Introduction

Administrative penalties in the tax area are intended to encourage tax compliance without involving the tax authorities in complicated and time-consuming issues of proof. They typically take the form of a financial sanction, and should be imposed as automatically as possible.¹ The purpose of the late-filing penalty is to encourage timely filing of the tax return,² or at least to encourage its filing as soon after the due date as possible.

The penalty for late filing of a tax declaration should be separate from the penalty for late payment. Separation of the two penalties provides an incentive for the taxpayer to pay by the due date even if the declaration is not yet ready for filing, and to file by the due date even if the taxpayer does not at that time have the funds to pay the tax. It is an advantage to the tax authorities to have the payment whether or not the declaration is available, and to have the declaration whether or not the payment has been made.

Country Practice

The details of country practice vary, but some examples are given to give an idea of possible approaches.

In the United Kingdom, companies must deliver their completed tax returns within one year from the end of the accounting period. Failure to meet this requirement results in lump sum penalties being payable: for a return filed up to 3 months late, the penalty amounts to £100. For returns over 3 months late, the penalty amounts to £200.³ The £100 and £200 penalties increase to £500 and £1,000 where the return is filed late for three successive accounting periods.⁴ For returns filed between 18 and 24 months late, there is an additional penalty in the amount of 10 per cent of unpaid tax (20 percent if more than 24 months late).⁵ For individuals, there is a penalty of £100 for a late return, and an additional £100 if the return is still outstanding after six months. These penalties are limited to the amount of the tax. If the return is more than 12 months late, there is a penalty of 100% of the tax. In specific cases, Inland Revenue may ask the Appeals Commissioners to impose a penalty of up to £60 per day to encourage the filing of a return. Penalties can be appealed against and waived if there is a "reasonable excuse" for the late filing.⁶

In Chile, in the case of corporate taxpayers, lateness or failure to file tax returns leads to a fine equivalent to 10 percent of the resulting taxes.⁷ The same rule applies in France.⁸

In Denmark, the penalty paid by companies for late filing of a return is calculated as DKK200 per day for each day the deadline is overrun up to a maximum total of DKK5,000.⁹

In Turkey, the penalty for delays in filing returns was increased as of January 1, 1999, to range between TL 1,000,000 to TL 12,000,000. If the taxpayer fails to file a return, the tax authorities may assess the tax liability by estimate, and an additional penalty of an amount equal to the tax assessed times one-half the delay charge also becomes payable immediately. However, this penalty is reduced by one-half, provided the taxpayer does not challenge the assessment of the authorities and pays the full amount due within one month of the assessment.¹⁰

In the U.S., the penalty for failing to file a return is 5 percent of the amount of tax required to be shown on the return, for each month during which the return remains outstanding, up to a maximum of 25 percent of the tax required to be shown on the return. In the case of income tax returns, there is a minimum penalty of the lesser of $100 or 100 percent of the amount of tax required to be shown on the return.¹¹

Fashioning a Solution

Late-filing penalties may be structured in a number of different ways. One is to impose a surtax on the total tax due for the period. Example A illustrates this formulation.

Example A. Late-Filing Penalty as Surtax on Tax Due

A taxpayer who fails to file a timely tax declaration for income tax or value-added tax is liable for a penalty equal to 3 percent of the tax payable for the tax period, for each month (or portion of a month) elapsed from the date the declaration was due until it is filed.

Another approach is to impose a flat fee linked to the taxpayer's gross or taxable income. This method adjusts the penalty so that it is meaningful to higher-income taxpayers, without having to know exactly the amount of tax due in order to calculate the penalty.

Example B. Late-Filing Penalty Linked to Income

A taxpayer who fails to file a timely income tax declaration is subject to a penalty in the amount of:

a) 100x, if the taxpayer's gross [or taxable] income does not exceed 100,000x;

b) 500x, if the taxpayer's gross [or taxable] income exceeds 100,000x, but does not exceed 350,000x; and

c) 1,000x, if the taxpayer's gross [or taxable] income exceeds 350,000x.

Example C. Monthly Flat Amount

A taxpayer who fails to file a timely declaration is liable to pay a penalty equal to 100x per month for each month the declaration remains unfiled, up to 12000x.

Both examples A and B relate the amount of the penalty to the taxpayer's income or tax payable so that the late-filing penalty gives high-bracket taxpayers an incentive to file, while not imposing an undue burden on low-bracket taxpayers. But the disadvantage of a link to any measure of net or gross income, or tax based on that income, is that the penalty cannot be determined until the taxpayer's income or tax payable is known-that is, until the tax declaration is filed or the taxpayer is investigated. The effectiveness of the late-filing penalty is reduced by delay.

Immediate imposition of the penalty, with a monthly notice and demand for payment, may have more of an incentive effect than a delayed imposition. Preferably, calculation of the penalty amount should be simple enough that it can be imposed on known taxpayers without waiting for the late declaration to be filed. A sensible alternative used in many countries is a late-filing penalty equal to a stated flat amount per month. This style of penalty, set out in Example C, can be imposed immediately after the declaration's due date (at least with respect to taxpayers known to the tax authorities), and charged again in the next month if the declaration still has not been filed. Setting a maximum penalty amount (or "cap") prevents excessive accumulation of the penalty. Yet this approach, though simple, may not be the best solution available.

