Beyond Reasonable Excuse and Negligence

It is true not trite that ignorance of tax law is an excuse! Penalties and freezing injunction are the two most important aspects of Income Tax Ordinance, 2001. However, penal provisions contain a most commonly used word reasonable coupled with the phrase opportunity of being heard. Apart from this, reasonable is also supplemented by many other words like ground, accuracy, basis, cost, amount, cause, opportunity, facilities, compensation, excuse etc.

One can say that this word is a sort of an act of mercy in the self contained code – Income Tax Ordinance, 2001. Similarly, the recovery sections contain an important aspect which is normally referred to as freezing injunction and is of utmost importance for Banks. This article is an endeavor to analyze the impact of two most important recent judgments which is closely related to the concept of penal provisions, reasonable and negligence. After analyzing the impact, we will move beyond reasonable excuse and negligence.

The Income Tax Ordinance, 2001 contains a number of onerous obligations on taxpayers and a number of penal provisions where the obligations are not met. In many cases, however, the penalty can be averted if the taxpayer can show that he has a reasonable excuse for failing to comply with the initial obligation. The word reasonable is equally important for the tax collectors and taxpayers. Although the word reasonable appeared at various places in Income Tax Ordinance, 2001 but let’s have a bird’s eye view over the Penalty sections of Income Tax Ordinance, 2001 only. The example of penalty sections is given in following table.

As far as the period of default is concerned, it is worthwhile here to note that penalty can be avoided if, throughout the period of default, the taxpayer had a reasonable excuse for not paying tax due, for not submitting the return or any other reason mentioned above. In furtherance, it is always deemed to be understood that a person to have done something if the person has a reasonable excuse for not doing it initially.

In Pakistan, ever since the introduction of self assessment scheme and increased tax compliance work, the load over the tax practitioner is cumbersome. This has increased the mushroom growth of tax advisors, consultants and cowboy accountants. On the other side Central Board of Revenue is still the examiner of already examined members of professional accounting bodies through section 223.

On the other side, the taxpayer cannot escape penalties by hiding behind their tax advisor, consultants and cowboy accountants. However, there were several instances in the past where the taxpayers have suffered huge penalties just because of ill advice or consultancy on the part of their tax advisor, consultants and cowboy accountants. One wonder! Why this position was never challenged. It is this position which Mrs. Rowland challenged.

Mrs. Rowland argued that her reliance on her accountants constituted a reasonable excuse, however, HMRC took the view that an error by a taxpayer’s accountant cannot constitute a reasonable excuse – Rowland v HMRC (2006) SpC 548.

The case was heard by Adrian shipwright. He noted that it is not sufficient for a taxpayer to have a reasonable excuse at some point during a period default. The reasonable excuse must subsist for the entirety of the period. On this question, the special commissioner made it clear that whether or not the accountants had any reasonable excuse for their error was irrelevant. The legislation requires Mrs. Rowland’s position to be determined. In particular, the court is obliged to consider Mrs. Rowland’s own knowledge and the measures she took to comply with her obligations.
While Mrs. Rowland had considerable experience as a company director and she understood the rules relating to companies’ filing obligations, it was held that she need not be aware of how film partnership schemes operated. It was therefore reasonable for her to engage a form of accountants that specialized in such matters and to trust them to matters right. It was only because of the wrong advice that Mrs. Rowland had received that the tax was not paid on time.

Furthermore, there is authority (Thorne v General Commissioners for Sevenoaks (1989) BTC 243) that reliance on third parties can constitute a reasonable excuse. The Special Commissioner therefore held that, subject to any special rules, Mrs. Rowland had a reasonable excuse for failing to pay the tax on time.

It is worthwhile here to note that reliance over third parties is now a reasonable excuse apart from shortage of funds; however, shortage of funds may not preclude the taxpayer from the application of section 205. This decision will be a relief to taxpayers and their advisers because it provides an opportunity for penalties to be waived in situations where, formerly, taxpayers had to make claims against their advisors.

On the other side, now it is reasonable for a taxpayer to turn to a particular firm of professional advisers to assist with a matter not with the range of the taxpayers’ personal expertise, then the Rowland Case is authority for the proposition that the taxpayer would have a reasonable excuse if the adviser made an inadvertent error.

Tax advisers will have studied tort law and in particular the tort of negligence. This was the area of law whose modern incarnation was Donoghue v Stevenson [1932] AC 562 and is often referred to as the ginger beer case. In order for a claim of negligence to succeed, a claimant must generally satisfy five tests.

  1. The alleged tortfeasor (wrongdoer) must owe a duty of care to the alleged victim;
  2. The tortfeasor must have breached this duty of care;
  3. The victim must suffer damage or loss;
  4. That damage or loss must be caused by tortfeasor’s breach of the duty of care; and
  5. The loss or damage must be a reasonably foreseeable consequence of the breach.

It was the first of these tests that gave rise to the neighborhood principle in Donoghue v Stevenson. That principle provides that one owes a duty of care to one’s neighbor – one’s neighbor being [those] persons who are so closely and directly affected by my act that [one] ought reasonably to have them in contemplation as being so affected.

In most cases of alleged negligence, the existence of a duty of care is obvious. For example, a driver of a vehicle owes a duty of care to his passengers, other road users and pedestrians etc; a tax advisor owes a duty of care to his clients and in some cases, to others whom the client wishes to benefit. However, there is a case in which the defendant argues as a preliminary point that the duty of care did not exist! Customs v Barclays was one such case (HM Customs & Excise v Barclays Bank plc [2006] UKHL 28).

