Modernising Powers, Deterrents and Safeguards: Penalties reform - the next stage ended 6 March 2008 and can be viewed on our website.

Q15. What information is available?

On the internet we have published technical guidance on the new penalties in a new Compliance Handbook - operational and process guidance will follow later in 2008/09. Customers can download from the website a leaflet that gives a simple overview of the new penalties, and take a short learning module.

There is also a new penalties mailbox to respond to questions where the answer cannot be found elsewhere.

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Q16. How can we be sure HMRC officers will apply these penalties properly?

HMRC officers will have guidance, training, supervision and will have to follow governance procedures.

Work has already begun on operational and process guidance that will be available later in 2008, in addition to the technical guidance already available in the Compliance Handbook.

HMRC has a major and on going commitment to training its staff, including training them about new legislation. Officers will be appropriately trained before the new powers are used. Training will cover important differences in approach such as the use of suspended penalties, and greater openness between the department and taxpayer.

Training will be supported by operational and process guidance.

Importantly, the new penalty framework will be more clearly set out in law aiding consistency. And taxpayers may complain or appeal to an independent tribunal.

Q17. How will the new penalties affect the voluntary disclosures customers can make for indirect taxes like VAT?

The Voluntary Disclosure procedure which applies to most indirect taxes allows taxpayers to correct errors made on previously submitted returns. Provided the errors were below certain limits, they can be declared on the next return due to be submitted.

The 2008 budget has announced an increase in the de minimis limit under which businesses can voluntarily report an error in indirect taxes such as VAT, insurance premium tax, landfill tax, climate change levy, air passenger duty and aggregates levy - see Budget Notice 75.

The term voluntary disclosure is confusing to some, because taxpayers have an obligation to correct errors, and must make a separate disclosure where the errors exceed the de minimis limits. For this reason the procedure is being renamed. In future it will be known as the Error Correction Procedure.

Currently there is a penalty applied in cases of under-declarations on VAT returns; this Misdeclaration Penalty applies irrespective of the behaviour that resulted in the error, so that mistakes made despite taking reasonable care can attract penalties. The new penalty system will take into account the behaviour that led to the error and no penalty will be due where a mistake is made despite taking reasonable care.

The majority of voluntary disclosures concern errors on VAT returns. The Misdeclaration Penalty does not apply currently where a voluntary disclosure has been made. Under the new regime, those who have made errors despite taking reasonable care will still not be penalised; however those who have made an error through careless or deliberate behaviour will now be liable to a penalty.

It is essential to distinguish between the current error correction arrangements, and the new facility through which taxpayers can obtain the maximum reduction in any penalty due as a result of failure to take reasonable care or worse. In the case of failing to take reasonable care this reduction can, where full unprompted disclosure is achieved, bring the penalty down to nil (see Q6 above on how a penalty can be reduced).

It is also important to emphasise that most inaccuracies in returns occur despite every effort to take reasonable care, in which case no penalty will apply. In these circumstances customers will not need to undertake any additional work. Where such errors are below the de minimis limit, customers can continue to correct them on the later return without penalties being an issue at all; we will treat this as taking the ‘reasonable steps’ to inform us of the error (see Q7 above). Where they are above the limit, a separate disclosure to HMRC will be required; this separate disclosure will meet the need to take the reasonable steps to inform us of an error (see Q7 above).

Where an inaccuracy is due to the taxpayer failing to take reasonable care, simply correcting it on a later return will not meet the statutory definition of a full unprompted disclosure, and would not reduce the penalty rate (see Q6 above on how a penalty can be reduced). In such cases a full and separate disclosure must be made if the taxpayer wishes to maximise the reduction of any penalty.

These changes support and reflect the legislative intention that HMRC should support those who seek to comply, but come down hard on those who seek an unfair advantage through non-compliance (see Q3 above on Why HMRC is doing this):
  • if people take reasonable care in completing their returns they will not be penalised
  • if they do not take reasonable care errors will attract penalties, and the penalties will be higher if the error is deliberate
  • disclosing errors to HMRC early will substantially reduce any penalty due