The best approach to the late-filing penalty is to design the law to be consistent with the penalty's purpose. If the object of the penalty is to encourage taxpayers to file on time-and, if they are late, to file as soon as possible-then the penalty should provide an incentive and penalize more severely a greater degree of lateness in filing. To be maximally effective, the late-filing penalty should be imposed immediately after the filing due date and should increase more than proportionally with the time the declaration remains unfiled. Moreover, a flat penalty as in Example C will be ineffective for high-income individuals and businesses.

For example, if a taxpayer known to the tax authorities has not filed a declaration within 30 days after the due date, the taxpayer can be notified that the late-filing penalty applies and is due (notice and demand for filing). With each month that passes, there can be an additional late filing fee, and the amount of the fee can escalate. Example D illustrates this approach. It seems reasonable to impose a cap of a stated amount, so that the penalty does not continue to accumulate beyond reasonable levels.

One disadvantage to the penalty structure illustrated by Example D is that it may be difficult to set the amount of the monthly penalty so that it provides a sufficient filing incentive for high-income taxpayers and yet does not unduly penalize those with lower incomes. This may be the reason that some countries have chosen to base the late-filing penalty on the taxpayer's income, or the amount of the underpayment, as in Examples A and B.

Example D. Late-Filing Penalty

(Escalating Flat Fee)

1. A taxpayer who fails to file a timely tax declaration for income or value-added tax is liable to pay a penalty equal to-

(a) 100x for the first thirty (30) days (or part thereof) the declaration remains unfiled;

(b) 200x for the next thirty (30) days (or part thereof) the declaration remains unfiled);

(c) 300x for each thirty (30) days (or part thereof) thereafter that the declaration remains unfiled.

2. The total amount imposed under this provision is limited to 1200x.

But the formulations in Examples A and B result in delayed imposition of the late-filing penalty. Preferably, calculation of the penalty amount should be simple enough that it can be imposed on known taxpayers without waiting for the late declaration to be filed.

In some countries taxpayers make quarterly reports of gross income or the approximate amount of taxable income so that some information is known at the time of an annual tax declaration's due date (at least with respect to taxpayers who are in the system). In countries that use this method, linking the late-filing penalty to the taxpayer's estimated income or tax due may be practical. A late-filing penalty can be imposed immediately, and can escalate as time passes, and yet be based on the taxpayer's gross or net income (assuming those amounts are known or can be readily estimated). Another alternative would be to use for this purpose the taxpayer's income for the preceding tax year. But this system would not work well for taxes other than an annual income tax.

It would be desirable to design a penalty that can be applied to known filers whose income is unknown at the time the penalty is asserted, but that has the flexibility to increase with income so as to be meaningful to high-income taxpayers. With this more sophisticated combination penalty, a flat amount would be imposed by immediate notice and demand, and the remainder of the penalty would be delayed until gross or taxable income is known. Of course, this combined approach has the disadvantage of increased complexity. Nonetheless, it may be the most effective package of incentives for taxpayers to file timely tax declarations. Example E illustrates the combined approach.

Example E. Late-Filing Penalty

(Combined Approach)

1. A taxpayer who fails to file a timely tax declaration for income tax or value-added tax is liable to pay a penalty equal to-

(a) 100x for the first thirty (30) days (or part thereof) the declaration remains unfiled;

(b) 200x for the next thirty (30) days (or part thereof) the declaration remains unfiled);

(c) 300x for each thirty (30) days (or part thereof) thereafter that the declaration remains unfiled.

2. In addition to the penalty imposed under paragraph (1), the taxpayer is also liable for a penalty equal to [1] percent of the taxpayer's gross income for the tax period for each month that the declaration remains unfiled.

3. The total penalty imposed under paragraph (1) of this provision is limited to 1200x.

The decision to use a percentage of gross income in paragraph (2) of Example E is based on the possibility that some taxpayers with substantial gross income may claim a loss for years in which the tax declaration is filed late. Use of gross income means that a taxpayer who has a loss will nonetheless pay a penalty for late filing, thus providing an incentive to file a timely declaration even though tax may not be due. Although this approach may entail some inequity, to sustain accountability in a tax system it is important to make loss declarations available for audit.

Finally, design of the late-filing penalty should be considered in the context of other penalties that may apply. Often the late-filing penalty and the late-payment penalty overlap because both use similar measurements based on tax payable. Some countries also levy an administrative penalty for understatement of income or understatement of tax. The impact of multiple penalties all calculated on the same basis may be unduly severe and unnecessary. (Unduly severe penalties should be avoided for one thing since they may not be levied in practice, thereby jeopardizing the credibility of the whole penalty system.) Therefore, provisions coordinating the various penalties should be considered. Keeping in mind the overall objectives of administrative penalties-that they be imposed only when the underlying noncompliance is easy to determine and by a method that is easy to apply-the best approach to a late-filing penalty is to make it no more than a penalty that motivates the taxpayer to file in a timely manner, and that motivates those taxpayers who have failed to file on time to file as soon after the deadline as possible.

As can be seen, there are trade-offs in the design of the late-filing penalty, so there is no universally applicable solution. The appropriate penalty for a particular country will depend on practices and capacities of the tax administration and on the tendency of taxpayers to respond to penalties. It will also depend on procedures for assessing and applying the penalty. The discussion above has assumed that the penalty is assessed automatically by the tax administration,¹² and that the taxpayer is typically notified by computer-generated letters. This approach may make the most sense from a tax administration point of view, but in some countries the legal rules concerning procedure for assessing penalties may mandate a different approach. Such rules may, for example, mandate assessment of penalties in special proceedings. Unless these rules can be changed so as to streamline penalty assessment, they may have implications for penalty design.