We have recently identified an issue with our VAT return preparation process which resulted in an error arising on several VAT returns. We disclosed the issue to HMRC by way of error correction. Following the error correction notification, HMRC carried out a VAT visit. No other issues were identified during the visit and, as far as we were concerned, the matter was closed. We did not receive a penalty for the errors made. Six weeks after the visit, I identified that we have been treating certain supplies as exempt rather than taxable (we provide corporate finance services). We have subsequently disclosed this error to HMRC by way of error correction which it has accepted. However, we have now been informed that it is of the view that we deliberately did not charge VAT on these supplies, and that the error correction notification was prompted by the VAT visit. We are informed that we could incur a penalty of up to 70% of the tax due. Is this correct?
Answer
We have seen an increase in activity from HMRC recently, both in challenging taxpayer VAT treatment of supplies and VAT recovery on services. In addition to this, we have also seen an increase in the suggestion that penalties are due, and a stricter approach to the mitigation of the penalties enforced.
FA 2007 Sch 24 sets out the law in respect of penalties. It confirms that a penalty is due where a document (including a VAT return) is provided to HMRC and that document contained an error that was the result of a careless or deliberate act on behalf of the taxpayer.
The way the law is drafted means that the starting point is that a penalty is due, unless a taxpayer has demonstrated reasonable care.
Careless or deliberate
The level of the penalty is determined by whether the penalty is careless or deliberate. (We assume HMRC is not indicating that the penalty was concealed, so we have not commented on this.)
We do not have enough details to comment on whether the actions were careless or deliberate. Historically, as a reasonable business person, the assumption would have been that your actions were careless at worst. As you have indicated, however, HMRC has started to consider whether omissions or inaction in making repeated errors are deliberate or not.
This is a key point, as it is the difference between a maximum penalty of 30% (careless) and 70% (deliberate but not concealed).
From the information provided, it seems that you were not aware that you had accounted for VAT incorrectly at the time of making the supplies, or when you submitted the VAT returns to HMRC. Corporate finance transactions can be difficult to allocate to the exemption or otherwise. As such, it appears that HMRC would have difficulty in arguing that your error was deliberate. We would suggest that you indicate to HMRC that the examples in its Compliance Manual indicate that a business must have knowingly paid less VAT than was due; and, as you did not submit the VAT return knowing you had made an error, it cannot be deliberate (see HMRC’s Compliance Handbook at CH81150 and CH81551).
Following this point being established, the next question is whether or not the notification of the penalty is prompted. If the penalty has been prompted, then any mitigation that HMRC can offer is limited. (Assuming your error was careless, then if the disclosure is prompted by HMRC the minimum penalty is 15%; if unprompted, then the error can be mitigated to 0%.)
Prompted or not?
HMRC’s internal guidance (CH403202) states:
‘A disclosure is unprompted if it is made at a time when the person making it has no reason to believe that HMRC have discovered or are about to discover the inaccuracy, under-assessment, failure to notify, deliberate withholding of information or wrongdoing. Otherwise it is prompted.
‘Disclosures made during a compliance check will usually, but not always, be prompted. A disclosure could be considered unprompted if the inaccuracy, under-assessment, failure or wrongdoing disclosed was outside the scope of the compliance check and would not have been found in the normal course of the check.’
In your question, you state that the visit was completed to the satisfaction of HMRC, and that you did not identify that you had made the error until six weeks after the conclusion of the visit. Based on HMRC’s own guidance, we would suggest that the error was not prompted. It seems inequitable for HMRC to continue to indefinitely maintain that an error is prompted following the conclusion of the visit. Had you identified the error before or during the visit and not disclosed it, then this could be a different matter.
We recommend that you enter into discussions with HMRC to mitigate the risk of a penalty, including demonstrating behaviours to mitigate any penalty (telling, helping and giving). If you do not succeed in getting the penalty fully mitigated and do not have any other penalties suspended, then you should consider raising the possibility of suspending any penalty that HMRC look to raise. This would result in an agreement that HMRC would suspend the penalty for a specific period of time, with the condition that the same error does not reoccur. If you do go down this route, we would recommend that any conditions for suspension are specific to the issue in hand and not generic, regarding any possible errors.
