HMRC’s proposed new correction of errors regime: what are the implications for M&A transactions
HMRC’s proposed correction of errors regime introduces new requirements in connection with the obligation for taxpayers to correct known inaccuracies that result in a loss of tax. The proposals could have significant implications for M&A transactions, particularly where tax due diligence identifies historic filing errors, uncertain tax positions or potential underpayments. Buyers, sellers, advisers and insurers should consider how the new rules could affect tax risk allocation and transaction documentation.
HMRC has published draft Finance Bill legislation introducing a new statutory duty. Under this revised law, the previous obligations to correct known errors are reinforced and increased imposing stronger punitive obligations for taxpayers who fail to correct such inaccuracies in tax returns and other documents provided to HMRC where those inaccuracies result in a loss of tax. For M&A transactions, the proposals matter because historic tax issues are often identified through diligence, disclosure and post-completion review, but it may not always be clear whether a finding is a known error, a technical risk or a matter requiring further factual analysis.
The measure also introduces a Customer Correction Notice power, allowing HMRC to require taxpayers either to correct a suspected inaccuracy or explain why no correction is needed. Although framed as a compliance reform, the proposals could affect how tax risks are reported, escalated and allocated in transactions, including through warranties, tax covenants, specific indemnities and, with significant impacts on, W&I or specific tax risk insurance policies.
What is HMRC proposing?
The new duty would apply where a taxpayer becomes aware of an inaccuracy in a relevant return or document, the inaccuracy causes a loss of tax and it remains capable of correction within the applicable statutory time limits. The taxpayer must take reasonable steps to correct the position directly or, where that is not possible, inform HMRC. In a transaction context, this could extend beyond corporation tax returns to accounts, computations, claims, elections, VAT, employment tax, stamp taxes and other documents reviewed during diligence.
The consequence of inaction could be significant. If the taxpayer fails to comply, the inaccuracy is treated as deliberate for penalty purposes, potentially increasing penalties and extending HMRC’s assessment window up to 20 years. A historic filing error which was originally careless, or even made despite reasonable care, could therefore be treated as deliberate with extended assessment windows and higher penalty rate if identified during a deal process and not addressed appropriately.
HMRC would also be able to issue a Customer Correction Notice where it suspects that a document contains an inaccuracy capable of correction. The notice would require the taxpayer, by a stated deadline, either to take reasonable steps to correct the position or explain why no inaccuracy exists.
Why this matters in M&A transactions
Tax due diligence commonly identifies historic positions that are uncertain, incomplete or potentially incorrect. Those issues are usually managed commercially through warranty disclosure, price adjustment, tax covenant protection, specific indemnities or specific transactional insurance policies. The proposed regime adds a separate compliance question: has the taxpayer become aware of an inaccuracy causing a loss of tax, and have reasonable steps been taken to correct or notify HMRC?
A diligence finding may be sufficient to support a price adjustment, disclosure or indemnity without necessarily meaning that the target has become aware of an inaccuracy requiring immediate correction. Conversely, where diligence confirms that a return is likely to contain an error and tax has been underpaid, the seller or target may have an obligation under these new rules, in addition to existing self-assessment requirements, to promptly inform HMRC.
This distinction may be difficult. Diligence reports are often prepared using materiality thresholds, assumptions and limited information. A report may identify a possible HMRC challenge without necessarily concluding that an existing filing position is definitely wrong. Clear wording will therefore be needed to distinguish known inaccuracies from judgemental positions or matters requiring further review.
What is the interaction with warranties and indemnities?
The proposed regime may have a particular impact on the way SPA protections are drafted. Tax warranties and tax covenants commonly operate for a negotiated period, typically seven years. Where diligence identifies a matter that may amount to an error, the parties will need to consider whether that period remains appropriate if failure to correct could cause the issue to be treated as deliberate, potentially extending HMRC’s assessment window to 20 years and increasing penalty exposure.
This will be particularly important for specific indemnities and capped protections. If a risk is not corrected because it is treated at signing as uncertain or non-deliberate but later falls within the new deliberate treatment because no correction or notification was made, the resulting tax, interest and penalties may exceed the level of protection originally negotiated. Indemnities may therefore need to be explicit on whether they cover increased penalties, extended assessment periods and adviser costs arising from a failure to correct.
Buyer conduct rights will also need careful thought. After completion, the buyer will control the target and may need to make a voluntary correction or notification to HMRC to avoid worsening the penalty or time limit position. SPA conduct provisions should not, in practice, prevent the buyer from taking reasonable compliance steps where a failure to act could increase exposure for the target. Equally, sellers may require consultation rights where a voluntary disclosure could trigger liability under a covenant or indemnity.
W&I and tax insurance considerations
W&I insurance typically excludes known risks and matters fairly disclosed in diligence, while specific tax risk insurance depends on the risk being capable of underwriting. Insurers may therefore focus on whether a diligence issue has triggered, or could trigger, a correction obligation, whether HMRC has been notified, and whether increased penalty exposure could arise from any delay in correction.
What are the practical implications for M&A transactions?
Although the legislation is still in draft, M&A participants should start considering how the new regime may affect transaction planning and risk allocation. In particular:
- tax diligence reports will need to clearly distinguish known inaccuracies requiring corrections from judgemental positions and matters requiring further enquiry;
- sellers and targets should consider whether identified issues require amendment, notification or further analysis before completion;
- SPAs should address control of corrections, HMRC engagement, seller consultation rights and buyer ability to make voluntary corrections after completion;
- buyers should consider post-completion correction rights for unresolved historic issues and how the new legislation might impact the existing drafting of such rules;
- time limits for warranty and indemnity claims should be considered in light of any potential extension of HMRC assessment time limits on uncertain matters;
- parties should keep a clear audit trail of when issues were identified, escalated and addressed, and any decision-making process on whether or not a correction is required under this regime; and
- W&I and tax insurance policies should be reviewed for known-risk, disclosure, correction notice and penalty exclusions.
Moore Kingston Smith comment
HMRC’s proposals are intended to encourage taxpayer-led correction and create clearer expectations around known tax errors. In M&A transactions, however, the practical effect may be to bring compliance questions directly into the deal process. A diligence finding may no longer be only a matter for contractual risk allocation; it may also require analysis of whether the target has a separate obligation to correct or notify HMRC, as the new statute increases the punitive obligations for taxpayers who fail to correct inaccuracies.
The most difficult issue will be determining when a taxpayer has become aware of an inaccuracy, as opposed to a possible risk or technical uncertainty. That distinction may be straightforward where an error is clear and quantified, but harder where diligence identifies a defensible disagreement, incomplete facts or an issue already under enquiry. Clearer HMRC guidance will be needed, particularly for corporate groups where relevant knowledge may sit with different individuals before and after completion.
For sellers, buyers and insurers, the proposed rules underline the importance of early tax input into SPA drafting when historic issues are identified.
Key takeaways
- HMRC proposes a new duty to correct known inaccuracies causing a loss of tax;
- failure to act could result in deliberate behaviour penalties;
- tax due diligence findings may create new compliance considerations;
- buyers and sellers may need to reassess tax risk allocation;
- W&I and tax insurance markets could face increased scrutiny of identified tax risks.
How prepared is your transaction for HMRC’s proposed changes?
Whether you’re a buyer, seller or adviser, early consideration of tax correction obligations can help avoid unexpected exposure and strengthen your position during negotiations. Our M&A tax specialists can help you assess identified risks, review transaction documentation and navigate evolving compliance requirements.
