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Mark McLaughlin points out that a pro-active approach by individuals to dealing with tax debts can have a positive financial effect.

Introduction

Taxpayers sometimes find themselves with tax arrears through no fault of their own. Unfortunately, that does not guarantee any sympathy from HM Revenue & Customs (HMRC)! They will charge interest and possibly penalties if the tax is paid late, even if the taxpayer has contacted HMRC to make payment arrangements. However, a recent tax tribunal case offers taxpayers hope of at least avoiding penalties in such circumstances.

In Brady v R&C Commrs [2011] UKFTT 415 (TC), the taxpayer appealed against surcharges for late payment of his Income Tax for 2006-07, 2007-08 and 2008-09, and interest on the tax paid late and the surcharges.

Incorrect Tax Code

The taxpayer’s gross employment earnings exceeded £100,000 for each of the three tax years. However, the PAYE tax code operated by his employer only deducted Basic Rate tax from his earnings. The mistake was not discovered until January 2010. The taxpayer quickly informed HMRC of the error. HMRC sent him tax returns to complete in February 2010. The taxpayer completed the returns and sent them to HMRC on 14 April 2010. HMRC sent tax calculation notices to the taxpayer during July 2010, showing tax due of £11,473 for 2006-07, £13,502 for 2007-08 and £15,322 for 2008-09.

The taxpayer then called HMRC, and pointed out that it was difficult for him to find so much money at short notice. He made a payment on account on 20 July 2010, and after trying through various sources to find the remaining tax owing, settled the balance on 10 September 2010. In the meantime, HMRC issued surcharges for 2006-07, 2007-08 and 2008-09. The taxpayer appealed.

Time To Pay

The tax tribunal was informed by the taxpayer that he had always relied on his employer to deduct the correct tax, and had contacted HMRC as soon as the issue was identified. He then completed his tax returns and paid the tax “as quickly as [he] reasonably could”. He said that the payment dates for the tax were never made clear to him. The taxpayer was also under the impression that he had agreed with HMRC that it would be acceptable for him to pay the amounts over the agreed timescale.

HMRC’s arguments included that, given the taxpayer’s level of income, he should have been aware that his tax was under-deducted, and that “ignorance of the law is not a reasonable excuse for late payment of a tax liability”. They submitted that the surcharges were properly due on the tax paid late, and that the taxpayer had no reasonable excuse for the late payment. HMRC also contended that a formal Time To Pay arrangement was not in existence prior to 10 September 2010.

Reasonable Belief

The tribunal observed: “[The taxpayer’s] evidence gives the overwhelming impression of an honest man seeking to do his best and pay the tax which he unexpectedly found to be due.” The tribunal also found as a fact that that the taxpayer had always relied on his employer to deduct the correct tax from his earnings before receipt and that he was therefore unaware of the shortfall in his Income Tax until January 2010. When he became aware of the error he immediately contacted HMRC and completed the Self-Assessment returns. The tribunal further found that when the taxpayer was informed of the amount due, he contacted HMRC and believed that he had negotiated a Time To Pay arrangement.

In response to HMRC’s argument that ignorance of the law is not a reasonable excuse, the tribunal held that the taxpayer was not ignorant of the law, but was ignorant of a fact, i.e., that an incorrect tax code was being used. The taxpayer had handed in form P45 when he started his employment, and believed that HMRC and his employer between them had ensured that the right amount of tax was deducted. The tribunal held that this was a reasonable belief, and that the taxpayer had a reasonable excuse for the late payment of tax on his employment income for the period before he discovered the under-deduction. Furthermore, for the period after the taxpayer’s discovery in January 2010, he genuinely believed that he had negotiated a delayed timescale for paying the tax, based on documented conversations with HMRC staff. This constituted a reasonable excuse for late payment.

The taxpayer’s appeals against all the surcharges were allowed (nb the interest on the surcharges fell away, but there was no right of appeal against the interest on overdue tax).        

Reasonable Excuse

The tribunal in the above case had noted that there is no statutory definition of ‘reasonable excuse’. Previous case law had established that:

• ‘Reasonable excuse’ is “a matter to be considered in the light of all the circumstances of the particular case” (Rowland v HMRC [2006] STC (SCD) 536);
• An excuse is likely to be reasonable where the taxpayer acts in the same way as someone who seriously intends to honour their tax liabilities and obligations would act” (B&J Shopfitting Services v R&C Commrs [2010] UKFTT 78 (TC)).

The tribunal held that the taxpayer had acted in accordance with the second bullet point above.

It is worth pointing out that the surcharge regime only applies for tax returns up to and including 2009-10. New penalties were introduced on 6 April 2011 for Self Assessment taxpayers, in respect of tax payable for 2010-11 and later tax years. However, like the previous surcharge regime, it is possible to avoid charges under the new penalty regime if the taxpayer has a ‘reasonable excuse’ for failing to pay the tax on time (FA 2009 Sch 56 para 16).

Conclusion

The message from Brady v R&C Commrs appears to be that taxpayers who find themselves in a similar unfortunate position to Mr Brady should deal with the issue proactively, and contact HMRC as soon as they discover a problem with their tax affairs, whether it is a tax underpayment or that they are unable to meet future tax liabilities on time.

Taxpayers who are clearly trying their hardest to satisfy their tax obligations will often find some help from HMRC. If not, it seems that the tax tribunal may well be prepared to treat the taxpayer’s case sympathetically. 

Mark McLaughlin CTA (Fellow) ATT TEP is a consultant to Tax Debts Limited, a debt management service for UK taxpayers.