In this article, we shall look at the penalty regime and how penalties may be avoided or reduced.
There are different penalty regimes depending on whether or not the taxpayer already files a tax return; also penalty legislation was substantially re-worked in Finance Act 2007, basically for 2008/09 and later tax returns. For simplicity, we shall use the current terms, but much holds good for the old rules.
The penalty scale
Briefly, the penalty regime follows in order of gravity:
The penalty rate increases going down the scale; there can be reductions where the taxpayer approaches HMRC first, and for actively helping HMRC to resolve the issue.
Is there a tax liability?
If a taxpayer has no additional tax to pay by reason of the letting activity then normally there should also be no penalty to pay.
Where the taxpayer has not told HMRC that he needs to file a tax return, there can be a ‘late notification penalty’ calculated by reference to the amount of tax which remained unpaid by the normal payment deadline for that year – normally 31 January following the relevant tax year. However, where the taxpayer has a ‘reasonable excuse’ for not having notified HMRC that a tax return was due, then there will be no penalty.
What is a ‘reasonable excuse’?
Unfortunately, there is no legal definition, leaving HMRC and the courts some latitude in interpretation. Perhaps unsurprisingly, HMRC’s position is more demanding than the courts’. HMRC’s Compliance Handbook manual (at CH71540) says that ‘a reasonable excuse is normally an unexpected or unusual event that is either unforeseeable or beyond the person’s control, and which prevents the person from complying with an obligation to notify when they would otherwise have done’.
The Tribunals, however, disagree; for example, in Mr TJ Fisher (T/a The Crispin) v HMRC  UKFTT 235:
“...As a matter of law, that is wrong. If Parliament had intended to say that a person could only avoid a penalty by establishing that an exceptional event or exceptional circumstance had arisen, it would have said so. Parliament chose to use the phrase ‘reasonable excuse’ which is an ordinary expression in everyday usage which must be given its natural meaning.”
Broadly, if an ordinary person would find the taxpayer’s excuse reasonable, that may suffice. A similar case, Perrin v Revenue & Customs  UKFTT 488 (TC), also confirms this.
The Compliance Handbook manual (at CH17540) later states:
“Each [reasonable excuse] depends upon the particular circumstances in which the failure occurred and the particular circumstances and abilities of the person who has failed.”
Essentially, the Perrin case also agrees with this. But note that the reasonable excuse must last up until the taxpayer takes steps to remedy the situation: once you have realised that a return is due, you must act reasonably quickly to file the return.
Where a taxpayer already files a tax return but has failed to include any (or all) rental profits, then this will constitute an inaccuracy in his or her tax return.
However, where the taxpayer has taken ‘reasonable care’ in preparing his return then, again, no penalty should be charged. The concept of ‘reasonable care’ is very similar to that for having a ‘reasonable excuse’ above. HMRC states (at CH81120):
“For example, we do not expect the same level of knowledge or expertise from a self-employed un-represented individual as we do from a large multinational company.”
Examples of reasonable care in a tax return:
Onus of proof
HMRC states (at CH84540):
“The onus is on the person to satisfy us that they took reasonable care to avoid inaccuracy.”
However, the truth is that, in a tribunal, it is down to HMRC to prove that a return or other submission contains a careless or deliberate inaccuracy (CH81180). HMRC’s old Appeals Handbook manual (at AH1325) discusses the onus of proof and confirms specifically for penalty appeals:
“When HMRC makes a penalty determination it is asserting that an offence has been committed. The onus of proof and evidential burden rest firmly with the Crown” (See also King v Walden  EWHC Ch 419). It also goes on to say, “The more serious the accusation the higher the standard of proof must be.”
This suggests that, to prove that a taxpayer’s behaviour was deliberate, especially with steps to conceal his actions, the standard of proof is higher than for mere carelessness.
Was it deliberate, or can the penalty be suspended?
According to HMRC (see CH402705), deliberate behaviour is when a person knows that he is required to notify HMRC about a relevant obligation, is able to do so, but does not. In the context of the ‘let property campaign’, in ‘Your Guide to Making a Disclosure’, HMRC says (at 3.9 Penalties): “HMRC may find it difficult to accept... that someone in business for many years, earning significant amounts without telling HMRC, has not done so deliberately”.
The higher thresholds (i.e., deliberate action) are important, not just because the penalties are higher, but because a penalty may not be ‘suspended’ for a taxpayer’s deliberate failure to take reasonable care. Where there is an inaccuracy in a tax return, the penalty may be suspended subject to conditions, for a probationary period (of up to two years) after which time, provided the taxpayer suffers no further inaccuracy penalties, the penalty is cancelled. The rationale is that, rather than simply punishing the taxpayer, suspension encourages future compliance.
The problem is that HMRC is quite reticent about suspending penalties – I can find no mention of them in the let property campaign – yet at CH83110 HMRC says:
“Whenever we decide that a person is liable to a penalty for a careless inaccuracy we must consider whether we can suspend it”.
HMRC also often says that the penalty can be suspended only if the same error could be repeated in future, whereas the courts have found that this is incorrect: the purpose of suspension is to help prevent any further careless inaccuracy (Testa v HMRC  UKFTT 151).
Conclusion – and a helping hand from HMRC?
Advice from a suitably qualified professional adviser is strongly recommended. Clearly, it makes sense to approach HMRC unprompted in any event, to minimise any penalties that may be due. If there is an opportunity to claim that there was a reasonable excuse for not notifying HMRC of any rental income, or that reasonable care was taken when submitting a tax return, then that should be explored. Likewise, any opportunity for suspending a penalty should be carefully considered – even if HMRC has not. But that may require care to indicate that conduct was not deliberate, while bearing in mind that it should be for HMRC to prove at tribunal.
HMRC has published a dozen representative case studies which some may find useful as parallels for demonstrating reasonable excuse/reasonable care. As HMRC puts it:
“There are many reasons why landlords may misunderstand the rules and so not pay the right amount of tax. Read examples of tax errors landlords make (see http://goo.gl/3Nkiif) to see if you’ve misunderstood the rules.”