Since HMRC came into existence in 2005, the government has been looking at the powers that the department has to deal with compliance. This has led to the introduction of new legislation which affects a wide range of issues. Some of this legislation takes effect from April 2009 and some has effect from April 2010.

HMRC have the legal right to enquire into any return and if they find that there is an error in that return which has caused tax to be underpaid, they have the power to levy a penalty which is usually based on the tax underpaid. It is these powers that are to change from April 2009.

Current penalties

At present, HMRC can levy a penalty if they believe that the taxpayer is guilty of fraudulent or negligent conduct. This can cover everything from a simple failure to include an item of income through to a planned fraud. The penalty level starts at a maximum of 100% of the tax and can be reduced by taking into account the level of disclosure made by the taxpayer, the degree of co-operation shown in the enquiry and the size and gravity of the offence. It has always been possible to negotiate penalties because the Inspector has had a considerable degree of discretion. That is going to change.

New penalties

Under the new regime, there will be a basic presumption that every taxpayer, whether individual or corporate, has taken reasonable care in completing their tax return. What constitutes reasonable care will depend on the size of the case – a large company will be expected to have sophisticated accounting systems in place, an individual will be expected to have records of all their income and expenses. There has been a legal requirement for many years that all taxpayers should have sufficient records to back up every item on their return and this will remain in place.

In considering whether an incorrect return should give rise to a penalty, the Inspector will consider the action taken by the taxpayer against the benchmark of ‘reasonable care’. No penalty will arise if it can be shown that the error was due to a simple honest mistake by the taxpayer. The three levels of unacceptable behaviour that will give rise to a penalty are defined as:

• careless action;
• deliberate action; and
• deliberate action with concealment

The precise way in which HMRC will interpret these terms is not yet known, although the legislation itself defines ‘careless action’ as not doing something that a reasonable person would be expected to do. The borderline between that and a simple mistake may become blurred.

Level of penalties

What is clear is that the legislation sets a maximum penalty for each type of offence. The rules then allow a certain level of reduction, taking into account only the level of disclosure, but there is a minimum penalty below which the Inspector will not be able to go.

Two types of disclosure are mentioned. ‘Unprompted disclosure’ is made by a taxpayer when they have no reason to suspect that HMRC are aware of any error. In other words, this is a completely voluntary admission by the taxpayer. Any other type of disclosure is deemed to be prompted. The effect of this can be seen in the table below which sets out the new penalty levels:

These levels are considerably in excess of the levels which have, historically, been negotiated with HMRC for similar types of offence. It seems inevitable that the cost of making an error is going to increase significantly and the utmost care needs to be taken in keeping records to ensure that they are accurate and complete.

The future

We are expecting HMRC to finalise guidance on these matters in the next few months and we will keep you up to date with developments. We will also let you have details in due course of the other changes that are being introduced, such as powers to obtain information from taxpayers and third parties. In the meantime, if you have any queries on the matters raised in this letter, please do not hesitate to contact us.