Replies to Queries - 1 - The time of reckoning

My client was gifted a property on 3 December 1996 on which rental income has been received throughout. No tax returns had been filed and this source of income was notified to the Inland Revenue in May 2001. The relevant tax returns have just been filed and the overall tax position for the respective years is:

The nature of the omission will attract interest, penalties and surcharges.

Although there is a vast library of information available on the legislation concerning penalties and surcharges, it is not very clear as some areas overlap. Readers' views as to exactly what form of penalties and surcharges may be applied by the Revenue would be appreciated.

(Query T15,904) – VSS.

Working on the basis that there will be no section 9A enquiry, this means that there will be tax-geared penalties in respect of the failure to notify.

In this case the client, who was not issued with tax returns, was required to have notified the Revenue within six months of the end of each of the tax years concerned of the liabilities. This gives rise to penalties, which must not be greater than the non-paid tax. When one fails to submit a return, there first is the automatic fixed £100 penalties with the filing dates of 31 January and 31 July being relevant. Therefore with an overpayment for 1996-97, the penalties will not apply for that year, there subsequently being £200 due for each of the years 1997-98 and 1999-00. Obviously we are still well within the time limit for 2000-01. There is then the tax-related penalty which is due because a return was still outstanding twelve months after its filing date, and again it must not exceed the tax due figure. This applies for 1997-98 and 1998-99.

There is also a daily penalty of up to £60, and this would only be applied where there was a substantial amount of tax due, with the fixed penalties being insufficient. This type of penalty may only be imposed by the Commissioners following application by the Revenue and only applies up to the date of submission of the returns.

I have of course stated the worst possible scenario. There is of course mitigation, which is somewhat in the hands of 'VSS'. Abatements of penalties will be given up to: 20 per cent for disclosure (although, as in this case, for voluntary disclosure 30 per cent will be considered); 40 per cent for co-operation and 40 per cent for gravity.

Where two or more penalties are chargeable on the same tax, section 97A, Taxes Management Act 1970 operates to ensure that the aggregate penalty does not exceed the greater or greatest of those penalties.

Under section 59C(2 and 3), Taxes Management Act 1970, surcharges are imposed at the rate of five per cent of the tax unpaid after 28 days following the due date (e.g. if the tax due by 31 January is not paid by the following 28 February) and then again if the tax is not paid after six months following the due date. However, under section 59C(4) where a penalty is charged, no surcharge is due, and no doubt the Inspector will take this into account when calculating the tax-geared penalties.

Finally we look at interest, and this will run from the relevant due dates of payment. Therefore, ignoring the 1996-97 overpayment and taking, say, 1 November 2001 as the payment date, then the interest for each year will be: 1997-98 – £679.94; 1998-99 – £674.47; 1999-00 – £410.56; 2000-01 – £130.34, which totals £1,895.31. Please also remember the 2000-01 balancing payment of £181.31 falls due by 31 January 2002, together with the 2001-02 first payment on account of £1,761.58. – N.K.

There are two distinct issues to consider, being penalties and surcharges, and I will consider penalties first of all.

For an individual, a tax-geared penalty could be imposed for a failure to notify chargeability under section 7, Taxes Management Act 1970, for failing to submit a return in response to a notice under section 93, Taxes Management Act 1970, or for submitting an incorrect return under section 95, Taxes Management Act 1970. In any of these cases, the penalty is up to the amount of the tax payable.

Given that 'VSS' has just filed the tax returns for his client and brought him up to date, a penalty under section 95 for an incorrect return is not likely to be in point.

For a penalty to arise under section 93, it would have been necessary for the Inland Revenue to have issued notices requiring the client to submit self-assessment tax returns. As it only became aware of the source in May 2001, it could not have done so before then. This means that unless the period between the date that the notices were issued and the date of submission is more than three months, a penalty under section 93 cannot arise. Two other points suggest that the Inland Revenue will not use this section. The first is that the period from the date of the notice cannot be more than six months, which means that the penalty could not exceed £100 per return. Secondly, a penalty could never be imposed for 2000-01 as the filing date is 31 January 2002 and the return has already been submitted.

This leaves us with a penalty under section 7 for failure to notify chargeability. Under section 7(1), Taxes Management Act 1970, if a person has taxable income in a tax year and does not receive a notice to submit a return, he must advise the Inland Revenue that he is so chargeable within six months of the end of that year. In this case, the client should have notified the Inland Revenue by 6 October 1997. Section 7(8) then goes on to state that in the event of such default, a penalty of up to the amount of the tax can be imposed.

A planning point does arise, as such a penalty can only be imposed if the tax remains unpaid by 31 January after the end of the tax year. The client should make sure that he pays the tax for 2000-01 by 31 January 2002 to avoid the penalty for that year.

The penalty can be up to 100 per cent of the unpaid tax, although the usual opportunities for mitigation will apply. Up to 20 per cent reduction from the base of 100 per cent will be given for disclosure. Up to 40 per cent will be given for co-operation in bringing matters to a conclusion. Finally up to 40 per cent will be given dependent on the size and gravity of the offence.

The deductions for disclosure and co-operation should be fairly large on the basis of the limited facts available. On the question of size and gravity, the number of years over which culpability continued will weigh against a substantial reduction and so an overall penalty of 20 per cent to 30 per cent is likely. 'VSS' should remember that if part of the tax payable is, for example, a Schedule E underpayment overlooked by the Inland Revenue, then that part of the amount payable is not likely to be culpable.

For surcharges, in the normal course of events, an amount of 10 per cent would be payable for each of 1997-98, 1998-99 and 1999-00. However, section 59C(4), Taxes Management Act 1970 will come to the aid of the client of 'VSS'. This provides that any amount of tax by reference to which a penalty under section 7, or indeed the other tax-geared penalties, is payable will not be considered to be unpaid. As a result, no surcharge is payable on that part of the tax. If part of the underpayment is not culpable under section 7, a surcharge of 10 per cent would still apply on that tax. – Hodgy.

Editorial note. On the basis of the comments by 'N.K.' and 'Hodgy', total penalties at 20 per cent/30 per cent are likely to be between £2,000/£3,000 and interest £1,895. The interest is non-negotiable, being regarded as commercial restitution. Bearing in mind that no tax returns were issued, voluntary disclosure has been made and the tax paid, it would be worthwhile attempting to reduce the penalty loading even further. There is no reason why the maximum 30 per cent for disclosure should not be given and 40 per cent for co-operation. This leaves size and gravity to be argued. An overall penalty of 10-15 per cent, if 15/20 per cent was granted for size and gravity would save a significant amount for the client.

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