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Mark McLaughlin CTA (Fellow) ATT TEP considers how the new penalty regime for errors might be used as the basis for a compensation regime for HMRC errors or delays.   

Introduction

Most people practice the ‘Golden Rule’, even if they do not know it by name. Perhaps the most common expression of the Golden Rule (irrespective of religious beliefs) is the phrase: “Do unto others as you would have them do unto you”. It is the ethic of reciprocity, if you prefer.

The most disappointing aspect for me of the draft ‘Charter for HMRC’ in its consultation document in February was that HM Revenue & Customs (HMRC) missed the opportunity to apply the Golden Rule. The exacting standards set for taxpayers in terms of making correct returns and keeping accurate records are hardly matched by the bland statement in the draft Charter “You can expect HMRC to…provide you with accurate information, making it easy for those who try to get things right.” Taxpayers who make mistakes in tax returns and do not meet the standards expected by HMRC are faced with a formidable penalty regime in FA 2007 s 97 and Sch 24. What recourse does the draft Charter provide to taxpayers when HMRC makes mistakes? This important issue is ambiguously addressed in the draft Charter in just two words: “Complaints process”.

Justice for all?

HMRC missed an excellent opportunity in the draft Charter to restore the faith of many taxpayers and advisers in the fairness and equality of the tax system by setting similar levels of accountability for themselves that apply to taxpayers. One can only hope that the final Charter is an improvement. For example, a taxpayer who makes a careless error in a tax return (i.e., without taking ‘reasonable care’ in HMRC’s view) is liable to a penalty of up to 30%. However, if an HMRC officer makes a mistake, what redress is available to the taxpayer? HMRC’s guidance ‘How to Complain to HM Revenue & Customs' states:

“If HMRC mistakes or delays have caused you a lot of worry or distress they may make a small payment to acknowledge and apologise for this. They might also make an additional payment if your complaint was handled badly or they took an unreasonable time to deal with it.”

In addition, HMRC’s leaflet ‘Complaints and Putting Things Right' advises:

“Where our mistakes or delays in using information you give us means that you get a late bill for Income Tax, Capital Gains Tax, or an overpayment of Tax Credits, we may not collect the full amount that you owe. However, strict conditions apply.” This statement presumably refers to Extra-Statutory Concession A19 (‘Giving up tax where there are Revenue delays in using information’), which is a remission of tax as opposed to compensation for HMRC errors or delays."

This hardly promotes taxpayer confidence or a sense of justice, and seems disproportionate to the financial risk to the taxpayer of getting it wrong. Why not apply similar tests of reasonable care and careless behaviour to HMRC in its dealings with taxpayers? And why not apply a formal mechanism that requires HMRC to compensate for careless behaviour by its representatives in a similar fashion that taxpayers are penalised, with quantifiable monetary amounts which are tax-related in some way?

A level playing field

Consider the following suggested framework of compensation for HMRC errors. It is based on the statutory penalty regime for taxpayers, and on HMRC’s guidance on that regime. A statutory framework for errors by HMRC is outside the scope of this article (but readers who are legally qualified and adept at drafting legislation could no doubt derive hours of amusement by contemplating provisions to penalise HMRC for their errors or delays).

1. Guidance for taxpayers and advisers

In the same way that HMRC publishes procedural manuals for its staff, detailed guidance could be published for taxpayers and advisers on errors by HMRC, which would of course be made available for HMRC and its staff (and without any information being withheld under the Freedom of Information Act!). In an ideal World, this guidance would perhaps be produced by a panel including the following:

• For represented taxpayers – those professional bodies represented on the Working Together Steering Group (The Chartered Institute of Taxation, Institute of Chartered Accountants of Scotland, Institute of Chartered Accountants in England and Wales, Association of Taxation Technicians, Association of Accounting Technicians and Association of Chartered Certified Accountants); and
• For unrepresented taxpayers – the Low Incomes Tax Reform Group and Taxaid.

