Reasonable care or careless behaviour – where is the line drawn?

A February 2024 Tax Voice article discussed the concept of carelessness in relation to indirect taxes. This month we expand our commentary and look at some recent First-tier Tribunal (FTT) cases involving direct taxes.

Why care about acting carelessly?

Careless behaviour (the failure to exercise reasonable care) is important when determining the level of penalties HMRC can apply, and how far back in time it can go in an investigation. 

Seeking a second opinion

The case of Magic Carpets (Commercial) Limited v HMRC concerned a tax planning arrangement involving an employee benefit trust (EBT).

The company had obtained professional tax advice, which the FTT determined was reasonable for the company to rely upon. Nevertheless, the FTT judged that the company directors had not taken steps to engage with and understand the advice.

The FTT also decided that the company had been careless in failing to seek a second opinion, but interestingly held that if a second opinion had been sought it would have come to the same conclusion. 

As such, although the FTT felt that not taking a second opinion was a failure to take reasonable care, that failure did not lead to a loss of tax, so HMRC could not charge penalties. 

Failure to act on professional advice

In Delphi Derivatives Limited v HMRC, the company took advice but did not act on it. Not surprisingly, the FTT was not impressed by this.

An EBT arrangement also existed in this case. The company appealed against the penalties issued, but these were upheld, with the FTT determining that a loss of tax had arisen as a result of the company acting carelessly by not addressing risks that were identified by the professional adviser. 

Failure to update professional advice

In Strachan v HMRC, the taxpayer had not obtained updated professional advice on his domicile position since 1987. HMRC argued that this was careless even though the FTT determined that new advice would not have changed the taxpayer’s filing position. 

Luckily for the taxpayer, the FTT concluded that HMRC had failed to prove that careless behaviour resulted in a loss of tax. However, it is clear from this ruling that relying on advice taken years ago is likely to be considered careless unless that advice is reviewed and updated at appropriate intervals.

Whilst FTT decisions are not binding on future cases, these recent examples show some important common themes.

Key takeaways

• What constitutes reasonable care depends on the specific facts of each case, meaning the potential implications for careless behaviour-based penalties are not always clear.
• A causation test is being applied by the FTT; the burden of proof falling on HMRC to prove there is a causal link between careless behaviour and a loss of tax.
• Simply obtaining professional advice will not, of itself, protect taxpayers. However, whilst not seeking such advice is not necessarily careless, it will often be risky.
• A lapse of time does not mean that professional advice necessarily needs to be updated, but the taxpayer has an obligation to review their affairs regularly and not just assume that advice taken in the past remains valid today.

Failure to exercise reasonable care can significantly increase penalties when things go wrong. It can also allow HMRC to go back further in time to raise a challenge. Thinking about your position carefully today can save a lot of stress and cost later.

For more information, please get in touch with Andrew Robins, or your usual RSM contact.