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Business Tax  •  Personal tax

Tax penalty cases illustrate importance of good tax advice

By RJP LLP on 28 September 2021

Some of the recent tax cases published involving HMRC and small business owners have been very dramatic, resulting in penalties of tens of thousands of pounds. They always make for interesting reading because they often arise as a result of unintentional errors, and they highlight the ongoing importance of staying up to date with tax regulations. In HMRC’s eyes, mistakes are not necessarily a good enough excuse for poor record keeping or to enable tax underpayments to avoid being penalised. Here are two examples of taxpayers who unintentionally ended up on the wrong side of HMRC and having to foot a very large tax bill as a result.

Underpayment of VAT resulted in a £60,000 penalty charge

Directors of Chohan Management Ltd were found guilty by HMRC of deliberately submitting an inaccurate VAT return, because they did not properly check the figures. HMRC decided their actions were deliberate when they failed to check the company’s final VAT return, on which significant amounts of output VAT were omitted.

Chohan Management Ltd was a property business incorporated in May 2014 and registered for VAT with effect from 1 June 2014. The company’s sole source of income arose from a property on which VAT was charged when it was purchased. The property was then opted to tax and let to Chohan’s associated company, Fazteck Limited.

Initially Chohan reclaimed the VAT suffered on the property purchase on its first VAT return and declared all the relevant output VAT on rents received. This was fine, but problems arose when Chohan deregistered from VAT with the justification that future income would be below the £85,000 threshold. When Chohan submitted its final VAT return, no output VAT was included in respect of the property or other smaller assets. This was a mistake because a de-registering trader must declare and pay VAT on any assets held on a date when previously recovered VAT was claimed, unless the VAT is £1,000 or less. In Chohan’s case, net VAT recovered on the purchase of the property and assets had been £84,569.26, so a sizeable amount was expected as output VAT on the final return.

The discrepancy led to an investigation, with HMRC challenging the directors for records documenting every transaction. After a full review, in March 2019 HMRC issued a final assessment for VAT outstanding of £89,893.00. This figure was based on the value of the property and assets at deregistration, interest, and penalties. Due to HMRC’s view that the errors made were deliberate, penalties were calculated as 92.5% of the potential lost VAT revenue.

This decision was appealed by the Directors who effectively blamed their bookkeeper, saying he had made the errors due to being severely ill. Unfortunately, the excuse didn’t wash with HMRC, who refused to concede and said the directors were responsible for information being accurate. Eventually, a settlement was reached whereby HMRC accepted there was no deliberate concealment, but that the error made was deliberate and subject to a penalty. Their case argument centred around the point that “intentionally not seeing something you do not wish to see constitutes a deliberate act”. The level of penalty ultimately payable was reduced to 70%.

Share sale was not eligible for business asset disposal relief

Another interesting case resulted in the directors of a company being unable to claim business asset disposal relief (previously ER or entrepreneurs’ relief) as expected.  The company involved, Monarch Assurance Holdings Ltd (MAH), was incorporated in 1979, and was limited by both share capital or by guarantee rights.

Shares could be transferred at the discretion of the directors with no provision for the transfer of distribution rights. This situation resulted in one of the directors, a shareholder who became involved with the company in 2008, not being entitled to business asset disposal relief following a share disposal. This individual was an investor member and he thought he had purchased 50% of the distribution rights and 50% of the voting rights in the company, however due to complexities on the sale of his shares he agreed to hold the rights to the shares as a nominee and on trust for the buyer. A price of £1 million was agreed and received by the director, who had expected to be eligible for business asset disposal relief. HMRC denied this claim, saying the statutory conditions were not met and requested an extra £175,158 in tax to be paid.

The Director appealed but HMRC’s decision was withheld. No relief was available because the assets sold were not “shares” in the way that HMRC defines them. In addition, the Director did not own the obligatory 5% holding.

There are many cases where business owners have inadvertently faced penalties because of incorrect VAT returns being submitted. There are also many examples of business owners not qualifying for business asset disposal relief, because they did not meet the relevant qualifying criteria. Both these examples highlight the importance of getting good tax advice, sooner rather than later, because mistakes can be very costly.

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