Future focus: the potential reform of behavioural penalties

HMRC are consulting on potential changes to penalties imposed in respect of inaccuracies in tax returns (under FA 2007 Sch 24) and failures to notify (under FA 2008 Sch 41) – particularly, seeking views on options to simplify and strengthen these penalties.

The context

The consultation, published on 26 March 2025, follows:

• the Tax Administration Framework Review: enquiries and assessment powers, penalties, safeguards call for evidence, launched in February 2024, which sought broad views on penalties as well as enquiry and assessment powers, harmonisation and safeguarding
• the Tax Administration Framework Review: new ways to tackle non-compliance consultation, published in October 2024, which explored whether changes to existing powers could improve HMRC’s and taxpayers’ approaches to correcting error and inaccuracy

The latest consultation has been brought forward as part of the 2025 Spring Statement, which contained a suite of proposals aimed at curbing tax avoidance and maximising HMRC’s tax collection. This context is important; the consultation confirms that the intention for the reform is to strengthen deterrents for deliberate non-compliance. The Chancellor’s self-imposed fiscal rules and political pledges means that every penny counts!

The consultation seeks input on two different proposals: targeted reform of the existing regime; and a more radical approach of adopting a different model altogether.

The existing regime 

Inaccuracies

Presently, penalties for inaccuracies are imposed by reference to the:

• amount of tax at stake (called the ‘potential lost revenue’)
• categorisation of the taxpayer’s behaviour (careless, deliberate but not concealed, or deliberate and concealed)
• prompted or unprompted nature of the disclosure; and • quality of a taxpayer’s disclosure

Penalty ranges are set out in the legislation (FA 2007 Sch 24 para 4), with set percentage reductions available for disclosure (Sch 24 para 9). HMRC give reductions for the level of taxpayer cooperation (i.e. for ‘telling, helping, and giving access’ to HMRC), but rarely give full reduction for any disclosure made after a ‘significant period’ of time (which, in HMRC’s view, is three years: Compliance Handbook at CH82430). HMRC may (but rarely) reduce penalties due to ‘special circumstances’ (Sch 24 para 11). They may also ‘suspend’ penalties in certain circumstances so that the penalty will effectively be cancelled if a taxpayer meets agreed conditions for a specified period (but will be payable otherwise) (Sch 24 para 14). The snag is that HMRC may only suspend penalties in cases where compliance with a condition of suspension would help the taxpayer avoid becoming liable to further penalties for careless inaccuracy. This can be problematic for taxpayers whose circumstances are such that no repeated inaccuracy is likely.

Failure to notify

Failure to notify penalties apply where taxpayers fail to notify HMRC on time of circumstances concerning their tax liability, including when they first become liable to pay certain taxes and if they intend to carry out a taxable activity that must be registered with HMRC. Similar to penalties for inaccuracy, there are degrees of culpability, with different penalty ranges depending on the taxpayer’s behaviour (FA 2008 Sch 41 para 6) and reductions available for disclosure (Sch 41 para 12). Penalties are not imposed in relation to non-deliberate failures where HMRC are satisfied that there is a reasonable excuse. With up to 24 penalty ranges, depending on the classification of taxpayer behaviour and the nature and timing of disclosure, simplification would be welcomed.

Reforming the existing regime

Timing of disclosure

The consultation seeks views on the removal of the minimum 10% inaccuracy penalty for disclosures made after three years and the removal of the minimum 10% failure to notify penalty for disclosures made after 12 months for non-deliberate behaviour. These changes aim to encourage more taxpayers to come forward at a later date. The penalties are currently unnecessarily punitive acting as a ‘cliff edge’ for taxpayers who have not engaged in deliberate behaviour, and we therefore consider their removal to be sensible. HMRC are well compensated for a late payment of tax given the exorbitant interest rates currently imposed.

Reductions for type and quality of disclosure

HMRC are considering changes to how they assess the timing, type of disclosure, levels of cooperation and overall quality of disclosure by a taxpayer.

The suggested changes to the way in which the type and quality of disclosure are assessed by HMRC are not particularly revolutionary: they seek to apply a set reduction to a maximum penalty, based on whether the disclosure is prompted or unprompted, and to merge the quality of disclosure factors of ‘telling’ and ‘helping’ into a single factor.

The stated focus, however, is on simplifying the process, with HMRC noting the current system is ‘complex for taxpayers to understand and for HMRC to administer.’ A pessimist may well conclude that HMRC’s motivation for these reforms is their desire for a more easily administrable system.

The risk is that an easier-to-administer system could be one which HMRC seeks to automate, potentially removing any genuine consideration of taxpayer behaviour. Additionally, any time savings achieved by HMRC through greater automation of penalties could be outweighed by an increase in the number of appeals by disgruntled taxpayers against such penalties.

Additionally, we would question whether there is a wider opportunity here to get rid of the binary categorisation of a disclosure as ‘unprompted’ or ‘prompted’. There is a world of difference between a taxpayer who makes a disclosure quickly following receipt of a nudge letter and one who discloses during the late stages of a lengthy investigation.

