Penalties and reasonable care

This was published in Taxation on 6 March 2023 in response to a reader’s query on penalties.

Essentially, a client had been through a tax investigation and HMRC had picked up two errors. One dividend had been missed out and another had been subject to a transposition error. The total additional tax due to HMRC as a result of the errors was c.£6,000, a small amount compared to a total declared liability of £150,000. The client consders there were simple errors but HMRC believe penalties should be payable. The question was around whether HMRC would accept that these errors did not justify a penalty.

There are two separate issues we need to consider here. One is the dividend that was missed (client error) and the other is the transposition error (adviser error). The only way HMRC will accept that these errors do not justify a penalty is if you can demonstrate the client took reasonable care/has a reasonable excuse for the error or if the client was careless and HMRC accept suspension of the penalty.

“HMRC consider a reasonable excuse to be something that stops a person from meeting a tax obligation despite them having taken reasonable care to meet that obligation. It is necessary to consider what a reasonable person, who wanted to meet their obligation would have done in the same circumstances and decide if the action of the person met that standard” (HMRC manuals CH23640). This means that we have to look at the client, in particular, their level of expertise and how they have handled their affairs in the past.

Reasonable care is referred to in legislation but we look to the courts for a definition. It is a mixture of an objective test

• Coales v R&C Commrs [2012] UKFTT at [26] Judge Brannan … said that the reasonable excuse exception was “an objective test applied the individual facts and circumstances of the appellant in question.” and that “…The word ‘reasonable’ imports the concept of objectivity, whilst the words ‘the taxpayer’ recognise that the objective test should be applied to the circumstances of the actual (rather than some hypothetical) taxpayer.”

and a subjective test

• Judge Medd QC in The Clean Car Co Ltd v C&E Comrs [1991] VATTR 23 said “One must ask oneself: was what the taxpayer did a reasonable thing … having the experience and other relevant attributes of the taxpayer and placed in the situation that the taxpayer found himself at the relevant time…?”

One thing that might raise concerns from HMRC’s perspective is that the documents supporting the value of the dividend that was missed have been misplaced. We would argue however, that

1. the fact that the documents were lost was the reason that the dividend was missed (objective);
2. only one transaction was missed and this could happen to anyone even if they took reasonable care (objective); and
3. as a proportion of income, the amount missed was small and therefore easily overlooked (objective);.
4. Further, carelessness implies a level of negligence and it would be up to you to demonstrate from a subjective perspective the client’s circumstances, how they manage their financial affairs and any taxpayer specific reason that the errors were missed.

The courts have determined that reliance on an adviser alone is not an excuse, however if the client has done everything that they could be expected to have done, if the adviser makes an error the client cannot be held responsible.

Whether or not HMRC are likely to accept that no penalty applies is a tricky question. In our experience, HMRC try to levy penalties unless there is a very obvious and direct reason for it not to be applicable (e.g. death). Trying to demonstrate reasonable care for checking a return will be diffficult and much will depend on who is reviewing the matter.

We note that HMRC’s view of reasonable excuse can be a lot stricter than that considered by the Tribunals, so it may be worth considering whether careless behaviour could be accepted and an application made to suspend the penalty.

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