Customs were concerned about outstanding VAT liabilities of two limited companies. As is common in such situations, customs applied to the courts to freeze the companies’ bank accounts, both held with Barclays Bank plc, so that any subsequent judgment customs might subsequently obtain would not be frustrated by the companies dissipating the funds in the meantime. The approach taken by customs is commonly known as freezing injunction.

Because of the need for secrecy, a party to a future action in the courts will make an application for a freezing injunction without notifying the other side. If the court grants the application, a temporary injunction is given until such time as the parties can come to Court to discuss its continued operation. Where a freezing injunction is in place, any person who disobeys it, that is dealing with funds in contravention of the terms of the injunction, may be held to be in contempt of Court with the risk of imprisonment or a fine. This threat is not directed only at the party against whom the injunction is obtained, the respondent, but also to third parties who know the injunctions and who do anything that helps or permits the respondent to breach its terms. Therefore, when freezing injunctions are granted, most applicants send a copy to the respondent’s bank.

This was precisely what happened in this particular case. However, shortly after the bank received details of the injunctions, it authorized substantial payments from the companies’ bank account. Subsequently, Customs obtained judgments against the two companies, but substantial sums were irrecoverable. Customs therefore sued Barclays for negligence.

The House of Lords considered as a preliminary point whether Barclays owed a duty of care to Customs instead of whether or not Barclays had actually been negligent, that is, whether there had been a breach of the duty of care were it to exist.

On reading the facts of the case, it might be easy to sympathize with Custom’s position. Due to the (assumed) negligence of the bank, substantial sums were lost to the Exchequer and the Bank could reasonably have been expected to foresee such a consequence. Indeed, the three judges in the Court of Appeal upheld Custom’s claim for damages.


SECTION 182 (1) – Penalty for failure to furnish a return or statement
Any person who, without reasonable excuse, fails to furnish, within the time allowed under this Ordinance, return of income or a statement as required under sub-section (4) of section 115 or wealth statement for any tax year as required under this Ordinance shall be liable for a penalty equal to one-tenth of one per cent of the tax payable for each day of default subject to a minimum penalty of five hundred rupees and a maximum penalty of twenty-five per cent of the tax payable in respect of that tax year.

SECTION 182 (2) – Penalty for failure to furnish a return or statement
Any person who, without reasonable excuse, fails to furnish, within the time allowed under this Ordinance, any statement required under section 165 shall be liable for a penalty of two thousand rupees.
SECTION 185 – Penalty for failure to maintain records
A person who, without reasonable excuse, fails to maintain records as required under this Ordinance shall be liable for a penalty equal to –

SECTION 186 (1) – Penalty for non-compliance with notice
A person who, without reasonable excuse, fails to comply with any notice served on the person under section 116 or 176 shall be liable for a penalty equal to –

SECTION 187 (3) (e) – Penalty for making false or misleading statements
To another person with the knowledge or reasonable expectation that the statement would be conveyed to an income tax authority.

SECTION 190 (1) – Imposition of penalty
No penalty may be imposed under this Part on any person unless the person is given a reasonable opportunity of being heard.

However, over the past 70 years, the law of negligence has been refined – particularly, in cases where the loss incurred to the claimant is purely financial loss. In particular, the Courts are wary of exposing potential defendants to claims for financial loss in novel situations. In Caparo Industries plc v Dickman [1990] 2 AC 605, Lord Bridge of Harwich held that the Courts should adopt an incremental approach to new categories of negligence – each new case being considered on its merits.

In the House of Lords, all five of their Lordships gave substantive speeches. They all held that, as a matter of policy, Barclays did not owe a duty of care to customs. Therefore, the claim failed at the first hurdle.

Lord Bingham cited six closely associated reasons for allowing the bank’s appeal. In particular, his Lordship highlighted the facts that:

  1. while the terms of the injunction refer to the duties to the Court, it makes no reference to other duties that might be owed to other persons; and
  2. Second, the bank, as an agent of its customer, is effectively acting as an opponent of Customs in their attempt to secure the missing VAT. And it is established authority that opposing parties in litigation do not owe each other a duty of care.

In respect of the second of these points, Lord Bingham said it would be strange anomalous – – if an action in negligence lay against the bank who allowed the horse to escape from the stable but not against the owner who rode it out.

In a similar vein, Lord Hoffmann held that a freezing injunction carries its won remedies, and the Courts cannot infer a wider consequence of a party failing to comply with it.

Lord Rodger was less convinced by the suggestion that the bank was effectively a party to the underlying impending litigation between Customs and the companies. In reality, he said, they were no more on the companies’ side in that dispute than the companies’ butchers, bakers or candlestick makers. He examined the recent cases that look at the duty of care where the loss suffered was purely financial, and concluded that to impose a duty on the bank would not be fair, just or reasonable.

Lord Walker, too, was disinclined to put much weight on the litigation context. He was attracted to the idea that banks ought to have the responsibility of dealing with freezing injunctions – especially when granted to the revenue authorities – in the same way as banks have other duties, example money laundering, imposed on them. However, his Lordship noted that other third parties, other than banks, might be served with a notice of freezing injunction, and to impose a duty of care on them would produce unfair, unjust and unreasonable results. Therefore, Lord Walker also allowed the bank’s appeal.

Lord Mance made a similar point and added that, while banks might be able to obtain insurance against such risks, other third parties are unlikely to be able to do so. His Lordship also provided a clear analysis of the various factors that give rise to a duty of care in cases of financial loss. He concluded by focusing on test of fairness, justice and reasonableness, and held that it would be inappropriate for the bank to be held to owe a duty of care in the circumstances.

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