HMRC can charge a penalty where a taxpayer has filled in his tax return carelessly with the result that he underpays tax.
In the case Eastman v HMRC, HMRC charged Mr Eastman a £21,547 penalty for failing to report a capital gain on the sale of some business premises on his tax return. The omission had been caused due to a change of the accountant preparing his tax return followed by Mr Eastman failing to notice the error when he checked his return. Mr Eastman accepted that he had been careless and paid the outstanding tax promptly when HMRC opened an enquiry.
However, he asked HMRC to consider suspending the penalty.
HMRC has the power to suspend a penalty where a return was inaccurate due to carelessness. However, this applies only if compliance with a condition of suspension would help the taxpayer avoid becoming liable to further penalties for careless inaccuracy in preparing his returns. If a penalty is suspended and the taxpayer follows the conditions of suspension (and does not become liable for another penalty for inaccuracy during the period of suspension), the penalty will be cancelled.
HMRC refused to suspend the penalty because it did not consider that it could impose any conditions which would help Mr Eastman to avoid becoming liable to further penalties for similar inaccuracies.
HMRC explained in a letter to Mr Eastman's accountant that it applied a three stage process when considering whether to suspend a penalty. This involved:
- identifying the underlying cause of the current careless inaccuracy, in this case omitting the capital gain on the sale of the business premises
- identifying any future careless inaccuracies that would result from the underlying cause identified
- considering and agreeing suspension conditions.
HMRC reasoned that, because Mr Eastman did not have further business premises to sell, imposing conditions would not prevent further penalties (because Mr Eastman would not have capital gains tax liabilities for these sorts of disposals in any case). It also stated its policy not to suspend penalties for one-off inaccuracies and said that, because the mistake was down to human error rather than a systematic failure, imposing conditions would not prevent Mr Eastman repeating the mistake.
The First-Tier Tribunal (FTT) applied the principles used in judicial review to decide whether HMRC had made its decision in a reasonable way. It found that HMRC’s decision was flawed and was not the decision of a reasonable decision maker. It also found that HMRC had fettered its discretion in applying a policy excluding the suspension of penalties for one-off inaccuracies. The FTT ordered HMRC to suspend the penalty though acknowledged that the conditions of the suspension were a matter of HMRC's discretion.
The main flaw which the FTT identified in HMRC's reasoning was that it had taken the “underlying cause” of the inaccuracy as being a specific omission of a capital gain and concluded that, because the taxpayer was unlikely to make the same specific omission again, no conditions to prevent him doing so could be imposed. The FTT found that the “cause” of the inaccuracy was inadequate record keeping, which could be addressed with conditions, which would prevent the taxpayer making other errors in his tax return carelessly.
The FTT found that the “acid test” in deciding whether a penalty can be suspended is to ask “what the taxpayer could reasonably have done differently that would have avoided the original inaccuracy”. In this case, they suggested that Mr Eastman could have kept more thorough records in order to double-check the return prepared by his accountant.
This case may give taxpayers a stronger basis for asking HMRC to suspend penalties for careless inaccuracies. However, it will still be necessary to identify specific conditions which could be imposed which would help to prevent other inaccuracies being caused in a similar way.