HMRC’s ‘default’ position on penalties criticised by tribunal

In the recent First-tier tribunal case involving H&H Contract Scaffolding Limited (H&H), the company had engaged with an adviser to prepare a research and development (R&D) tax relief claim. HMRC disputed the validity of the claim and after several rounds of correspondence, the taxpayer accepted the claim was invalid. 

The detail of the claim was not discussed by the tribunal as it was no longer disputed. Instead, the tribunal sought to determine whether the issue of a £6,632 penalty for ‘careless behaviour’ was appropriate, as H&H believed it acted with reasonable care by employing a firm it believed was a competent professional adviser with suitable experience of preparing and submitting R&D tax relief claims in the same industry.

In HMRC’s Statement of Reasons, it argued that as the taxpayer could not show that it qualified for the R&D tax relief included in the claim, the taxpayer had by default been careless. In the proceedings, the judge was very critical of this summation, twice pointing out that the mere existence of an inaccuracy cannot determine that it was careless.

The judge considered that the Statement of Reasons was in fact a ‘confused document’ and that HMRC had failed to understand its own guidance that the burden to prove that H&H acted carelessly laid with HMRC. On the basis H&H had relied upon a firm that it believed to be a competent professional adviser, the judge found that the taxpayer had in fact taken reasonable care when the claim had been prepared and submitted on its behalf.

It is not unusual to see HMRC adopting such an approach to penalties. If there is an adjustment, HMRC may often appear to assume there must be a penalty due, as opposed to properly considering the circumstances of the case.

This has been particularly evident in HMRC’s current campaign in relation to R&D tax relief claims, and was highlighted in the Chartered Institute of Taxation’s open letter to HMRC in July 2023 regarding HMRC’s current approach to R&D tax relief enquiries and associated penalties. HMRC’s response dated 29 August 2023 states that it will always consider charging a penalty if a return or other document provided to it contains an inaccuracy, noting that ‘HMRC officers gather evidence to support their conclusions on the behavioural penalty charged’, but this case suggests this may not always be the case.

It is also worth considering what is happening practically – an HMRC enquiry could run for 12 months (often longer). If an inaccuracy is identified which results in additional tax, the application of a penalty can increase HMRC’s ‘take’ for a careless error by up to 30%, with relatively minimal additional effort. In some situations where reasonable care has in fact been taken, this can cost the taxpayer significant time and money to contest, resulting in many simply accepting unwarranted penalties to bring matters to a close. The question is: does this lead to some HMRC officers being overzealous and applying penalties where they are not appropriate?

An additional consideration when looking at taxpayer behaviour is the potential for HMRC to seek additional tax from earlier years. If it is accepted that a penalty applies, another consequence is the ability for HMRC to extend the normal assessment window of four years to six years for careless behaviour, and 20 years for deliberate behaviour. Could this be another reason why it is increasingly common for HMRC is to seek penalties in relation to adjustments? 

The tribunal ruling in favour of H&H was made on the basis it had not seen enough evidence to suggest that the taxpayer had acted carelessly. Whilst this is of general relevance, it is interesting given it related to an R&D tax relief enquiry. It is well documented that claims for R&D tax relief face a challenging environment at present with HMRC’s aggressive approach to enquiries sometimes resulting in collateral damage that affects genuine claimants. We do not dispute that as part of a robust R&D tax relief regime, genuine claims can and will be enquired into. However, current evidence suggests that poor HMRC case selection procedures are resulting in many more well prepared genuine claims than might be expected being selected for review, many reviews concluding in adverse decisions without proper consideration of the underlying facts and validity of such claims, and typically a binary ‘all or nothing’ decision. For businesses involved in such enquiries, the scope for HMRC to pursue penalties inappropriately can often result in additional uncertainty and costs. This can directly impact on the operation, development, and even the financial viability of businesses making legitimate claims. 

Following engagement with R&D tax relief professionals, HMRC has acknowledged that it has not been getting the assessment of penalties right in a number of cases. It is understood that HMRC is undertaking further staff training to ensure penalty assessment procedures are correct. However, the standard approach to push for penalties in most R&D cases is still evident at present. 
The current penalty regime for inaccuracies in tax returns has been in place since changes were introduced in Finance Act 2007, and there is no dispute that penalties should be applied in appropriate cases at appropriate levels. However, this case illustrates that there has often been a blinkered default application of penalties by HMRC. So, is it misunderstandings on the back of insufficient training, an overzealous approach, or revenue raising to meet yield targets that has led to this approach?