In the first part I related the case of a landlord who had spent a substantial sum on repairing and improving his rental property. He had kept sufficient records to be able to demonstrate how much he had paid and he was confident that he had made a fair apportionment between repairs and capital based on the guidelines I had given him. HMRC enquired into the return and required production of various documents to substantiate the apportionment. A notice under Paragraph 1, Schedule 36 of Finance Act 2008 was issued to force production of the documents and an appeal was lodged on the grounds that some were not in the taxpayer’s possession or power. As a result, further time was given to supply the information. That was where the first part of the story ended.
Unfortunately it proved impossible to obtain all of the information requested (despite numerous telephone calls, letters and faxes to the builders, tradesmen and consultants involved). Fortunately the inspector accepted that we had done all that it was in our power to do and invited us to put forward a case based on what we had. That we did, but with a lower repairs figure than had originally been claimed because that was all we had documentation to substantiate. The client remained adamant that his original apportionment had been accurate.
You are in the fortunate position of being able to choose which ending you like best
With the apportionment agreed we moved to the question of penalties for inaccuracies. Here I am going to depart from straightforward narrative so that I can illustrate how things could have gone as well as how they actually went and give you some alternative endings. You are in the fortunate position of being able to choose the one you like best.
The relevant penalty provisions are in schedule 24 of Finance Act 2007.
For a penalty to be due, the inaccuracy must either be careless or deliberate. It was common ground in this case that the error was not deliberate, but was it careless?
At paragraph CH81120 of its compliance handbook HMRC says that “Every person must take reasonable care, but ‘reasonable care’ cannot be identified without consideration of the particular person’s abilities and circumstances....In HMRC’s view it is reasonable to expect a person who encounters a transaction or other event with which they are not familiar to take care to find out about the correct tax treatment or to seek appropriate advice.”
HMRC then continues at paragraph CH81130 “Where an inaccuracy in a document has been made despite the person having taken reasonable care to get things right, no penalty will be due. Examples of when a penalty would not be due include.... a reasonably arguable view of situations that is subsequently not upheld.” In paragraph CH81140 officers are instructed to examine “what the person did or failed to do and ask whether a prudent and reasonable person would have done that or failed to do that in those circumstances.”
If HMRC agrees that the behaviour was not careless – as the client in this case maintained and as I believe was true - we are home and dry.
If not – and I said there would be alternative endings - we might consider whether to ask for the special reduction (see CH81011).
Failing that, we might ask HMRC to consider suspending the penalty under paragraph 14 of Schedule 24. Officers are obliged to consider suspension for careless inaccuracies. If granted, the suspension must be for a set period with at least one condition attached. As HMRC acknowledge at CH83110 “The penalty provisions in Finance Act 2007 seek to influence behaviour by encouraging and supporting those who try to meet their obligations and penalising those who do not.” In this case a suitable condition would be to ensure that in addition to keeping records of expenditure, sufficient evidence should be kept to accurately ascertain whether an item is a repair or capital.
If we have failed to persuade HMRC on all of these counts then we have to look at the maximum penalty for an inaccuracy due to careless behaviour, which is 30% of the potential lost revenue (PLR). The minimum penalty – as the disclosure was prompted rather than unprompted - is 15% of the potential lost revenue and where in this range the penalty charged rests will depend on the nature and quality of the disclosure. The process is set out at CH82000. I don’t intent to go into more detail because this territory is well known to practitioners and because I want instead to draw attention to another aspect that is less well understood: PLR.
Where the inaccuracy is in a year where, when corrected, the actual tax liability increases by a known amount the PLR is easy to identify: it is that change in tax. This is also the case when a repayment is reduced by a known amount.
But what happens in a case such as mine if the repairs claimed have given rise to a loss that is still being carried forward at the date the enquiry is concluded. No actual tax bill will have been affected so the potential lost revenue will be unknown. Schedule 24 Paragraph 7 prescribes a special rate of 10% for such a situation. If there is no actual or reasonable prospect of the loss ever being used, the PLR can be reduced to zero.
So there you have it, a nightmare enquiry resulting from the fact that although the taxpayer had kept a record of all amounts expended, he had not obtained sufficient evidence of what constituted repairs and what constituted capital to satisfy HMRC that his judgment of the split was accurate. He remains adamant that his apportionment was reasonable, even conservative.
Which of the alternative endings actually happened?
That would be telling.
Paul Aplin is a tax partner with A C Mole & Sons and Chairman of the ICAEW Tax Faculty Technical Committee; you can follow him on Twitter: @PaulAplinOnTax