Duty to correct tax return errors: A new compliance risk for businesses and taxpayers?

As part of its ongoing programme to modernise compliance powers, HMRC has proposed a new statutory “Duty to Correct” tax return errors, alongside a new power to issue Customer Correction Notices.

If enacted, the changes would represent a significant shift in the relationship between taxpayers and HMRC, moving beyond the current focus on inaccuracies at the point a return is filed and placing greater emphasis on what happens after an error comes to light.

While the proposals are intended to encourage taxpayers to correct mistakes promptly, they also raise important practical questions. In particular, when does a taxpayer become aware of an error, what steps must they take to address it, and what happens where there is genuine uncertainty over the correct tax treatment?

What is changing?

Under the current regime, penalties for inaccuracies generally focus on the taxpayer’s behaviour when the return was submitted. An error may be categorised as careless, deliberate, or made despite taking reasonable care, with different penalty consequences depending on the circumstances.

The proposed legislation would create a new and explicit obligation requiring taxpayers who become aware of an inaccuracy in a tax return or other document provided to HMRC to take reasonable steps to correct it. Where the taxpayer cannot correct the error directly, they must notify HMRC.

Perhaps most significantly, failure to comply with this duty could result in the inaccuracy being treated as deliberate behaviour for penalty and assessment purposes, even where the original error was not deliberate. This could expose taxpayers to substantially higher penalties and allow HMRC to assess tax for a much longer period.

When does “awareness” arise?

One of the most challenging aspects of the proposals is determining when a taxpayer becomes aware of an error. In straightforward cases, the answer may be relatively clear. If a business discovers that a transaction has been omitted from a VAT return or that income has been excluded from a corporation tax computation, awareness is likely to arise once that issue is identified.

However, many tax disputes are far less clear-cut. Businesses regularly encounter situations where there is uncertainty over the correct interpretation of legislation, competing technical arguments, or incomplete factual information. In such circumstances, awareness of a potential issue is not necessarily the same as awareness that an error has been made.

The practical difficulty is that taxpayers may feel compelled to disclose positions to HMRC much earlier than they otherwise would, simply to protect themselves from any future allegation that they failed to act after becoming aware of a possible inaccuracy.

What are “reasonable steps” to correct an error?

The draft legislation requires taxpayers to take “reasonable steps” to correct known inaccuracies but does not provide a comprehensive definition of what this means in practice. The tax courts have consistently viewed ‘reasonableness’ as what would a reasonable person with the same knowledge and abilities have done, had they been in the same position. Consequently, we suspect HMRC (and the courts) will look for evidence of when the taxpayer suspected there to be historic irregularities and what they did or did not do thereafter to satisfy that suspicion.

Whether the steps taken are deemed to be reasonable is likely to vary depending on the size and complexity of the issue. A multinational group dealing with a complex transfer pricing issue may require extensive technical analysis before concluding whether an error exists, whereas a simple computational mistake may be capable of immediate correction. Regardless, the lack of certainty around what constitutes sufficient action may become a significant area of future dispute.

What happens if no action is taken?

The consequences of identifying a potential error but failing to act could be severe. Under the proposals, a taxpayer who does not take reasonable steps to correct an inaccuracy after becoming aware of it could find themselves treated as having acted deliberately. This reclassification has important implications both for penalties and for HMRC’s assessment time limits.

For many taxpayers, the greatest concern may be the possibility of HMRC obtaining access to the extended 20-year assessment period ordinarily associated with deliberate behaviour. Issues that might otherwise have fallen outside HMRC’s normal assessment window could potentially remain in play for many years. Taxpayers need to be mindful of protecting their position while ensuring they don’t make unnecessary disclosures to HMRC.

Customer Correction Notices: A new HMRC power

Alongside the Duty to Correct, HMRC proposes to introduce Customer Correction Notices (“CCNs”).

Where HMRC has reason to suspect that a document contains an inaccuracy, it would be able to issue a notice requiring the taxpayer to:

1. Review their position.
2. Correct the inaccuracy if one exists.
3. Explain why no correction is required.

This is potentially a significant development. Rather than opening a formal enquiry or undertaking a lengthy investigation, HMRC would have a mechanism to require taxpayers to revisit specific issues and justify their treatment.

For compliant taxpayers, responding to a CCN may become an increasingly important part of managing tax risk. The quality of the review undertaken, the evidence gathered and the reasoning documented could all become critical if HMRC later challenges the position.

What about uncertain or disputed tax positions?

Many businesses adopt tax treatments after careful consideration and professional advice, only for HMRC to subsequently take a different view. While the proposed rules may be relatively easy to apply where a factual mistake has clearly occurred, they become considerably more difficult where the tax position is genuinely uncertain.

Questions that may arise include:

• When does awareness occur if advisers disagree on the correct treatment?
• Does awareness arise when a risk is identified, or only when the taxpayer concludes that an error has actually been made?
• What happens where case law subsequently develops against the taxpayer’s position?
• How should taxpayers respond where HMRC’s view differs from their own?

Without further clarification, there is a risk that disputes over technical interpretation become disputes over whether a taxpayer should have recognised an error earlier.

Looking ahead

Although the legislation remains in draft form, the direction of travel is clear. HMRC wants taxpayers to play a more active role in identifying and correcting mistakes, and is seeking stronger tools to encourage that behaviour.

While deliberate penalties and extended time limits should not be underestimated, taxpayers should avoid the temptation to disclose too early. It is now more important than ever to devise a well considered strategy for handling potential HMRC disclosures and notifications. We anticipate a significant increase in the number of ‘nil disclosures’ being submitted to HMRC and for HMRC to scrutinise behaviour more aggressively than it has historically done so when in receipt of voluntary disclosures.

If you would like to talk through how any of this applies to you, our Tax Investigations team would be happy to help. Please contact us today to discuss your needs in more detail.
 

FAQs and responses accurate at time of publish