As is widely known, HMRC are piloting Business Record Checks. A wide range of professional bodies has been debating the justification for and the methodology of this initiative with HMRC, resulting in the institution of a strategic review of the project as a whole to try to find an acceptable way forward, which should be reporting by the end of January 2012.
The principal area of dissent concerns the question of whether or not TMA 1970 s.12B allows HMRC to impose penalties for failures to keep or preserve records in real time – invariably before the accounts forming the basis for the return for the year have been prepared.
The CIOT felt that views were needed, both from HMRC and from its own technical team, so that members can provide their clients with an informed choice about whether or not to appeal against any penalty levied for a real time record keeping failure.
HMRC’s view was provided by Pete Woodham, Policy Adviser in Tax Admin Policy. He set out the Revenue’s view in the following terms.
“HMRC do not see anything in the wording of s12B to imply that a penalty cannot be charged before the end of the tax year. We must look at the plain language of these provisions, not try to impose a contrary view on them.
S12B (1) imposes an obligation on any person who may be required to make a return, to keep and maintain records. Use of the word ‘may’ means that the obligation to keep records exists before there is any certainty that a return will be required from the taxpayer and therefore the requirement comes into existence before the end of the tax year or period of assessment. This interpretation is supported by the use of the present tense in subsection 12B (1) (a), where it says the person shall ‘... keep all records ...’. The obligation to keep records, therefore, begins as soon as a person may be required to make a return.
S12(B)(1) does not detail what records must be kept nor the standard they must be kept to, other than to say they be ‘… requisite for the purpose of enabling [the taxpayer] to make and deliver a correct and complete return …’. The plain reading of these words is that the records must be of such a quality that he will be able when the time comes to make a correct return; in other words, it is to ensure the taxpayer arms himself with the right information. There is nothing here to say that a return must be submitted before a judgement on the standard of the records can be made.
As the obligation to keep records begins at that point during the year when the taxpayer reaches a position where he might receive a notice to file, it follows that the obligation can be breached during the year and that the sanction for that breach can be applied during the year. Section 12B(5) is also written in the present tense, which allows for a penalty to be charged when a person ‘… fails to comply ...’.
S12B(3) sets particular requirements for those in trade. This section says that the records required to be kept under subsection (1) shall include records of all amounts received and expended in the course of trade; and for those dealing in goods, a record of all sales and purchases of goods made in the course of trade. Although not explicit, this requirement must be contemporaneous, otherwise it has no purpose – for most trades, it would be impossible to reconstruct such a record at a later date. S12B(3) does not specify the format in which these records should be maintained, merely that a record be kept. It would, for instance, be perfectly acceptable to construct, say, a sales ledger at the end of the year provided there was suitable and sufficient source material on which to base this construction.
The obligation to keep and maintain records is detailed in s12B, and the section contains a penalty for failing in this obligation. There is a separate obligation to make a complete and correct return, in sections 8, 8A and 12AA depending on the status of the taxpayer. These sections also specify the dates by which returns must be made. There are penalties charged for failing these obligations, being found in Sch 55 FA09 for returns made late and Sch 24 FA07 for returns containing inaccuracies caused by carelessness or deliberate action and which lead to a loss of tax.
Thus the requirement to keep records and the requirement to submit an accurate return are different obligations and so have different penalties attached to them. A failure of one obligation might or might not be related to a failure in the other, but they remain separate.
For those years subject to penalties under s95 TMA 1970, HMRC took account of the state of the records when deciding the level of penalty to be charged for an inaccuracy on a return. Charging a separate penalty under s12B(5) in such cases could be perceived to be unfair. However, for those years subject to penalties under Sch 24 FA07, no such allowance can be made. Sch 24 sets the maximum and minimum penalty levels for a given behaviour, and also determines the factors that HMRC can consider when deciding the penalty level within those parameters. Paragraphs 9 and 10 detail that a penalty can only be reduced from the maximum level by taking into account the quality, nature and extent of any disclosure and whether or not that disclosure was prompted or unprompted. The state of the records is not a factor that can be considered.
