Don’t give HMRC more than you have to – Penalties, behaviours, and their impact on HMRC’s assessing time limits

In this current climate, the bombardment of the HMRC one-to-many ‘nudge’ letter campaigns is becoming ever more frequent. Now, a client comes to you with news that they have omitted to return income for some past tax years.

What should you do? Should you arrive at all the omitted income for those past years? Calculate the tax due and then plug it into the relevant HMRC digital disclosure platform? Add on the interest, and look at the penalties blurb to settle on either careless or deliberate behaviour?

Stop! At that point, it is likely that you have included years that HMRC has no right to assess. Additionally, you have likely failed to properly consider the behaviours that led to the inaccuracy in the returns filed. This means that you are potentially overstating the penalty too.

No client is going to thank you for giving HMRC too much tax and an excessive penalty. Similarly, no client is going to thank you when HMRC rejects a disclosure, which has understated the position. Especially after the client has paid what you told them to and is expecting HMRC acceptance.

Where returns are being made with omitted or understated income, the client would be in an inaccuracy situation. Where no returns are being made, the client would be in a failure position.

Inaccuracy position

When a client files their returns annually with omitted income for whatever reason – therefore understating the tax position – those returns are inaccurate.

The time limits for HMRC to assess the lost tax arising from an inaccuracy are:

• Normal time limits (NTL) 4 years from the next year-end based on reasonable behaviour
• Extended time limits (ETL) 6 years back from the next tax year end for careless behaviour
• Further ETL 20 years back from the next tax year end for deliberate behaviour

Failure position

When the client does not file self-assessment returns with HMRC for the years in question, that is a failure to notify (FTN) situation. Unless the client has a reasonable excuse for not declaring the income previously, a FTN means we need to look back 20 years from the next tax year end. Generally, the penalties for FTN are higher than for omissions or inaccuracies from filed returns.

The timing of any disclosure is also important. If you are at or near a 5 April tax year end, then it is highly likely that the oldest year will drop out before HMRC review the position. This requires you to consider the timing of such disclosures in late March or early April.

Disclosing years outside of HMRC scope

If you settle those years outside of HMRC’s assessing grab, you are doing so under Voluntary Restitution (VR) principles. HMRC has no power under the Taxes Management Act 1970 to recover those years based on the behaviour of the client. So, HMRC are appealing to the client’s innate philanthropic nature, saying, “would you like to pay the tax, even though it is legally no longer due?”

If you offer duties, interest, and penalties for years that HMRC are legally no longer entitled to, then you are in the hands of the officer: reviewing the disclosure, finding the mistake, rejecting the disclosure, and offering VR or a refund of the out-of-date years for which payment is being made.

Behaviours and penalties – impact on time limits

The HMRC digital disclosure service usually allows you to self-assess the penalty position, based on the considered client behaviour, giving rise to the inaccuracy.

I have seen instances of incorrect or questionable choices happening here, where I have concerns whether the behaviour was careless at all. It is therefore vitally important to establish precisely how and why the income was omitted.

If there was a reasonable excuse, for example the client was unaware of their entitlement to the income at the time, then HMRC should only be going back four years from the next year end. Additionally, it is likely that the penalties could be £nil.

If we are approaching HMRC without an earlier ‘nudge’ letter from them, then the disclosure is unprompted. This also makes quite a difference to the quantum of the penalty. Potentially, the starting point could be 0%.

With inaccuracy penalties only – not FTN penalties – there is also the potential to suspend careless inaccuracy penalties. This is something HMRC offer. In fact, they are duty-bound to do so in almost every instance. If we can agree suspension conditions, then all the penalties effectively go away. Only as long as the client fulfils those suspension conditions for the agreed period.

Disclosures require careful handling. If foreign income or offshore gains are being omitted, then the need for careful handling is magnified. This means the starting point for penalties are at least 100% of the tax arising, under the draconian Failure to Correct (FTC) regime. The draft legislation in recovering overstated Coronavirus Job Retention Scheme funds is similarly as draconian.

How we can help

Our investigations team can help. Penalty consideration and establishing behaviours are issues we deal with every day. We embrace the opportunity to engage with HMRC enquiry officers to secure the best deal available in the client’s circumstances.

We are here to help. We can save you time and save the client from making an excessive disclosure. This saves the client from settling too many tax years and paying higher penalties than the legislation allows. Conversely, it can also prevent a rejected undercooked disclosure.

The cost vs benefits of engaging with us are ample in favour of your client. Please get in touch with Dave Wase or Steve Ashworth of the Tax Advisory Investigations Team before you submit a disclosure report.