Penalties - new regime

(No, nothing to do with failing to kick a ball 12 yards without falling over, and then blubbing like a big jessie.)

Last month saw the commencement, via section 97 FA 2007, of a new penalty system, which applies to return periods beginning on, or after, 1 April 2008 with a due filing date of 1 April 2009 onwards. The outgoing system will continue to apply for all earlier return periods but will, otherwise, become increasingly obsolescent over the coming years.

The new regime applies to income tax, corporation tax, capital gains tax, VAT, PAYE, NIC and the construction industry scheme. Provision exists to extend the regime to other taxes, being most notably stamp duty and stamp duty land tax, from 2009.

The new code reflects many changes to the old, and the introduction of some new concepts. There is a move away from the principles of old regime, which was generally considered to be too soft in penalising more serious errors.

The longstanding non statutory policy of the mitigation of penalties for co-operation and gravity is no longer relevant. In its place we have a statutory, behaviour based, scale of penalties, with mitigation for the quality of disclosure and a long stop discretion afforded to the Revenue to reduce penalties in special circumstances where it is felt that the penalty provided at law is inappropriate or disproportionate. There is also the facility for the assessment of penalties to be suspended for up to two years whilst the taxpayer has the opportunity to get their affairs in order and not re-offend.

The standard penalty scale is as follows:

* Mistake – no penalty
* Careless inaccuracy – 30% of potential lost tax
* Deliberate inaccuracy – 70%
* Deliberate and concealed inaccuracy – 100%

The minimum penalty which can be charged, after taking account of the maximum permitted reduction for disclosure, will be as follows:

* Mistake – no penalty
* Careless inaccuracy – no penalty
* Deliberate inaccuracy – 20%
* Deliberate and concealed inaccuracy – 30%

These minima assume that disclosure of the error on the return, or other document, is made wholly unprompted by the taxpayer who provides all pertinent information and records to put the Revenue in a position to assess the correct amount of tax due.

Where, instead, the disclosure is prompted by the Revenue, the scope for reduction of the standard penalty is less, with the minimum penalties being 0%, 15%, 35% and 50%.

In considering the scale of offences, doubtless much effort will be spent in the coming years in arguing the offence down the scale, before considering mitigation for disclosure and, lastly, whether there is any scope for seeking a reduction for special circumstances at the Revenue's discretion.

Mistake is not used in the new legislation but is a convenient way of describing an innocent error; being one where reasonable care was taken but an error resulted nevertheless.

Careless behaviour is where the taxpayer fails to take reasonable care. What is reasonable will be based on the standards established in tortious negligence.

Deliberate behaviour is just that. Using terminology of old, this behaviour is broadly analogous to acts of omission, e.g., deciding not to declare a source of income on a tax return.

Deliberate and concealed behaviour is comparable to the old acts of commission, being those which, in extremis, could result not in civil penalties but in criminal prosecution, e.g. claiming an invented expense and falsifying an invoice in support.

The Revenue has published its first round of guidance on the new regime, in which it gives many examples of offences which, whilst not binding, should, nevertheless, prove useful in determining where the Revenue will argue that borderline instances fall.

Whilst the new regime is focused on errors in returns, and other documents, which give rise to potential lost tax revenue, the absence of an inaccurate return etc., does not mean a penalty is not capable of being incurred. Where, in the absence of a return, the Revenue raise an estimated assessment, which is known by the taxpayer to be understated, the taxpayer will be required to correct the assessment within 30 days of issue. Failure to do so will result in a penalty being due for the resulting lost tax revenue.

New to the direct tax environment is the penalisation of errors leading to an overstatement of a loss, even where that loss may not be immediately relieved against another source of income or gains. The penalty, of 10% of the overstated loss, is avoidable only where it can be shown that there is no reasonable prospect of the loss ever being relieved e.g., where a trade has ceased, leaving the loss stranded.

A further new concept in direct tax will be the imposition of personal liability on the officers of companies which have made errors or inaccuracies in their returns etc. The principle has previously been present in the outgoing system of penalties for VAT, from which some guidance can be gleaned. Whilst the new rule is likely to cause much consternation in certain circles, it is reasonable, at this time, to expect that the Revenue will use their powers in this regard sparingly. An example where the Revenue might be tempted is where the less than upstanding types undertake phoenix-ing and similar practices.

We would venture that the level of penalty assessed on a taxpayer, for an error leading to the potential loss of direct taxes, will now, typically, be double that which could have been expected under the outgoing system. Whether this will have a deterrent effect, and encourage compliance, or result in a bonus for the Treasury coffers, remains to be seen.

Whilst it will take a few years for the new system to bed down, with there probably being a slew of tribunal cases come 2010 and 2011, care will be needed now when it comes to the keeping of records and the maintenance of accounting systems etc., which will be used for returns falling to be filed from April 2009 onwards.