With the cost-of-living crisis piling on financial pressures, it’s not surprising that many are looking to extra sources of income or to maximise what they already receive.
Keeping details of new or existing income sources from HMRC is not wise. It’s tax evasion and illegal and those that HMRC catch risk ending up paying not just the tax they should have done, but substantial additional costs in interest and penalties, too. This is where former Formula 1 boss Bernie Ecclestone came a cropper when he admitted tax fraud in October 2023. His hiding of £416 million in a trust eventually cost him £650 million in tax, penalties and interest and led to a 17-month prison sentence suspended for two years.
Missing tax
Each year, HMRC estimates the difference between what it thinks it should collect in tax and what it actually manages to collect. Called the tax gap, the latest estimates (for 2021-22) put this figure at £36 billion.
According to Helen Thornley, a technical officer at the Association of Taxation Technicians, the gap comprises different factors, from fraud to differences between HMRC and taxpayers on how each thinks the law operates. Within that figure, she says that tax is also lost to “ghosts” – people entirely outside the tax system – and to moonlighters – those who have not fully declared all their income sources.
Beyond those numbers are billions more that relate to taxpayers not getting things right through what HMRC categorises as error or a failure to take reasonable care, as Margaret Curran, a technical officer at the Chartered Institute of Taxation, highlights. And then, there are losses from criminal activity.
Compliance
To ensure taxpayer observance, HMRC carries out a wide range of compliance activities. In figures that Thornley cites, during 2021-22 HMRC launched 265,000 investigations and yielded an extra £30.8 billion in tax. “These figures,” says Thornley, “were lower than usual due to COVID-19, which restricted HMRC’s abilities to carry out as much compliance work as it would like to as staff were redirected to other roles.” However, she warns staff have been back in post for some time.
She explains that, in general, HMRC has 12 months from the date that a tax return is submitted to open an enquiry – called a compliance check – into that return.
What does HMRC know?
Although most are aware that HMRC can carry out enquiries into their tax affairs, the risk of being the subject of a random enquiry is perceived as low. However, HMRC has access to an enormous amount of information that allows it to make many more targeted enquiries where what a taxpayer has declared doesn’t fit with the information that HMRC has.
HMRC has access to an enormous amount of information that allows it to make many more targeted enquiries where what a taxpayer has declared doesn’t fit with the information that HMRC has
In short, Thornley tells how HMRC either automatically receives or has the ability to request information from third parties, including banks and building societies, financial institutions, letting agents and online cryptoasset exchanges, as well as other government bodies such as HM Land Registry, Companies House and DWP. It can also request data about sales or income from popular online marketplaces, such as Airbnb, eBay and Etsy.
And as she comments, “Because of information exchange agreements with other countries, HMRC also automatically receives information from banks and building societies held by UK residents in overseas accounts.” From her standpoint, this can help HMRC to spot undeclared wealth held overseas.
But with regard to overseas data, Curran remarks that its use by HMRC should come with a health warning – that it is difficult for the body to interpret it correctly. She says that, for example, “Discrepancies in the data received from overseas tax authorities may exist due to it often relating to a calendar year, thereby crossing over two UK tax years, which makes it difficult to match it with the figure reported on UK tax returns.”
Curran adds that matching problems may also exist due to how or where figures have been reported on UK tax returns. This may occur where a total or global figure was included in boxes on the tax return, not a breakdown of that figure. Additionally, income may have been put on the tax return as one type, for example interest, but reported to HMRC by the overseas tax authority under automatic exchange as something else, possibly dividends. Curran’s point is that HMRC may wrongly interpret the data about individuals, so it should always be checked.
Because of information exchange agreements with other countries, HMRC also automatically receives information from banks and building societies held by UK residents in overseas accounts
But apart from raw data, HMRC also gets information directly from whistle-blowers, including unhappy business partners, spurned ex-spouses/partners, disgruntled employees and jealous neighbours.
However, as Thornley cautions, data is only part of HMRC’s compliance approach. In fact, without proper analysis, it’s meaningless, and HMRC cannot identify areas of risk. She points out that since 2010, HMRC has had access to powerful data analysis software called CONNECT which helps to match information from multiple sources to taxpayers and identify patterns or anomalies which need to be investigated.
