The Government is unlawfully using late-payment penalty fines against tens of thousands of small firms who do not file their tax returns on time as a "cash generating scheme" for the Exchequer.
In a damning judgment, the Tax Tribunal has ruled that HM Revenue and Customs (HMRC) is operating a policy of "deliberately" waiting months before alerting businesses that had not filed their tax returns so that late-payment fines could stack up.
If upheld on appeal, the judgment could result in between 50,000 and 100,000 firms being able to claim refunds on tens of millions of pounds paid in fines. "It is no function of the state to use the penalty system as a cash generating scheme," said judge Geraint Jones. We have no doubt that any right-thinking member of society would consider that to be unfair and falling very far below the standard of fair dealing expected of an organ of the state."
The judgment will put more pressure on ministers to reform HMRC in the wake of a string of revelations about its poor management.
Under the scheme, firms are given no notification of a failure to complete their end-of-year return by the May deadline. Instead, HMRC waits until September before sending out a computer-generated letter telling them they have failed to complete the return and are liable for four months of late payment fees of £100 each plus another £100 fine for late completion.
In court, HMRC tried to argue that it was not obliged to provide reminders to firms who failed to submit the correct tax returns, and that the penalties for doing so were clearly publicised.
But in three separate rulings, Judge Jones dismissed this defence, saying that when Parliament legislated to allow a penalty fine it did so "to encourage compliance and, in cases where compliance did not take place, to levy a proportionate penalty".
A spokeswoman for HMRC denied it was using penalties to raise revenue. She said she could not comment on the tribunal case because the litigation was ongoing, but added: "The vast majority of employers file their returns on time."