So if a taxpayer makes an inaccurate return and fails to keep proper records, he has failed two separate obligations, each with its own discrete penalty. When deciding if an inaccuracy is careless or deliberate, an officer will take the quality of the records into account, but this is just one piece of evidence amongst others. All available evidence will be weighed to help decide the underlying behaviour, but the penalty arrived is a sanction against the inaccuracy on the return, not the factors contributing to it. There is nothing in our guidance, or in the outcomes of the Powers review, to imply that we could use Sch 24 penalties for record-keeping failures.
HMRC’s discretion in the area of penalties is circumscribed. In assessing the level of penalties to be applied, all relevant circumstances are taken into account. If any taxpayer believes he has been wrongly penalised, he may request the decision be reviewed or appeal to an independent Tribunal."
CIOT, by contrast, does not believe that HMRC usually have the power to levy penalties under s.12B TMA 1970 in respect of periods for which returns have not been submitted.
From a high level perspective, s.12B TMA 1970 was enacted in 1994 in order to provide a statutory record-keeping requirement for the enquiry regime, which is a post-return function. The language and policy purpose of the section was and is entirely consistent with that purpose. Our view is that as a result it is inherently incapable of applying to the pre-return matrix provided by Sch.36 FA 2008 without imposing a highly strained construction on the words of the section.
The principal criticism of HMRC’s approach is that it treats s.12B(3) as though it were a free-standing operative provision. It is not: it is merely an interpretative provision for s.12B(1), which is the actual operative provision. The text of s.12B(3) makes that clear:
“In the case of a person carrying on a trade, profession or business alone or in partnership the records required to be kept and preserved under subsection (1) … above shall include records of the following, …”.
S.12B(1) says in turn, so far as relevant to the point at issue:
“Any person who may be required by a notice … to make and deliver a return for a year of assessment or other period shall keep all such records as may be requisite for the purpose of enabling him to make and deliver a correct and complete return for the year or period; and preserve those records until the end of the relevant day…”.
The word “required” in s.12B(3) refers to the requirement imposed by the imperative “shall” in s.12B(1). It follows that the records mentioned in 12B(3) are simply included within the class of records that have to be kept and preserved and that are mentioned in 12B(1) as requisite for a particular purpose, namely that of enabling the taxpayer to make a correct and complete return.
If the interpretative words of 12B(3) are inserted into 12B(1) at the point required by the statutory language as a relative clause interpreting the word ‘records’, one ends up with this:
“Any person who may be required to make and deliver a return for a year of assessment or other period shall keep all such records [which] in the case of a person carrying on a trade, profession or business alone or in partnership shall include records of the following, namely all amounts received and expended in the course of the trade, profession or business and the matters in respect of which the receipts and expenditure take place, and in the case of a trade involving dealing in goods, all sales and purchases of goods made in the course of the trade as may be requisite for the purpose of enabling him to make and deliver a correct and complete return for the year or period; and preserve those records until the end of the relevant day…”
Our view is that a natural and unforced reading of that shows that read together as intended s.12B(1)+(3) do not in fact require taxpayers to keep all records, period. It requires all records requisite for a specific purpose. ‘Requisite’ is not a synonym for ‘required’, and means ‘required of necessity’. So read as a whole 12B requires taxpayers to keep all the records they feel they need to keep within certain specified categories to enable them to make a correct and complete return.
The records required to be kept may include those mentioned in s.12B(3), but they still have to fulfil the purpose of the legislation that they enable the taxpayer to make a complete return. That is a judgement that, self-evidently, is only possible after the return has been made. The statutory language gives no justification at all for treating s.12B(3) in isolation as a free-standing requirement in addition to that imposed by s.12B(1) or for seeing a simple failure to keep the records mentioned in s.12B(3) as offensive without more.
Unequivocal support for that proposition is found in the language of the penalty provision s.12B(5) itself:
“… any person who fails to comply with subsection (1) … above in relation to a year of assessment or accounting period shall be liable to a penalty not exceeding £3,000”.