One-to-many “nudge” letters
Using information obtained from automatic data exchanges and with the help of CONNECT, instead of a specific, tailored enquiry into an individual, HMRC often now starts by issuing a standard letter to a number of individuals or businesses which have been identified as potentially under-declaring tax. In Thornley’s view, these one-to-many letters act as a cue for taxpayers to review their tax affairs and take appropriate action.
Thornley makes the point that individuals should not ignore these letters: “It is important to read the letter carefully to see what action is needed and take appropriate professional advice on how to respond as HMRC will normally want taxpayers to confirm that they consider their tax position is correct. If no action is taken, or HMRC does not accept the response given, then it may move on to open a formal enquiry.”
Indeed, Curran says the same and advises taxpayers to tell the truth, cooperate with HMRC and seek appropriate advice if they think they need it. If HMRC decides to open a specific compliance check into a taxpayer’s affairs, HMRC’s tax compliance checksguidance on gov.uk and on YouTube explain what is involved.
In terms of any investigation, Curran emphasises that HMRC doesn’t have the right to demand anything, but it does have broad formal powers to obtain information from taxpayers and third parties if it thinks it’ll assist the investigation: “There are safeguards in place, though. For example, HMRC can ask for information but only if it is reasonably required for checking a tax position; a taxpayer can challenge that if they don’t think the information is reasonably required.”
Coming clean
Ultimately, Thornley reiterates that if a taxpayer knows that they have undeclared income, they are advised to seek professional advice and get in touch with HMRC to declare and pay the tax as soon as possible.
She details that penalties are calculated as a percentage of the underpaid tax – potential lost revenue (PLR) – and can be anything from zero to 100 percent, or over 100 percent for offshore income or gains. “Penalties,” she says, “will be lower where the taxpayer voluntarily comes forward to HMRC, and if the taxpayer is cooperative. Taxpayers are scored on how much they tell, help and give to HMRC during the enquiry. The highest penalties are, therefore, reserved for uncooperative taxpayers who had sought to conceal their income.”
Penalties will be lower where the taxpayer voluntarily comes forward to HMRC, and if the taxpayer is cooperative
Curran expands the point, noting that there are also penalties of fixed amounts, such as £100 for filing a self-assessment tax return late. But of those based on a percentage, she says that there will be no penalty if the error was made despite the taxpayer taking reasonable care: an innocent mistake, if you like. Not quite the line that Bernie Ecclestone took with HMRC.
Careless or deliberate errors will, says Curran, attract a penalty. “For careless errors, the penalty is 30 percent of the PLR. For deliberate but not concealed errors, the penalty is 70 percent of the PLR. And for deliberate and concealed errors, the penalty is 100 percent of the PLR.”
She adds that the penalty will be reduced to reflect the quality of the disclosure – that is, telling, helping and giving access. The amount of the reduction will depend on whether the disclosure is prompted or unprompted – in other words, whether the taxpayer came forward voluntarily or HMRC asked first.
Another consideration is the need to look back. Thornley states that where income has been under-declared as a result of an innocent error, then, broadly, any returns for tax years (or periods of account for companies) ending no more than four years ago will need to be corrected. This can be extended to six years if the understatement was careless, and up to 20 years if the understatement was deliberate.
It is important to check that undisclosed income doesn’t have a wider impact; there may also be tax consequences over more than one tax
She caveats her point: “It is important to check that undisclosed income doesn’t have a wider impact; there may also be tax consequences over more than one tax – for example, a business which has not declared all of their sales will not only have paid insufficient income tax or corporation tax, but they could also have under-declared VAT, or missed that they should have registered for VAT.”
In summary
Once a taxpayer knows or suspects that they have under-declared tax, they should act quickly to correct their position with HMRC. In the long run, this will be the most cost-effective and least stressful approach. With so much data on individuals and businesses, it’s only a matter of time before it finds missing tax.
HMRC isn’t going away, so ignoring tax obligations or the authority isn’t an option.