We have recently identified an issue with our VAT return preparation process which resulted in an error arising on several VAT returns. We disclosed the issue to HMRC by way of error correction. Following the error correction notification, HMRC carried out a VAT visit. No other issues were identified during the visit and, as far as we were concerned, the matter was closed. We did not receive a penalty for the errors made. Six weeks after the visit, I identified that we have been treating certain supplies as exempt rather than taxable (we provide corporate finance services). We have subsequently disclosed this error to HMRC by way of error correction which it has accepted. However, we have now been informed that it is of the view that we deliberately did not charge VAT on these supplies, and that the error correction notification was prompted by the VAT visit. We are informed that we could incur a penalty of up to 70% of the tax due. Is this correct?
Answer
We have seen an increase in activity from HMRC recently, both in challenging taxpayer VAT treatment of supplies and VAT recovery on services. In addition to this, we have also seen an increase in the suggestion that penalties are due, and a stricter approach to the mitigation of the penalties enforced.
FA 2007 Sch 24 sets out the law in respect of penalties. It confirms that a penalty is due where a document (including a VAT return) is provided to HMRC and that document contained an error that was the result of a careless or deliberate act on behalf of the taxpayer.
The way the law is drafted means that the starting point is that a penalty is due, unless a taxpayer has demonstrated reasonable care.
Careless or deliberate
The level of the penalty is determined by whether the penalty is careless or deliberate. (We assume HMRC is not indicating that the penalty was concealed, so we have not commented on this.)
We do not have enough details to comment on whether the actions were careless or deliberate. Historically, as a reasonable business person, the assumption would have been that your actions were careless at worst. As you have indicated, however, HMRC has started to consider whether omissions or inaction in making repeated errors are deliberate or not.
This is a key point, as it is the difference between a maximum penalty of 30% (careless) and 70% (deliberate but not concealed).
From the information provided, it seems that you were not aware that you had accounted for VAT incorrectly at the time of making the supplies, or when you submitted the VAT returns to HMRC. Corporate finance transactions can be difficult to allocate to the exemption or otherwise. As such, it appears that HMRC would have difficulty in arguing that your error was deliberate. We would suggest that you indicate to HMRC that the examples in its Compliance Manual indicate that a business must have knowingly paid less VAT than was due; and, as you did not submit the VAT return knowing you had made an error, it cannot be deliberate (see HMRC’s Compliance Handbook at CH81150 and CH81551).
Following this point being established, the next question is whether or not the notification of the penalty is prompted. If the penalty has been prompted, then any mitigation that HMRC can offer is limited. (Assuming your error was careless, then if the disclosure is prompted by HMRC the minimum penalty is 15%; if unprompted, then the error can be mitigated to 0%.)
Prompted or not?
HMRC’s internal guidance (CH403202) states:
‘A disclosure is unprompted if it is made at a time when the person making it has no reason to believe that HMRC have discovered or are about to discover the inaccuracy, under-assessment, failure to notify, deliberate withholding of information or wrongdoing. Otherwise it is prompted.
‘Disclosures made during a compliance check will usually, but not always, be prompted. A disclosure could be considered unprompted if the inaccuracy, under-assessment, failure or wrongdoing disclosed was outside the scope of the compliance check and would not have been found in the normal course of the check.’
In your question, you state that the visit was completed to the satisfaction of HMRC, and that you did not identify that you had made the error until six weeks after the conclusion of the visit. Based on HMRC’s own guidance, we would suggest that the error was not prompted. It seems inequitable for HMRC to continue to indefinitely maintain that an error is prompted following the conclusion of the visit. Had you identified the error before or during the visit and not disclosed it, then this could be a different matter.
We recommend that you enter into discussions with HMRC to mitigate the risk of a penalty, including demonstrating behaviours to mitigate any penalty (telling, helping and giving). If you do not succeed in getting the penalty fully mitigated and do not have any other penalties suspended, then you should consider raising the possibility of suspending any penalty that HMRC look to raise. This would result in an agreement that HMRC would suspend the penalty for a specific period of time, with the condition that the same error does not reoccur. If you do go down this route, we would recommend that any conditions for suspension are specific to the issue in hand and not generic, regarding any possible errors.
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