Think Tank

HMRC tax penalties – can a change in behaviour prevent them?

13th March 2022

Deal with it now, not next week or never.

We all have that place we put things when we tell ourselves that we’ll deal with it later, or next week, or maybe never. Sometimes it’s just easier to put off something that looks unappealing, time consuming, or as though it might be difficult to resolve.

Many people behave like this when it comes to dealing with a tax form or any official letter relating to financial matters. So is it fear? A lack of understanding? Being disorganised? Or is it simply because we don’t think it’s important enough?

For HM Revenue and Customs (HMRC), an assessment of precisely those underlying behaviours is playing an increasingly prominent role in VAT enquiries and investigations, and in the resulting issue and treatment of financial penalties.

Put simply, in the event of even a routine VAT enquiry, the identification of behaviours which have resulted in VAT or other tax errors or failings can trigger a potential financial penalty. And if HMRC deem that such findings stem from negligent behaviour – as opposed to genuine human error – any penalties are likely to be harsher, and have a longer lasting effect on a business.

As a VAT specialist at Old Mill, advising on and defending against HMRC VAT assessments and related penalties is a key part of my work. We have considerable success in reviewing HMRC’s proposed actions, including – where possible – suspending or cancelling penalties, or reducing the category of penalty. But taxpayers themselves need to be much more aware and focused on the type of behaviour which can lead to an HMRC penalty charge. Not only are these charges a non-deductible expense, but they also create an aura of non-compliance for the business or individual. Which means an increased focus from HMRC in the future, and less likelihood of any possible concessions.

Why the extra scrutiny from HMRC?

It is important to recognise HMRC’s changing focus and behaviours. Their 2017-18 Annual Report and Accounts shine a light on the scale of the effort to ‘tackle deliberate tax avoidance and evasion’. Total tax revenues for that year reached £605.8 billion, an increase of £30.9 billion over the previous year. VAT revenues in 2017-18 were £128.6 billion, or just over 21% of the total, and almost twice that generated from Corporation Tax.

So it’s no surprise that there is heightened concentration on this important source of income, and on closing what HMRC refer to as the ‘tax gap’. This is the difference between what HMRC believe should be paid in tax and what is actually paid.

HMRC have been adapting and increasing their resources to meet the new financial targets, and have a clear strategy for meeting revenue goals – focussing on evasion and targeting avoidance through aggressive penalty regimes and primary points of focus. Increased scrutiny, enhanced technology and the deployment of 25,000 tax compliance officers are the main pillars of a strategy that has every one of us in its sights.

Numerous penalty regimes now exist, covering in particular:

  • failure to file and/or pay tax due on tax returns
  • failure to notify (a liability to register for tax/VAT)
  • penalties for inaccuracies, where tax claims or returns have been submitted to HMRC containing errors resulting in underpayments or over-claims of tax.

As well as VAT, the above regimes cover a wide range of taxes and duties, such as customs duty and excise duties. The introduction of these penalties has come over a number of years; while some have existed for decades, albeit in different forms, others took effect as recently as 2010-11. But whatever the history, it’s clear that HMRC’s current focus is on penalties, tax assessments and interest charges to increase revenue. If you are in any doubt, it’s worth noting that at the start of a VAT enquiry – and before they have even looked at the business and accounting records – HMRC routinely issue a penalty factsheet and a Human Rights factsheet to taxpayers.

How can I avoid ‘bad behaviour’?

HMRC now seek to categorise the different types of behaviour that have resulted in non-compliance and under-payment or over-claiming of VAT. And depending on the categorisation (which is often subjective) there can be vastly different consequences for the taxpayer, regardless of whether the person or entity concerned is even aware that problems have arisen.

A key factor in avoiding penalties is to take ‘reasonable care’ when carrying out any accounting, business or financial activity that has a tax implication. This includes creating and maintaining accounting and tax records, issuing tax invoices, claiming VAT, filing and paying returns, determining whether a VAT registration is needed, or seeking a VAT relief for a relevant residential or charitable purpose building.

No penalty can be imposed by HMRC where it can be demonstrated that ‘reasonable care’ has been taken. Of course, HMRC have their own definitions of ‘reasonable care’. In their internal VAT Compliance Handbook (CH81120), HMRC state: “Every person must take reasonable care, but ‘reasonable care’ cannot be identified without consideration of the particular person’s abilities and circumstances. HMRC recognises the wide range of abilities and circumstances of those persons completing returns or claims.”

