New penalties for errors in returns and documents

Introduction

This brief explains how the new penalties will affect our customers and their advisers.

HM Revenue & Customs (HMRC) inherited a confusing variety of penalty charging powers. 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 with our customers and other interested parties during the Review of Powers, Deterrents and Safeguards.

The legislation aims to help those who try to comply, and come down hard on those who don't. The clear messages for customers are that:

• if they take reasonable care when completing their returns they will not be penalised
• if they do not take reasonable care, errors will be penalised and the penalties will be higher if the error is deliberate
• disclosing errors to us early will substantially reduce any penalty due

Taxes affected

The new penalties are for errors on returns and documents initially for VAT, PAYE, National Insurance, Capital Gains Tax, Income Tax, Corporation Tax and the Construction Industry Scheme.

For these taxes, it applies to returns or other documents for tax 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.

When can a penalty for inaccuracy be charged?

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

1. The document given to HMRC must contain 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
2. The inaccuracy must be careless, deliberate or deliberate and concealed.

A penalty can also be charged where, in the absence of a return, we issue an assessment which is too low and the person does not take reasonable steps to tell us of the under-assessment within 30 days of the date of the assessment.

How is the penalty calculated?

There is no penalty if a person takes reasonable care but submits an incorrect return. However, if the person later discovers the error but does not take reasonable steps to tell us about it, the inaccuracy will be treated as careless.

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:

• 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 person conceals it

The penalty chargeable where tax has been underassessed because of the customer's failure to send us a return is 30 per cent of the potential lost revenue.

How can penalties be reduced?

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 HMRC has discovered, or is about to discover, the error.

Further reductions can be given based on the quality of the disclosure. The more a person tells, helps or gives access to HMRC the more the penalty may be reduced.

To calculate the reduction for disclosure we will consider three elements of disclosure. To what extent is the customer?

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

The reductions are made because we want to encourage people to come forward when they think there is a problem with their tax affairs, or they have not met a requirement.

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 simple, straightforward tax affairs needs to keep a simple system of records, which are followed and regularly updated. A person with larger and more complex tax affairs will need to put in place more sophisticated systems and maintain them equally carefully.

We believe it is reasonable to expect a person who encounters a transaction or other event with which they are not familiar to take care to check the correct tax treatment or to seek suitable advice. We expect people to take their tax seriously.

Some penalties may be suspended

Suspension is intended to support those who try to meet their obligations by helping them to avoid penalties for inaccuracies in the future.

Only a penalty for failing 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 for 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.

Other taxes

The 2008 Finance Bill makes provision to extend the new penalties to cover incorrect returns for the other taxes and duties HMRC administer. We expect the new provisions will apply for periods commencing on or after 1 April 2009 where the return is due to be filed on or after 1 April 2010 - see Budget Notice% (PDF 66K).

More information

Please check the Frequently Asked Questions (FAQs) and the technical guidance in the Compliance Handbook on our internet site.