Tax sanctions must be proportionate
By Philip McNeill, Head of Taxation (Tax Practice and Owner Managed Business Taxes)
25 February 2021
Tax sanctions are aimed at improving compliance. Lapse of time may mean sanctions are inappropriate and get a business off the hook.
A recent tax case looked at proportionality in regard to tax sanctions. In RMF Construction Services Ltd (RMF Construction Services Ltd TC07995 [2021] UKFTT 0009 (TC)), HMRC was wanting to apply the sanction of withdrawing a company’s gross payment status for the construction industry scheme (CIS). What made the case unusual was the delay. It was now 10 years after the end of the accounting period under review.
Gross payment status and compliance sanctions
Gross payment status allows a construction firm the privilege of receiving its subcontract income without an income tax deduction at source. The deduction is usually 20%, but rises 30% where a contractor is unregistered or can’t be verified with HMRC. This is obviously a significant cashflow advantage, particularly for a firm which has its own employees or subcontractors to pay.
As those familiar with CIS will know, withdrawing a firm’s gross payment status is something of a nuclear option. It has the potential to put a business out of action due to the severe cashflow consequences. Loss of gross payment status means that the firm will need to pay its workers in full out of only 80% of the income. On the other hand, the 20% deduction was introduced as an anti-evasion measure, as it was all too easy for wily subcontractors to escape tax completely, especially when paid in cash.
Added to which s66(8) Finance Act 2004 means that anyone whose gross payment status is cancelled, cannot re-apply for gross payment status for 12 months.
To balance these conflicting demands, the system includes a number of conditions which must be met in order to obtain and retain gross payment status. For a company, these include submission of returns, compliance with requirements of the taxes acts and company law and payment of taxes on time (see HMRC Manual CISR46060).
Where these conditions are not met, gross payment status can be withdrawn (per s66 Finance Act 2004). HMRC’s decision to withdraw gross payment status is subject to a right of appeal by the contractor.
Exceptional delays
In the current case, the company accepted that HMRC was technically correct, following a September 2011 Tax Treatment Qualifying Test review and a subsequent appeal. The company had filed its July 2010 corporation tax return late. It was late in paying its corporation tax for the year to 31 March 2013. HMRC’s 2012 post-appeal response was technically correct.
But was it reasonable and proportionate eight years after the review, and ten years after the accounting period under investigation, to apply a potentially devastating sanction?
What is more, the company currently met all the conditions for gross payment status and had done so for the last four to five years. If it applied for gross payment status now, it should get it. So had not the threat of the sanction alone achieved the objective of compliance envisaged by the legislation?
The main reason for the delay was that the case was stacked behind another CIS gross payment status case which reached the Supreme Court. This case, JP Whitter (JP Whitter (Water Well Engineers) Ltd v HMRC [2018] STC 1394) was finally decided in May 2018. It addressed the question of whether HMRC needed to consider the consequences on a business when withdrawing gross payment status.
Does HMRC need to consider the consequences?
In Whitter, the key issue was the potential impact of loss of gross payment status. The Supreme Court noted:
‘cancellation would have been likely to lead to the loss of around 60% of the company’s turnover, and the dismissal of about 80% of its employees, and that recovery would be expected to take about ten years’
But it went on to find in favour of HMRC. Quoting the Court of Appeal, the Supreme Court confirmed that HMRC’s discretion was limited. It did not include taking into account matters ‘which do not relate, directly or indirectly, to the requirements for registration for gross payment, and to the objective of securing compliance with those requirements.’
As the Upper Tribunal put it ‘the power to cancel registration was there principally to ensure compliance with the substance of the CIS’ (Revenue and Customs Commissioners v J P Whitter (Water Well Engineers) Ltd - [2016] STC 204).
If consequences were not to be considered, could proportionality and impact be relevant?
Proportionality
The issue of proportionality was considered in Barry Edwards (Barry Edwards v HMRC [2019] UKUT 131 (TCC)). The Upper Tribunal found that thousands of pounds of late filing penalties incurred when the taxpayer had no tax liability for the relevant years, was not disproportionate.
While the Tribunal allowed that proportionality was relevant and could count as ‘special circumstances’ grounds for reducing a penalty, there was, in its view, ‘a reasonable relationship of proportionality between this legitimate aim {of securing compliance} and the penalty regime which seeks to realise it’.
The penalties were not waived.
Excessive punishment
The next issue for discussion was that of excessive punishment. To address this issue, the Tribunal turned to the Hook case (R v Barnsley Metropolitan Borough Council, Ex parte Hook [1976] 1 WLR 1052, 1057). The significance of this case, which went to the Court of Appeal, is that it set aside a sanction imposed by the authorities on the grounds that it was excessive and out of proportion.
The background to the case is that on Wednesday, 16 October 1974, three-quarters of an hour after the public toilets had been locked, ‘Mr Hook had an urgent call of nature’.
Following on from this ‘trifling incident’, Mr Hook, a market stall trader, was banned for life from the market by Barnsley Council. The Court of Appeal found that the Barnsley Council’s response had been excessive, and it over-ruled their action.
Was the punishment in this case, of loss of gross payment status over eight years after the event, similarly disproportionate? The Tribunal decided that it was. Key was the fact that the threat of imposition of the penalty had already achieved compliance.
In its own words:
'The tribunal decided that the withdrawal of CIS gross status over eight years after the “offence” of the company’s failure to file its corporation tax return on time, together with other minor infringements would be totally disproportionate.
The objective of the CIS, ie, the enforcement of compliance, has been achieved by the mere threat of the withdrawal of gross status and to carry through on that threat by withdrawing gross status now, when the company has been fully compliant since that time, would serve no useful purpose whatsoever and is therefore disproportionate.'
Conclusion
It is helpful to know that there can be limits to proportionality of tax sanctions which the courts are willing to impose. While cases in exactly this model will perhaps be uncommon, it is helpful to have the Tribunal state clearly that ‘the objective of the compliance regime for the CIS is to encourage compliance. It is not its purpose to punish non-compliance’.
It would be helpful indeed if this motto were applied across the board in tax compliance. But as this is a non-binding First Tier decision, it remains open to question how widely this approach will be followed.
