David Anderson

In the past, if the honest tax payer made an error in excess of £1m VAT, or an amount which represented 30% or more of the correct tax for the return period, they were liable to a misdeclaration penalty. The taxpayer was automatically exculpated in full if they voluntarily disclosed the error to HMRC or if they had a ‘reasonable excuse’.

The joining of the revenue and VAT arms of HMRC has seen the introduction of a single set of penalties to cover income tax, PAYE, corporation tax, VAT and NI contributions. This was included in the finance bill 2007 and will shortly become law, coming into operation for return periods commencing after 31 March 2008. At the same time, we will see the introduction of the ‘compliance spectrum’, which grades error according to the behaviour of the taxpayer.

Taxpayers will have to convince an HMRC officer that their error is innocent to which no penalty should be charged. This puts a lot of power in the hands of the officer responsible for supervising the taxpayer’s affairs. I will leave you to decide whether this is a good thing. If this fails, taxpayers can no longer achieve automatic exculpation by having made a voluntary disclosure. Also the ‘reasonable excuse’ statutory defence disappears altogether. For professional advisors this means the end of settled case law.

It is expected that not many officers will accept mistakes as innocent errors. Additionally under the new starting point for negligent penalties is 30% of the amount of tax due (an increase from the old misdeclaration penalty of 15%), following which the taxpayer can plead that the penalty should be mitigated down - again not great news for taxpayers.

These changes mean taxpayers who makes a full unprompted disclosure of an error no longer has an automatic nil liability to a misdeclaration penalty. Inevitably there will be litigation on issues such as an officer’s decision on where the taxpayer’s conduct falls under the ‘compliance spectrum’ or the level of mitigation to be allowed following a disclosure in order to re-establish the scope of what is reasonable.

The regime captures VAT registered businesses regardless of the size or the error. While there will be rights of appeal, many will lament the loss of a system where honest errors were only penalised if significant and full disclosure or reasonable excuse defences meant even those penalties could be readily avoided.

David Anderson is an associate in the tax litigation practice of McGrigors