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Penalty spot

03/10/2017 James Quarmby, partner & head of private wealth, Stephenson Harwood,

However you may wish to dress it up, taxation is the license the government gives itself to confiscate your money, or at least a defined portion of it. 

We cannot argue against the good that tax revenue brings society – without it the state would not be able, for instance, to defend itself or care for its citizens - but we also cannot ignore the complete lack of voluntariness of the system. 

The government tells you how much to pay and you must acquiesce - if you do not, there will be consequences. One of the consequences for the non-acquiescent is a financial penalty but as any penalty also involves the confiscation of yet more of your money it must follow the rules of natural justice in that it must be clear, fair and proportionate. 

As soon as those principles are forgotten then any penalty regime looks oppressive and oppression is not something we generally like to do in this country. For instance, we do not send people to prison for life for stealing a loaf of bread, as that would be disproportionate. It’s just not cricket.

This brings me to this edition’s topic – the Requirement To Correct (RTC), a mundane sounding measure with far reaching and disproportionately harsh consequences for those caught up in it. 

What is the Requirement To Correct?

If you have any tax irregularity, whether caused innocently, negligently or deliberately, in respect of any offshore assets, income or gains then you must notify HMRC of your desire to correct by the deadline of 30 September 2018.

What happens if I don't notify HMRC?

This is the controversial part – you will be subject to a minimum 200 percent penalty of the underpaid tax PLUS a further 50 percent uplift for those who attempt to move assets to other jurisdictions to avoid detection PLUS a 10 percent asset based penalty where the undisclosed tax exceeds £25,000 in any tax year. That’s a lot of penalty. 

You had it coming...

 We are talking about offshore non-compliance here so surely if you are caught then you deserve it? After all, if you know you’ve been a bad boy or girl then you should ‘fess up, right?

That sounds good in principle but the huge, planet-sized problem with this measure is that the penalties apply irrespective of how the irregularity occurred - it can and will catch entirely innocent mistakes, oversights or misunderstandings about the law, unless there is a ‘reasonable excuse’. Unfortunately, HMRC’s idea of ‘reasonable’ is quite narrowly drawn and you will be a lucky punter if you fell within it.

Don't read this if you are a trustee 

Let’s say you are a professional trustee and one of the hundreds of trusts you administer has some UK directly held assets to the value of £10 million. For some reason, no one has noticed that the ten-year anniversary of the trust occurred in 2015 and that an IHT anniversary charge of six percent was due and payable. It is now past the deadline of 30 September 2018 and you would like to regularise the position. What’s the damage?

The tax under-declared is six percent x £10 million = £600,000. You will need to pay that, plus interest, but let’s look at the penalty. In the old days, you would be looking at 10 – 20 percent, especially if you have volunteered the information to HMRC. However, in the dystopian new RTC world it gets rather ugly. First, you apply a 200 percent penalty,  which equals £1.2 million, already a stiff penalty. However, to that you can add a 10 percent asset based penalty (ABP) because the tax in that year exceeds £25,000. So, that’s another £1 million. The total penalty is therefore an eye-watering £2.2 million, against a tax charge of £600,000. This means, dear trustee, you will only have £7.2 million left in your £10 million trust fund. Not a good day at the office.

There is an ‘awareness’ test for the ABP, in that if you were not aware of the irregularity then it should not apply. However, I’m not sure how evenly this will be applied. What if the trustees in question were told when the trust was set up ten years ago that there would be an anniversary charge but between then and now it was forgotten - are the trustees aware? They were, but then they weren’t. Which state of mind will be applied? 

Don't read this part if you are anyone else 

Another example – you have £7.5 million in an offshore bank account. It pays a paltry one percent interest rate. You forget to include the interest of £75,000 on your tax return. That’s careless and you should be punished. So, let’s look at that penalty: 200 percent x £33,750 (the tax due) = £67,500 plus £750,000 (10 percent of your bank balance) = £817,000. This represents a penalty of 2400 percent of the under-declared tax. Yes, that’s the correct number of zeros.

In respect of the ABP of £750,000 – was the client aware? He should have known that the interest must be included on his tax return, he just forgot. It was an oversight. Was he aware?

Whatever way you look at it, a 2400 percent penalty goes way beyond any idea of disproportionality and in my view just isn’t fair.

What's a reasonable excuse?

You have a reasonable excuse if you relied upon professional advice from a suitably qualified person who is not an ‘interested person’ in the tax planning. That’s a bit awkward since most people ask their tax advisors to help with the tax planning in question, which will probably make them ‘interested’. There are a few other reasonable excuses, most of them paltry.

Commentary

This new law is a real shocker. I have no problem with punishing people for the deliberate or negligent under-declaration of tax but our existing penalty regime seems to tackle that adequately. To disproportionality punish people who make honest mistakes, oversights or whose interpretation of the tax law is genuinely different to HMRC cannot be justified.

What is more, I’m pretty sure this measure offends against EU law in that it only catches assets or profits offshore, so if the bank account in question is within the EEA (like Liechtenstein) then you get a 200 percent penalty, whereas if the account is in the UK you do not. That looks like direct discrimination against bank deposits (or other assets) held in EU territories.

I should point out that any penalties under the RTC can be appealed through the normal channels and one would hope that a tribunal, when asked to review a 2400 percent penalty imposed by HMRC, might decide that it is a little unfair and to substitute a lower, more proportionate, penalty.

Finally, at the risk of stating the obvious – do get some advice on your existing tax affairs well before the RTC deadline of 30 September 2018.  I’m here if you need me.  

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