To Penalise or not to Penalise?

The current penalty regime for VAT has now been in place for 3 years and the approach taken by HM Revenue and Customs (HMRC) has gone through a number of phases over that time (rather like a tax caterpillar turning into a not so pretty butterfly!). This month is a brief overview of what is happening on the penalty front today and what a taxpayer can expect if they get VAT wrong.

When the penalties were first introduced on 1 April 2009 (for returns commencing on or after that date), HMRC promised a light touch in applying penalties. To give them their due, for a while, this was the case. There were issues over whether or not an Inspector could look at the errors adjusted via the VAT return and levy a penalty, but this has, by and large, gone away (although I still advise clients to drop HMRC a line if they make any adjustments via their VAT returns).

However, in these tough economic climes, HMRC are under pressure to bring in the revenue as efficiently as possible. This has resulted in an increased number of inspections and pre-repayment checks and, inevitably, an increase in the number of penalties as a result.

So what can a penalty be levied on? Well, basically any error made on any return or as a result of any repayment of tax that HMRC considers “careless”, “deliberate” and/or “concealed”. In addition, a penalty can be levied for the late application to register for VAT, incorrect issue of an invoice and a raft of other misdemeanours. Going forward, the legislation is in place for late submission of returns and also late payment of the tax due on a return (although no commencement date has yet been set for these).

Penalties for errors on returns or for incorrect repayments

For a penalty to apply, a number of tests have to be fulfilled. Firstly, there has to be an understatement of liability or overstatement of a claim, which is the actual error. Then it has to be “careless”, “deliberate” or “deliberate and concealed”. Where the tax at stake relates to a VAT matter, the maximum penalty is 30% (careless), 70% (deliberate) and 100% (deliberate and concealed) of the tax lost to the Treasury. Easy? Well if you look at the issues of the meaning of “careless”, “deliberate” and concealed, then it becomes apparent that the terms are rather subjective. This is a problem that HMRC are coming across when penalties are being levied.

“Careless”

For example, if I, as a fairly knowledgeable VAT professional claimed the VAT on an invoice that relates to a third party’s costs on a VAT return, this would be considered to be careless. I have (or should have) a detailed knowledge of the VAT system and what should be claimed as input tax.

However, if I were to be an unqualified purchase ledger clerk, fresh from school and just being trained, is it fair for the error to be careless? The answer should be “no” (and to be fair to HMRC often is). However, if that clerk’s work was overseen by a Financial Controller, the error could still be “careless” on the basis that the more knowledgeable Financial Controller should have picked this error up.

Contrast this again with the business that decides to engage a business advisor to review the VAT return prior to submission because they do not have a Financial Controller in-house. Again, the error should be picked up and should be deemed “careless” as a competent business advisor should have enough knowledge to know that third party costs are not recoverable. But is this careless on the part of the taxpayer business or careless on the part of the business advisor? I have known instances where HMRC have not levied a penalty in these circumstances as the inspector’s view is that the error should have been spotted by the business advisor (and the error is only careless if it is the taxpayer business that is careless). I have also known instances where this argument has been turned down on the basis that the owners of the business are ultimately responsible for the tax affairs of the business and so should have checked the accuracy of the return!

“Deliberate”

Surely all tax payers avoid deliberately making errors on their VAT returns? Well, apparently not! But again, how do you work out if it is deliberate? If someone has not included the VAT on some sales in the period is this deliberate? What if there was an issue with the accounts software that coded the VAT to a suspense account? Or some invoices were raised without VAT and it was decided subsequently that VAT was due? (Place of supply of services being the obvious culprit here!) Is it deliberate not to include them? What if the accounts were closed down early and the sales after the close down were usually manually included on the VAT return but, on this occasion another person completed the return and left them off? This is hardly deliberate. Careless perhaps, depending upon who was dealing with the return, but not necessarily deliberate.

