HM Revenue & Customs has won a £3.1 Million tax dispute against a taxpayer after a judge had ruled the Revenue service could challenge calculations that were made based on HMRC’s technical specifications. The tribunal was called after a scheme that employed insurance policies to create a massive tax deduction was used to reduce a taxpayer’s other liabilities. Although HMRC accepted that the insurance policies had reduced the taxpayer’s income tax bill, it disputed the taxpayer’s argument that his capital gains tax bill had also fallen.   

The Complexity of Tax Software

This dispute is one in a long line of examples of the difficulties software has in coping with the incredible complexity of the tax system. This follows previous software glitches that put thousands of taxpayers at risk of paying hundreds more in tax than they owed for the 2016-17 tax year.

Given these difficulties, the tribunal found that HMRC should not be stopped from making inquiries into aspects of tax returns that made use of information it had provided. The judge said that a ruling to the contrary would make “HMRC much more guarded about the assistance it provides in the future”, which would be to the detriment of those taxpayers who could not afford professional assistance when filing their returns.

The ruling could also have implications for HMRC’s plans to digitise the tax system in the future. The worry is that similar problems will occur as the ‘making tax digital’ initiative would require businesses with more than £10,000 in turnover to rely on third party software that uses specifications provided by HMRC to file their tax returns.  

Details of the Dispute

This particular tax dispute dated back to the 2006-2008 tax years, when the rate of capital gains tax depended on whether a taxpayer paid tax at the basic- or higher-rate. In this case, the taxpayer argued that the scheme he had used produced a negative figure for his income that led to his chargeable gain falling into the lower rate band. The software his accountants used then calculated that his £23.6m in capital gains should be taxed at 20 percent and not 40 percent.  

The court sided with HMRC, which had realised there was a problem with the software’s calculations for capital gains tax when life policies were involved. There were 12 other cases when the same miscalculation has led to a capital gains tax underpayment, although in those 12 cases the total underpayment was a more modest £23,000.  

Exceptions to the Rule

Every year, changes to the tax legislation mean there are some special cases when software does not calculate a tax liability accurately. Figures need to be entered into the software in a particular way to prevent these errors. There are also cases known as exceptions when taxpayers are required to file a paper tax return because the software is known to be inaccurate in the circumstances the taxpayer is in.