How to avoid penalties for tax return errors

A new system for calculating penalties for incorrect tax returns has come into force, with the prospect of some errors not incurring any penalty at all.  

Filling in tax return forms is an unavoidable part of being in business, and scarcely any more popular than paying the tax.  To encourage taxpayers to file their returns correctly, there are of course penalties for errors.  Under the new regime, which came into force on 1st April, penalties will be charged as follows, expressed as percentages of the tax lost as a result of the inaccuracy. 

The good news at the lower end of the scale is the clear possibility that some errors will not result in any penalty.  Three classes of error will incur no penalty (although the tax will still have to be paid, with interest, when the error comes to the attention of HM Revenue & Customs (“HMRC”)):   

1. An error which is made despite the taxpayer taking reasonable care to make a complete and correct return; 
2. A careless error which the taxpayer notifies to HMRC unprompted; and 
3. A suspended penalty. 

The new regime applies to tax returns which are due to be filed on or after 1 April 2009 for periods starting on or after 1 April 2008.  So for income tax, VAT, and employers’ PAYE it applies to your next return, but for corporation tax the old rules may apply, e.g. for a corporation tax return for the year ended 31 December 2008, due by 31 December 2009. 

“Reasonable care” is not defined by the statute, so HMRC have published their view on its meaning.  It includes:

• keeping accurate records and giving them all to your agent to prepare your return;
• implementing professional advice received and not neglecting some vital step; and
• checking the agent’s work, to the extent that you are able – a layman cannot challenge professional advice on a complex point, but ought to be able to tell if a major transaction has been omitted altogether. 

So if you do all of that, you should never end up with a penalty, even if your tax return is wrong.  More surprisingly, this applies even if your agent makes a careless error which you cannot be expected to spot. 

Unprompted disclosure means telling HMRC when you have no reason to suspect they are going to check your tax affairs.  Owning up to a VAT or PAYE error after getting a letter saying they are coming round for a routine control visit does not count.  To qualify under this heading the taxpayer must:

• tell HMRC about the inaccuracy;
• give them reasonable help in quantifying it; and
• allow them access to records so they can ensure it has been fully corrected. 

This may result in some extra work for the taxpayer or his accountant, so it is not completely free of costs. 

The suspended penalty is a significant departure from anything that has been done before.  If there is a careless error which is not disclosed unprompted, the taxpayer can still avoid a penalty for it in some circumstances.  The penalty is set but it is not charged for a period of up to two years.  If during this period the taxpayer satisfies certain conditions, the penalty is cancelled.  The conditions are likely to be to do with putting in place accounting or other procedures for ensuring that the error does not reoccur. 

Overall the new regime should encourage compliance by honest taxpayers, and free up more time for HMRC to chase the dishonest ones. 

For further information please contact: Alastair Johnston

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