However, if the business owner decided because cash was a bit tight this quarter, to leave the sales off the return, this would be deliberate. The owner has taken a conscious decision to omit the sales.

“Concealed”

Looking at the previous example, if the sales were not only omitted from the return, but the owner instructed the accounts person to remove them from the ledger and file the invoices elsewhere, this is blatantly concealed. In such circumstances, the penalty should be harsh.

What then if the owner is unaware that a member of staff has omitted the invoices from the return and has destroyed the trail themselves (presumably asking for the payment to be made to another bank account!) Is this concealed on the part of the actual taxpayer? Is it even deliberate or careless? There is a school of thought that says that all business owners should be fully aware of the income and expenditure of the business, but for SMEs this is not always possible, particularly where the owner is heavily involved in one aspect of the business and trying to build it up.

Can a penalty be mitigated?

The short answer is “yes!” If the inspector is provided with full assistance in their investigations and you provide them with the details of how the error arose. The more cooperation there is, the more the penalty can be mitigated. If the error is disclosed at the start of an inspection for instance, this is classed as a prompted disclosure. A penalty could still be due, but it will be reduced to take into account the fact that the taxpayer has disclosed it, rather than hoped that it won’t be found! Any obstruction, however, will work the other way. The most the mitigation could be is usually 50% of the standard penalty. Therefore, if the error is deemed to be careless and the taxpayer has disclosed it to the inspector, provided them with all the records and cooperated fully, the penalty could be reduced from 30% to 15% (or anywhere in-between).

Can a Penalty be suspended?

Yes a penalty suspension is possible. The period that it is suspended for currently ranges from 6 months to 2 years. The taxpayer signs an agreement that the error will not happen again and that procedures are in place to prevent it. HMRC will then quash the penalty altogether if they are satisfied that there is no repeat or possible repeat of the error. However, it’s not all good news, as the suspension is not actually error specific and, if during the suspension period, another error of any kind is made, the suspension is revoked and a penalty is due for both the original error and the new error. And it does not just relate to VAT for the errors, so beware!

Can a Penalty be levied for a Voluntary Disclosure?

In certain circumstances, a penalty can be levied. If HMRC believes that the error has arisen as a result of the deliberate and deliberate and concealed categories. In these cases, if HMRC have not prompted the disclosure (e.g. where a business has suspected theft on the part of a director) and there is no inspection in the offing, then a minimum penalty of 20% or 30% of the tax loss is due as a penalty.

Late Registration

Beware registering late for VAT! Currently HMRC is looking at the self assessment trading income of taxpayers and launching enquiries if that income is over the VAT registration threshold (now £77,000). If this is the case and the result is a late VAT registration, a penalty of 30% of the tax that would have been due in the period from registration (“period A”) should have occurred to when it did occur (“period B”) becomes due. This is reduced to 10% if the period from A to B is less than 12 months in length.

If the late registration is as a result of no prompt from HMRC (i.e. the business has no reason to believe that HMRC are looking at its affairs) the penalty is reduced to 0% if the period between A and B is less than 12 months.
Late Returns and Payments

At some point, the late submission of VAT returns and the late payment of the tax will be brought into line with the other taxes. Under the current VAT system it is possible to submit the return late and not incur a surcharge if a payment is made on time.

However, under the new rules, once the due date has been exceeded (even by a minute after midnight) a £100 late return penalty will be due. This will increase for each late return and extra penalties will apply for returns that are 6 months or more overdue.

In addition, if the tax is then paid late, the first late payment will escape a penalty, but subsequent late payments will not. There are to be increased penalties for payments that are over 6 months old and interest can also be levied.

There are no plans, as yet to implement these penalties and it was surprising to find that the date was not announced in the Budget this year. However, the current system will not stay in place for too mush longer.
Ruth Corkin is Head of VAT Services at accountants and business advisers James Cowper Kreston and Chair of the VAT Practitioners Group (VPG) National Technical Committee. She can be reached by email: RCorkin@jamescowper.co.uk.