The panel would have two primary responsibilities. The first would be to define ‘reasonable care’ (‘careless’ is already defined in FA 2007 Sch 24 para 3(1)(a) as being due to a failure to take reasonable care) in the context of HMRC’s dealings with taxpayers and agents. The penalty categories of 'deliberate but not concealed', and 'deliberate and concealed' are obviously not relevant. The panel’s second responsibility is discussed at 3 below.

There would be no liability to pay compensation if HMRC took reasonable care in dealing with a taxpayer’s affairs. In the case of a careless error, the level of compensation would be on a scale of 0% to 30%. Under the penalty regime which applies to taxpayer errors, the normal rule is that a percentage is applied to ‘potential lost revenue’, being the additional tax resulting from an inaccuracy or assessment (FA 2007 Sch 24 para 5). The normal rule for calculating compensation payable by HMRC could perhaps be that a similar percentage scale is applied to the amount of tax to which the error relates.

The maximum compensation of 30% could be reduced to 0% if HMRC owned up to their error before it is discovered, in a similar way to a taxpayer ‘unprompted disclosure’ under the existing penalty regime. Otherwise, the disclosure is prompted (e.g., the taxpayer or agent brings the error to HMRC’s attention), in which case the minimum compensation payable would be 15%.

HMRC’s Compliance Handbook states that if “…the person has been careless, for example by not taking advice when they should have, then on challenge the disclosure cannot be unprompted (CH82421). The same principle could be applied to an error by HMRC.

Example 1

Joe is a subcontract builder. He submits his own tax returns with the help of his wife Eve, a bookkeeper. During an enquiry into Joe’s tax return, the HMRC officer disallows certain travel expenses, calculates a substantial amount of additional tax, and issues a closure notice. Joe engages a firm of accountants to check the position. Following a review of the case, Joe’s agents appeal against the closure notice, pointing out that not only was the travel expenditure allowable, but that case law and HMRC’s Business Income Manual supported their client’s claim. HMRC concedes the point. Unfortunately for HMRC, the disclosure is prompted, so the minimum compensation payable is 15% of the tax incorrectly calculated. Worse still for HMRC, the officer had spread the disallowance back over three years, thereby multiplying the compensation payment due.     

The maximum penalty would be reduced according to the quality of disclosure. The ways in which a taxpayer discloses an inaccuracy under the penalty regime applicable to taxpayers are by ‘telling’, ‘helping’ and ‘giving access’, and the quality of disclosure is determined by factors including timing, nature and extent (FA 2007 Sch 24 para 9). Under a regime for HMRC errors, the elements of disclosure quality and appropriate percentage reductions might similarly be as follows:    

Element of disclosure              

Telling the taxpayer/agent about the error - 30% 

Helping the taxpayer/agent to quantify the error - 40%  

Giving access to HMRC information to establish how and why the error arose (subject to any Freedom of Information Act restrictions) - 30%  

As in the case of taxpayer errors, the quality of each of the above disclosure elements could be assessed by reference to timing, nature and extent in arriving at the disclosure reduction, albeit in a different context. For example:

• ‘Timing’ could include the length of time between an error arising and the taxpayer or agent being notified, the period over which HMRC assists in dealing with the problem, and whether it was necessary to send reminders for HMRC to respond;
• ‘Nature’ may include considering why the error has occurred, whether HMRC has been proactive in dealing with the issue, and whether HMRC has freely given access to information and explanations to establish the reason for the error or delay; and
• ‘Extent’ might include the depth of HMRC’s disclosure, the degree of cooperation by HMRC in discussions over the error or delay, and what information and explanations HMRC made available to the taxpayer or agent about the error or delay.  

