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Understanding HMRC’s approach to penalty mitigation

29 September 2017

Hanna Sandford, Consultant at Aspire Business Partnership LLP, discusses the benefits of being cooperative during HM Revenue and Custom (“HMRC”) enquiries wherever there is a possibility that the enquiry could result in penalties being issued. 

When can HMRC issue penalties?

HMRC can issue penalties for any reason which results in tax being unpaid, understated or if a return or other document is returned late. A penalty may also be due if you do not inform HMRC that you are liable to pay a tax at the right time, or if HMRC raise an assessment which is too low and you do not inform them.

Below are the three main reasons which result in HMRC issuing penalties; -

1. Late filing or late payment

  • Self-assessment tax return
  • Pay As You Earn (PAYE)/National Insurance Contributions (NICs) late payment
  • VAT returns
  • Construction Industry Scheme (CIS) monthly returns

2. Inaccuracies on returns, payments or paperwork

  • An inaccuracy which leads to an understatement of the tax due
  • An inaccuracy which leads to misrepresentation the tax liability
  • If HMRC issue an assessment for tax which is too low and you do not tell them it is incorrect, you may also be subjected to a penalty

If an individual or a company submits a document that contains a mistake or inaccuracy, HMRC will charge a penalty if the error is believed to be due to lack of “reasonable care”, a deliberate mistake, or if the error was deliberate and concealed.

Reasonable care refers to the expectation that a business or individual must keep records which allow them to provide accurate returns and/or documents to HMRC. The level of care which constitutes as reasonable differs according to the individual circumstance.

The penalty amount will be dictated by the reason which caused the error to occur and higher penalties will be issued if the reason is more serious i.e. if the error was deliberate and concealed you may be issued with the maximum penalty allowed by law.

3. Failure to notify

  • A penalty may arise if an individual or company doesn’t inform HMRC when they are due to pay tax because their business is making a profit
  • If an individual or company does not inform HMRC that they are liable to for corporation tax
  • An individual or company sells an asset which they make a capital gain on and hence tax should be paid
  • A business’ turnover has exceeded the VAT registration threshold

How do HMRC calculate penalties?

There are eight stages which HMRC complete in order to calculate the penalty due.

1. Establishing the potential lost revenue (PLR)

The penalty which is issued is a percentage of the PLR. The PLR is the amount which arises as a result of correcting an inaccuracy.

2. Determining the type of behaviour

The behaviour refers to the reason behind why the inaccuracy occurred. There are four different types of behaviour which are as follows;

  • Reasonable care
  • Careless – failing to take reasonable care to get things right
  • Deliberate – this is where you were aware that a document was not accurate when you sent it to HMRC
  • Deliberate and concealed – this is where you were aware that a document contained inaccuracies and you took active steps to hide those inaccuracies from HMRC

3. Was the disclosure Prompted or Unprompted?

Once the behaviour has been established, HMRC will look to decide whether the disclosure was prompted or unprompted. A prompted disclosure is where you inform HMRC of an error following them opening a compliance check or if you believe they are about to identify the error. A disclosure is unprompted if it is made at a time when the person making it has no reason to believe that HMRC have discovered or are about the discover the inaccuracy.

4. Establishing the range which the penalty falls within

Following the completion of stages 1 to 3, the penalty will fall into one of 6 categories which are determined by the type of behaviour and whether the disclosure was prompted or unprompted and whether a penalty is due for an inaccuracy or a failure to notify.

Penalties for inaccuracies in returns/documents

Type of behaviour

Unprompted disclosure

Prompted disclosure

Reasonable care

No penalty

No penalty

Careless

0% to 30%

15% to 30%

Deliberate

20% to 70%

35% to 70%

Deliberate and concealed

30% to 100%

50% to 100%


Penalties for failure to notify

Type of behaviour

Unprompted or prompted disclosure

Penalty range

Non-deliberate

Unprompted – within 12 months of tax being due

0-30%

Unprompted – 12 months or more after tax was due

10% to 30%

Prompted – within 12 months of tax being due

10% to 30%

Prompted – 12 months or more after tax was due

20% to 30%

Deliberate

Unprompted

20% to 70%

Prompted

35% to 70%

Deliberate and concealed

Unprompted

30% to 100%

Prompted

50% to 100%

If you have a reasonable excuse for a non-deliberate failure to notify, HMRC will not charge you a penalty.

5. Telling, Helping and Giving – The Quality of Disclosure

The Quality of Disclosure determines where the penalty will fall within the penalty range. Reductions are given based on the assistance that you provide HMRC. Dependent on the Quality of Disclosure, you could be entitled to reductions for the three following factors up to and including the amounts;

  • Telling up to 30% reduction
  • Telling HMRC about, or agreeing that there is something wrong and how and why it happened
  • Telling HMRC everything you can about the extent of what is wrong as soon as possible
  • Telling and helping us by answering HMRC questions in full  
  • Helping up to 40%
  • Helping HMRC to understand your accounts or records
  • Helping HMRC to check your own records to identify the extent of the inaccuracy
  • Helping by responding to correspondence quickly and efficiently
  • Giving (access to records) – up to 30%
  • Giving HMRC access to documents that they have asked for without any delay
  • Giving HMRC access to documents which they may not know about as well as those which they ask to see

If you can prove and show that you have given a high-quality disclosure, i.e. you have complied with “telling, helping and giving”, then you will be entitled to a higher reduction.  If you are not cooperative then you may still be entitled to a reduction but it will be of a lesser percentage.

6. Working out the penalty percentage rate

The penalty percentage rate is determined by the penalty range and the reductions allowed based on the quality of disclosure.

Case Study

HMRC opened a compliance check into Bob’s 2014/15 tax return and found a careless inaccuracy which he had not notified HMRC of prior to them opening the compliance check, hence it was a prompted disclosure. HMRC informed the individual and they agreed with the inaccuracy.

The penalty range for a careless inaccuracy with a prompted disclosure is 15% to 30% of the potential lost revenue (PLR).

The reduction for the quality of disclosure was 25% for telling, 40% for helping and 30% for giving, equalling a total reduction of 95%.

Steps to calculate penalty percentage

Calculation

  1. Work out the difference between the minimum and maximum penalty percentages within the penalty range.

30% (maximum penalty rate) - 15% (minimum penalty rate) = 15%

 

  1. Multiply that figure by the total quality of disclosure reduction.

15% * 95% = 14.25%

  1. Deduct the percentage reduction from the maximum penalty percentage

30% - 14.25% = 15.75%

 

7. The amount of the penalty

HMRC then work out the amount of the penalty by multiplying the PLR by the penalty percentage rate. For example, if the PLR in the example above was £3,000, the penalty would be £3,000 * 15.75% = £472.50.

8. Considering other reductions

If there are any other reductions which are due, for example, if a penalty has been issued on the same inaccuracy or tax previously, then a further reduction may be due. Once this has been established the final penalty amount will be charged.

Aspire Comment

Whilst we would hope that there are no inaccuracies in our midst that could lead to a HMRC compliance check – we are all human and mistakes do happen! Alternatively, if you are aware that you are not meeting a tax obligation required by your company then please do not leave it any longer and get in touch with Aspire.

The importance of being cooperative with HMRC is vital to ensure that penalties can be reduced by the highest possible amount. Aspire have a vast knowledge and experience in dealing with HMRC investigations and can assist you in dealing with and negotiating your penalty assessments.

If you have been issued with a tax and/or penalty assessment, or if a compliance check has been opened into your tax affairs, please give Aspire a call to discuss how we can help.

Email: enquire@aspirepartnership.co.uk

Phone: 0121 445 6178