That applies a penalty in terms to failures to comply with s.12B(1), not s.12B(3). There is no failure to comply with s.12B(1) until the return is shown to be incorrect because of record inadequacy. Moreover, s.12B(5) applies to such a failure “in relation to a year of assessment or an accounting period”. The language reinforces the view that until the year or AP is over and the return for it has been made, it is impossible to know whether there is a failure in relation to the year or accounting period (AP) in respect of which a penalty might be exigible under s.12B(5). After all, record inadequacy might be remedied to the required statutory standard after the end of the year. That is wholly cognate with the natural construction of s.12B(1).
S.12B(1) itself repays more careful study. Two points stand out in s.12B(1).
The first is that it refers to a person’s obligation to keep (which all agree means ‘create or retain’ to distinguish it from ‘preserve’) records requisite (ie required out of necessity) for the purpose of enabling him to complete a correct and complete return (which sets out, exhaustively, what the statutory purpose of keeping the records is). Thus keeping records per se as an end in itself is not the aim of the section: and that makes sense, because if there was no statutory purpose to keeping them, it would be unacceptably burdensome to businesspeople. But it is plainly impossible to ascertain whether the records fulfil that purpose, and thus whether the requirements of s.12B(1) have been complied with, until one can ascertain whether the return is correct or not.
The second point is that there is no reference at all within s.12B to any time by which or within which the statutory records must be kept, save for the logically implied long-stop date by which the taxpayer makes his return. Thus the section leaves open and acknowledges the very real possibility that taxpayers may well seek, some considerable time in arrears, to reconstruct records, or write them up in the first place, or pursue copies from third parties in due course – and very sensibly gives taxpayers the latitude to take what steps they need to do what they can to amass records that are requisite for the purpose of making a correct and complete return in a timescale that suits them, thereby satisfying the requirement of s.12B.
By setting a single time by reference to return submission, s.12B also gives scope for the law to apply equally to all taxpayers with similar risk for all, which is a fair and policy-positive result. An alternative approach that illustrates the fallacy in HMRC’s analysis is to ask, if the date by which records have to be kept is not that at which the return is submitted, by which time do records need to be kept? Is it immediately? The end of the business day? A month later? Six months later? Or just by the time that an HMRC officer comes along, whenever that might be? Approaching the question in that way demonstrates just how arbitrary the imposition of penalties is on HMRC’s analysis, as compared to the commercially sensible and humane matrix actually enacted by Parliament.
A further suggestive point relates to appeals. If HMRC’s approach is right and the test of adequacy is whether a trader has kept ‘all’ the records mentioned in 12B(3), an appeal is pointless because the bar is set at the level of perfection and even a minor lapse means that the statutory test cannot be met and the appeal must fail: ‘all’ means all. Such an absurd consequence suggests that the construction must be wrong.
Adopting CIOT’s approach, that the test is a subjective one based on the taxpayer’s view of what needs to be kept to make a correct and complete return, judged on the basis of whether the return is correct and complete to the evidential standard that applies for tax purposes, removes that anomaly. Rather than being an absolute test of total completeness, it would become a question of fact and degree for the Tribunal, which it properly should be in the interests of justice. At a stroke that removes the perceived problem with incomplete records, estimates based on representative samples and sundry other points of a similar nature that are a fact of life in the commercial world, not to mention the difficult and necessarily arbitrary judgement calls that HMRC’s visiting officers (VOs) would otherwise be required to make in the course of a BRC. It also avoids the intrinsic difficulty of trying to justify on a purposive basis statutory language that, seen both in the commercial context to which it applies and in the tax context of a civil evidential test of accuracy, seems otherwise to be absurdly and unworkably over-prescriptive.
HMRC say that using the penalties provided by s.12B is justified by the fact that there is no longer any scope to charge a penalty for record inadequacy within sch.24 FA 2007. We disagree with that contention. Although the criteria for penalty reduction may not include references to record keeping, failure to take reasonable care with record keeping can lead to an inaccuracy in a return and thus be directly responsible for triggering a penalty in no less a direct way than was possible under s.95 TMA 1970. Schedule 24 is written in ordinary language and on that basis does not exclude and is more than able to encompass poor record-keeping as a reason for inaccuracy. Using s.12B in the way that HMRC wishes to do risks charging the taxpayer with two penalties for the same behaviour.