Example 2

An HMRC officer takes over an enquiry into an individual’s tax return from a colleague who has retired. The HMRC officer discovers that his predecessor’s conclusion that a termination payment received by the individual should be taxed in full, was incorrect. His colleague has overlooked the fact that the exemption on account of injury to the employee in ITEPA 2006 s 406(b) was applicable in the circumstances. The taxpayer had made a payment on account of the tax thought to be due. The HMRC officer acted quickly and promptly to put the matter right. The compensation payment by HMRC in the circumstances would be at the lower end of the 0% to 30% scale.   

Different rules might apply to excessive delays by HMRC in dealing with a taxpayer’s affairs (i.e., ESC A19 scenarios), or in processing tax overpayments. For example, under the taxpayer penalty regime, the calculation of potential lost revenue if an inaccuracy results in the late declaration of tax is 5% of the delayed tax for each year of the delay, with a pro-rata reduction for periods of less than one year (FA 2007 Sch 24 para 8). A similar percentage could be applied to the amount of tax which is the subject of delays by HMRC.   

Example 3

An enquiry into the Corporation Tax Return of Happy Days Ltd takes well in excess of two years to complete. During the enquiry, a delay is caused by a change of HMRC personnel dealing with the case. A further delay is caused when the new HMRC officer refers a technical point to a specialist colleague based in another office, and a misunderstanding between the two HMRC officers results in the matter being addressed only after the company’s agents send two reminder letters. The total period of delay is six months. The enquiry is closed without any adjustment to the company’s tax liability. The company claims a compensation payment from HMRC of 2.5% of its Corporation Tax liability for the year of enquiry.     

2. Consultation with HMRC

The guidance on errors by HMRC would be subject to a period of consultation with HMRC. The professional bodies could perhaps take the opportunity here to set a generous timescale for consultation, in order to demonstrate what a reasonable consultation period looks like in practice. [Ouch! - Ed.]

3. Setting the Compensation

The second responsibility of the panel mentioned above would be to determine an appropriate level of compensation for the taxpayer to claim from HMRC.  

4. Appeals procedure

There would be an opportunity for the taxpayer (or agent) and HMRC to reach an informal agreement on the level of compensation payment by HMRC. A formal right of appeal would exist before the First-tier Tax Tribunal if the parties could not reach agreement.

Reap the benefits

The suggested parallel regime for HMRC errors and delays is by no means a basis for exacting revenge on HMRC. There are numerous potential benefits arising from such a regime. For example:

• Quality control - A regime which compensates taxpayers for errors or delays would hopefully compel HMRC to review its systems and look very carefully at quality control in its dealings with taxpayers and agents. 
• Accountability – Taxpayers and agents could draw comfort and confidence from a regime that makes HMRC accountable for errors in a way that is transparent and readily accessible.
• Fairness – Equality of treatment between taxpayers and HMRC might seem somewhat unrealistic. However, there could be few complaints from taxpayers or agents about the harshness of the existing penalty regime if HMRC were subjected to a similar code.

How would you like it?

My suggestion of tax-related compensation impositions for HMRC errors or delays is admittedly made slightly tongue-in-cheek. However, the purpose of this article is to make the point that there is an imbalance between HMRC’s powers to impose a penalty for taxpayer errors, and the remedies available to taxpayers in respect of HMRC errors. No-one is perfect. Everyone makes mistakes, some of which may be careless. The difference between careless taxpayer errors and careless HMRC errors is presently one of financial accountability. 

The Taxpayer Charter (or whatever it is eventually called) provides an excellent opportunity to redress this balance. One could be forgiven for having mistaken the draft Charter released for consultation in February as being a Charter for HMRC staff rather than for its ‘customers’. Perhaps the Charter should be written by the major professional bodies and other interested parties, rather than HMRC? In any event, a recognised compensation regime for HMRC errors would surely give taxpayers a greater sense of justice and fair play. In addition, potentially substantial liabilities to compensation for such errors would hopefully concentrate the mind, and encourage HMRC officers to practice the Golden Rule when dealing with taxpayer errors.           

The above article was first published in Taxation, 2 July 2009, as "Turning The Tables".