It has released a 36-page report, Tax penalties: final report, following a short project to review the HMRC penalty system and has made 14 recommendations to improve the system.

The investigation followed calls from tax advisers to review the overly-complex penalty system.

OTS said: ‘Many such suggestions are sparked by a feeling that an aspect is operating unfairly, but at the hub of almost all is that the extensive changes that followed the lengthy review of HMRC Powers & Penalties consequent on the formation of HMRC in 2005 would benefit from a “post implementation review”.’

As the OTS has only had four months to complete the work, it stresses that the review focused on inconsistencies of the current system rather than focusing on problems with the operational aspects of the penalty system.

However, it has identified a number of areas of concern, including the number of erroneous entries on the Income Tax Self Assessment (ITSA) register of people who should not be registered, which means that automated penalties are issued to the wrong people. ITSA came in for particular criticism about the way HMRC deals with people who consistently fall below the tax threshold, and those with years of zero income. OTS criticised the treatment of these groups.

After two years, anyone still on the register, but falling below the tax threshold, should be sent ‘an automated letter… asking if the taxpayer still needs to be on the SA register’, recommended OTS.

It also said that issues arise when taxpayers leave the PAYE system, particularly as HMRC is relying on old technology and systems, forcing people to pay outstanding tax by cheque, a financial transaction system barely used today and out of kilter with HMRC’s digital strategy.

‘People leaving the PAYE system owing tax are put into SA if the tax is not paid. Currently the only way to pay overdue PAYE/NICs is by a cheque in UK sterling but not everyone has a UK bank account,’ the OTS report said.

It recommends that HMRC set up a system for taxpayers to pay the tax due by an alternative method such as credit card or bank transfer, options that do, after all, exist in many tax areas already’.

It also pointed out that ‘the introduction of behavioural penalties was a cultural change for the staff, which has been difficult to implement’.

One of the most worrying criticisms was levelled at the quality of training and awareness among HMRC staff.

OTS said HMRC needed to do more work with tax department staff to ensure that they understand the penalty system and are more consistent in their application. There should also be more training for contact centre staff so that they understand the system and advises taxpayers about the penalty regime upfront.

HMRC staff confirmed that they found it difficult to put conditions in place to ensure that one-off errors did not recur, in order to access the rules allowing suspension of the penalty. This again points to training failures.

At the same time the volume of £100 penalties is putting pressure on HMRC collection services. There is also a disproportionate impact on the elderly and the more vulnerable members of society as a result of the new automated late filing penalties.

The tax authority should also conduct a regular audit of penalty issuance; OTS recommends that it ‘carries out regular assurance activity to assess the accuracy of the penalties issued’.

In the report, John Whiting, tax director of the OTS, said: ‘The main conclusion is that there needs to be the full post implementation review we have alluded to, together with a completion of the aspects of the general review that remain unfinished.

‘This should test whether the design features of the system are appropriate in an increasingly automated world.

‘There are aspects that require judgments by HMRC staff and achieving consistency is clearly difficult at times. Such a review would potentially deliver the sort of changes that may seem lacking in this report.’

The OTS also confirmed that HMRC is currently looking at penalties and said that ‘we hope that their policy team will take a formal review exercise forward. We would encourage them to make this a comprehensive exercise and to include external (and independent) input’.

The project work was led by HMRC officer Sally Munnings, on secondment to the OTS from HMRC.

The report is available here https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/374509/OTS_tax_penalties_final_report_121114.pdf