In addition, this appears to be a fundamental shift in policy. The level of penalties under Schedule 24 depends upon the underlying behaviour, one of which is failing to take reasonable care. The consultation document issued on 19 December 2006 at page 40 provided some examples of failing to take reasonable care, resulting in an inaccurate return. These included several examples relating to record keeping:
‘Getting something wrong through failing to take reasonable care
A21. Examples might include:
- making arithmetical errors (too many, or too large, relative to the overall liability, to suggest they are simply isolated mistakes);
- mis-classifying items of income or expenditure without giving the matter adequate consideration or – if the amounts and complexity warrant it – taking professional advice;
- keeping books and records that are incomplete in some respects;
- not having appropriate accounting systems in place, including to ensure items captured in the correct return period (failure over a sustained period may however be an indication of “deliberate understatement”);
- omitting occasional items of income or gains;
- having insufficient quality control and not checking the work of others …’'
It is clear from this consultation document and discussions at subsequent meetings that two of the main purposes of penalties under Schedule 24 were to deter and to penalise poor record keeping.
Those purposes were duly represented in HMRC’s published manuals. The latest text of EM 4650, dated as recently as August 2009 (but hurriedly withdrawn following the promulgation of HMRC’s view above), equated the interaction of s.95 and Schedule 24 with s.12B thus:
“In the majority of cases where the taxpayer has failed to keep adequate records and where, as a result, we have brought to light offences under Section 95 TMA 1970 or Paragraph 20 Schedule 18 FA 1998 or Schedule 24 FA 2007, it will be sufficient simply to continue to reflect those failures in calculating the level of penalties you consider to be appropriate.
Assurances have been given that Section 12B(5) etc. penalties will only be sought in the more serious cases, where, for example, records have been destroyed deliberately to obstruct an enquiry or where there has been a history of record keeping failures.
On the first occasion that a failure under this heading comes to light and it is not a provable, deliberate destruction of records, a written warning should be sent to the taxpayer (copy to agent) in the following terms, modified to fit the particular circumstances, as soon as the failure is established:
“I am writing to you concerning your failure to keep/preserve [part of] the records of [your business/the business trading as .........] for the accounting period from [date/month/year] to
Your failure renders you liable to a penalty not exceeding £3,000.
On this occasion I do not propose to charge a penalty specifically for this failure but I must advise you that if there is any failure to keep or preserve records, to support your [tax return/claim], in future years a penalty may be charged..’
If you are considering a second failure under this heading but no written warning was given on the first occasion you should send the above letter.
Where the warning letter is issued there will be no need to submit the case on this occasion and the failure may be reflected in any calculation of the level of penalties under Section 95, Schedule 24 FA 2007 etc. …
Where a specific penalty determination for failure to keep or preserve adequate records is not thought appropriate for penalty action under this heading, the failure will continue to be taken into account in determining the level of any Section 95, FA07/SCH24 etc. penalties”.
This plainly accepts that record failures are considered for primary penalty action within sch.24, and adopts a far more measured approach than that for which HMRC is arguing. Even in the context of the Compliance Handbook, records loom large:
- CH 81145 example 1 and arguably examples 3, 5, 6 and 7 all relate to record inaccuracies and yet are cited as examples of failure to take reasonable care of a kind that attracts a penalty under sch.24.
- CH 81151 and 81161 both include record inadequacies as examples of deliberate inaccuracy that would be subject to penalties under sch.24.
- CH 83154 gives examples of conditions for suspending penalties that are intimately connected with record keeping.
It seems to us that there is a clear risk of penalties being levied under two headings for the same offence. We suggest that HMRC’s thinking in this area lacks clarity and consistency and that there is a strong case for going back to the drawing board – or, better still, reverting to the previous more balanced interpretation of s.12B.
Should BRC become a reality beyond the current pilot and penalties under s.12B become the order of the day for record keeping inadequacy, we hope our members will be well placed to make a correct and balanced decision about whether to challenge the penalty by way of appeal.
Andrew Gotch BA MA CTA (Fellow) is the Principal of Chartered Tax Advisers TaxFellowship and is currently Chairman of the Chartered Institute of Taxation’s Owner Managed Business Technical Sub-Committee.