Penalties can be harsh
Tax legislation is complex in many areas, so it is not surprising that people sometimes make errors due to either a lack of understanding of the law or by not having taken sufficient care in preparing their tax returns. Unfortunately, as well as having to pay any extra tax that should have been due, the person may also incur significant interest and penalties. A recent case at the Upper Tax Tribunal has shown how difficult it can be to have such penalties overturned, even where the original error was clearly inadvertent.
The case concerned a married couple, who were directors of a company that traded as financial advisers and in which they each held approximately 6% of the ordinary share capital. In 2018, they and some other shareholders decided to sell their shares to other continuing shareholders.
A meeting was held, during which the taxpayers were advised by their solicitors that as each shareholder held more than the required 5% interest in the company, they would qualify for entrepreneurs’ relief (ER), the predecessor of business asset disposal relief (BADR). All at the meeting were aware of the 5% minimum holding that was necessary in order to claim ER.
However, in order to more accurately reflect each individual’s contribution to the business, the directors decided that the consideration should be split in a different manner. To facilitate this, the couple each gifted shares to other shareholders, reducing their ownership to approximately 4.14% each. These gifts of shares did not produce any immediate CGT bill, as holdover relief was available and claimed jointly with the recipients of the gifts. However, the ER position on any subsequent disposal was not reconsidered at this time.
After gifting the shares in April 2019, the following month the couple disposed of their remaining shares, claiming ER in their 2019/20 tax returns. Following an HMRC enquiry, the couple accepted that they were not entitled to claim ER, as their shareholding was below the required 5%. However, HMRC issued a penalty, calculated as 15% of the underpaid tax, on the basis that the taxpayers had acted carelessly in respect of the failed claims.
The couple appealed, arguing that they had taken reasonable care or, alternatively, that HMRC should suspend the penalties, with the condition that, going forward, the couple would attend an annual meeting with their accountants to review each entry on their return before it was submitted, to make sure that errors did not happen again.
The Tribunal decided that the couple had acted carelessly by failing to take further professional advice after changing their shareholding. Their tax returns were completed based on previous advice given that related to different facts. The errors were not simple oversights. HMRC may exercise its discretion to suspend penalties for carelessness. However, this can only be done if it would help the taxpayer avoid becoming liable to future penalties for careless inaccuracy. The inaccuracy in this case was a one-off event, which meant suspension was not appropriate.
If your circumstances change, make sure that you update any advice that you have previously been given, otherwise you may find that unexpected tax bills arise that could have been avoided. For further information or to discuss further please do contact the JRW Hogg & Thorburn team.
