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When is a penalty unfair?

23 September 2011. Published by Adam Craggs, Partner

A recent tribunal case, Hok Limited v Revenue and Customs Commissioners (TC 1286) has found that HMRC did not act fairly and in good conscience where it had deliberately delayed sending out a penalty for the late filing of an employer's end of year returns until four months after the deadline had expired.

A fair organ of the state, acting in good conscience towards its citizens, would send out a penalty notice immediately after default.

The facts

Hok Limited, the appellant company, appealed a penalty for the late filing of its employer's end of year annual returns.  It received a penalty notice from HMRC, but only four months after the expiry of the deadline of 19 May for filing its end of year returns.  The penalty was, therefore, £400 which equated to £100 per month of default.  Hok then duly filed its return.  Its director had, in fact, decided that the returns were not required as the company's only employee had ceased employment several months earlier.  HMRC argued that the penalties were not intended to be reminders.  Instead, they were simply issued regularly throughout the year, the first penalties after expiration of the deadline being issued in late September.

The appellant company strongly disputed this and argued that if it had been promptly notified of default by HMRC it would have remedied the failure much earlier and ongoing penalties would have been avoided.

In the Tribunal

The case came before Judge Geraint Jones QC and Mr Mark Buffery.  The Tribunal acknowledged that the Taxes Management Act 1970 section 98A(2)(a), provided that a person who failed to make a return in accordance with the relevant provisions 'shall be liable to a penalty'.  However, crucially, the state and its organs have a common law duty of fairness – see R v Secretary of State for the Home Department [2003] EWCA CIV 364, which had to be taken into account.  The Tribunal said:

'… Thus, HMRC deliberately waits until four months have gone by and does not issue the first interim penalty notice until, as in this case, September of the year of default.  By that time a penalty of £400, being four times £100 per month, is said to be due.  In fact, if the penalty notice operates as a reminder and the tax payer undertakes the necessary filing forthwith, a further one month penalty arises because the de facto reminder is received only after it is too late to avoid a further £100 penalty … HMRC is an organ of the state.  It is no function of the state to use the penalty system as a cash generating scheme … it is inexplicable why HMRC deliberately delays sending out a penalty notice for four months, with the effect that a penalty for five months becomes payable … it has long been part of the common law of this country that organs of the state must act fairly and in good conscience with its citizens … in our judgement, HMRC has neither acted fairly nor in good conscience in the manner described above…'

The Tribunal decided that HMRC could charge a penalty of no more than £100 unless they could prove, the onus of proof being upon them, that even if such a penalty notice had been issued earlier, it would still have been ignored by the taxpayer.

The penalty regime

The levying of penalties is an important function of HMRC. For some time, there has been a growing concern that penalties are seen as a significant cash gatherer for the Exchequer which is keen to increase the tax yield given the state of the UK's finances.  This case is a timely reminder that the powers given to HMRC to impose penalties should not be miss-used.  Anecdotal evidence suggests that the penalty regime operated by HMRC, for example for errors in returns or documents under Finance Act 2008,  schedule 40 or for failure to notify under Taxes Management Act 1970,  section 7 of liabilities to income tax or capital gains tax, are being operated in an  aggressive manner by HMRC.  The Hok case is a salutary reminder to HMRC that they are obliged to act fairly and to apply the legislation in a proportionate and reasonable manner and that penalties are not a cash extraction machine for the Exchequer.