Deliberate and repeated inaccuracies/failures to notify

HMRC are considering how penalties for deliberate or repeated failures could be strengthened, noting that the current legislation treats each inaccuracy or failure to notify in isolation and does not consider any previous compliance history – although, in reality, many practitioners find that HMRC officers do take historic compliance into account when assessing penalties under the current system. In any event, the suggestion is threefold:

• to introduce higher inaccuracy or failure to notify penalties for those who intentionally conceal or underreport to HMRC
• to strengthen the sanction for deliberate behaviour by raising the penalty ranges and combining the (currently separate) categories of ‘deliberate but not concealed’ and ‘deliberate and concealed’ behaviour into a single category of ‘deliberate’
• potentially, creating an even higher penalty range for repeated deliberate behaviours

Instinctively, one struggles to muster much sympathy for taxpayers who may find themselves subject to enhanced penalties. However, as respondents to the 2024 call for evidence pointed out, safeguards will need to be adopted; for example, ensuring taxpayers are fully on notice and aware that, given their historic behaviour, future offending behaviour will result in enhanced penalties.

Additionally, HMRC are cognisant that several related mistakes might be uncovered by a taxpayer at the same time, potentially covering different taxes and time periods. The authors’ view – and one that we shared with HMRC as part of the original call for evidence – is that this scenario is not uncommon (for example, following a change of finance personnel or adviser), and it would not always be appropriate to treat each of those mistakes as a repeated occurrence of non-compliance when the overarching aim of the taxpayer in making such disclosures is to lay all cards face up on the table and return to a compliant position.

Offshore penalty rates

The consultation seeks opinions on how the current offshore penalty regime (for income tax, inheritance tax and capital gains tax) could be simplified whilst still acting as an effective deterrent. The UK penalty regime in respect of offshore tax liabilities operates similarly to the domestic one, with penalties calculated by reference to the taxpayer’s behaviour. However, foreign territories in which the offshore tax liability has arisen are categorised according to the ease with which HMRC can obtain information or cooperation from the territory in question. 

As a result, there are 18 potential penalty ranges for offshore inaccuracies or failures to notify – which may be considered excessive, especially given the increasing sophistication and frequency of information sharing between tax jurisdictions.

Penalty suspensions

It can be time consuming (and sometimes challenging) to establish appropriate penalty suspension conditions. Moreover, HMRC often relies on taxpayers self-certifying that they have met the relevant suspension conditions, which arguably undermines the exercise.

To address this, HMRC are considering reforms such as automatic penalty suspension without conditions, or replacing suspensions with a ‘caution’ (i.e. waiving the first penalty). This seems a sensible move that will save time on both sides.

The potential downside to these proposals is that taxpayers might be tempted to accept an automatically suspended penalty or caution, regardless of whether the penalty is legitimate or reasonable, given its suspended nature. If automatic suspension of penalties is introduced, taxpayers should be cautious about taking such a relaxed approach since if, for whatever reason, the suspension lifts such that the penalty becomes due, the time to appeal against the penalty may have passed. Ideally, we would like to see this timing point addressed by providing taxpayers with a right of appeal from the time any penalties become due (rather than from the time of any automatic suspension).

Adopting a new model altogether

As an alternative to reforming the existing regime, the consultation invites views on a total redesign of behavioural penalties. For example, HMRC have suggested the introduction of: 

• a ‘misdeclaration’ penalty, to apply in all cases, regardless of taxpayer behaviour, but subject to a taxpayer demonstrating a ‘reasonable excuse’ and/or cooperating with HMRC. However, on reading the broad suggestions, HMRC appear to be proposing to write back a lot of the existing principles into the new penalty (for example, the principle that a reduction is available on making an unprompted disclosure), which begs the question as to how this could be said to be a redesign in any real sense. The only real change proposed would appear to be a shift of the burden of proof to taxpayers – which we would strongly oppose
• a ‘civil evasion’ penalty, to target those who deliberately break the rules. It is unclear whether this would be pursued alongside criminal prosecution in the most serious of cases
• non-financial penalties and sanctions, such as cancellation of a person’s passport or disqualification for driving for deliberate and repeated non-compliance. These instinctively feel like draconian measures regardless of the deliberate and repeated nature of the non-compliance these measures would be targeting. If HMRC consider it desirable to have a measure of last resort for egregious non-compliance, a criminal sanction, subject to the criminal standard of proof, would be more appropriate

Clearly these ideas are in their infancy, and the details provided in relation to them are scarce which makes it challenging to meaningfully engage with them. However, at a high-level, the authors are sceptical that adopting a wholly different model of behavioural penalties is a sensible or necessary approach to reform – the expression ‘throwing the baby out with bathwater’ comes to mind. As HMRC note, such reform could lead to increased transitional costs and administrative complexity (at least in the short-term).

Final thoughts

The consultation will run until 18 June 2025, and there is plenty to digest and consider. Some of the suggestions for reform to the existing regime are promising and appear sensible, but it will be crucial to ensure there are appropriate taxpayer safeguards. Further, the authors cannot shake the concern that ‘simplification’ of the regime could ultimately translate to attempts to automate the process – eliminating discretion in the name of consistency – which could result in unfair outcomes for taxpayers.

This article was originally published in the Tax Journal.