The handbook continues: “For example, we do not expect the same level of knowledge or expertise from a self-employed un-represented individual as we do from a large multinational company. We would expect a higher degree of care to be taken over large and complex matters than simple straightforward ones.”

Penalties range between 0%, for example where it is determined that despite reasonable care having been taken, an error occurred, to 100% of the net VAT lost, where an error has been deemed to be both ‘deliberate’ (i.e. the taxpayer knew that VAT should have been declared) and ‘concealed’ (i.e. the taxpayer took steps to hide the error from HMRC).

HMRC expects business owner(s) to ensure that they and their employees take reasonable care when compiling and submitting VAT returns. If reasonable care is not taken, this pushes the behaviour category (and therefore the penalty amount) into the ‘careless’ category. Where carelessness is determined, penalties will range from 0-30% of the net tax due; behaviour leading to non-compliance that is deemed ‘deliberate’ carries a penalty range of 20-70%.

Reasonable care includes putting procedures in place to ensure accurate and timely returns are filed, and seeking input from a specialist for an unknown, such as the VAT treatment of a particular transaction. The expectation is that sufficient effort will be made to ensure the timely and accurate filing of returns. If a matter is still uncertain, despite taking such steps, HMRC suggest that the matter is highlighted to them, at the same time as the return is filed or in advance of a transaction occurring.

Finally, behaviour deemed to be both deliberate and concealed can result in a penalty between 30-100%, with emphasis on the upper end. The discussion around the boundaries can be open to subjective judgement, and it’s often in these situations that we are called on to work with our clients, and to formulate a case for a favourable judgement.

I’ve been issued with a tax penalty – what can I do?

A penalty within a certain category can be reduced if it’s disclosed to HMRC in an ‘unprompted manner’, at a time when HMRC are not enquiring or actively looking into that taxpayer’s affairs. Whether an error is ‘prompted’ by HMRC can be open to debate. For example, would it be prompted if the matter was in the process of being disclosed to HMRC when HMRC contacted the taxpayer to arrange a routine VAT inspection? An unprompted disclosure can result in a significant reduction of a penalty amount; in addition, factors such as helping HMRC look into the background to the error, providing additional information as requested by HMRC, and seeking professional assistance in dealing with the matter are all factors that can potentially reduce the penalty.

Although certain VAT errors may fall below the limit for separate disclosure to HMRC, and can therefore be adjusted on a current VAT return, there is still scope for HMRC to raise a penalty for non-disclosure despite this. We would always recommend that the implications of such matters are considered before deciding not to disclose to HMRC.

Is ‘reasonable excuse’ my saviour?

In terms of mitigating a penalty amount, there is also the concept of ‘reasonable excuse’. This arises when a taxpayer has not met a legal requirement – for example, failing to notify their liability to register for tax, file a return or pay tax – but believes there is a reason why this should not be penalised. There’s a lot of case law surrounding the area of reasonable excuse, and what might be treated as reasonable in one case may not be viewed the same way in another instance.

Awareness and prevention is better than cure

In our experience, the root cause of VAT problems is rarely negligence. Instead it’s much more likely to be carelessness, or the absence of clear systems and processes, or fear of the unknown, or ignorance of the law regarding taxation. All businesses can suffer from mistakes caused by genuine human error, the results of staff turnover, and the loss of expertise and sometimes of focus. Sickness and other unplanned absences of key members of a team can all be factors that can lead to genuine and innocent errors.

However, allowing these situations to continue over time, or taking no action to regain tax compliance, can quickly escalate the behaviour to the ‘careless’, ‘deliberate’ or even ‘concealed’ penalty categories, meaning higher penalty charges and greater HMRC scrutiny.

Whatever the underlying behaviour that leads to a VAT error, or a failure to notify or a failure to file and pay tax, we are experienced in supporting our clients to get their VAT in order and have had considerable success in supporting clients in mitigating or cancelling potential penalties. Ideally though, the question of a penalty will not arise – we also review matters such as VAT compliance procedures, to provide a business with bespoke guidance on the key steps to take to avoid incurring a penalty.

As always, awareness and prevention is usually better than cure.