DESPITE HM Revenue & Custom’s best intentions, tax investigations can be stressful, timeconsuming and expensive. Some investigations can take up to two years to finalise and the penalty and interest charges imposed can be crippling, especially in an economic downturn.
Roughly one in a thousand enquiries is selected on a random basis, in order to test the system and act as a deterrent. In the majority of investigations, however, an Inspector’s risk assessment has highlighted that there is something wrong with the return.
There are a number of items which will increase the risk of an enquiry. Some enquiries are unavoidable. For example,are turn featuring a capital disposal of shares in a close company can be expected to be subject to an aspect enquiry. Many enquiries, however, arise due to ignorance and carelessness.
Here we look at the main triggers for investigations, and provide tips to ensure you are not selected. The best way to survive a tax investigation is to avoid one occurring in the first place.
Full disclosure
HMRC undertakes formal investigations to ensure that taxpayers (companies and individuals) are disclosing their full receipts of income and pay their fair share of tax. Inspectors will look closely at the individual entries in a return and will often ask for documentary evidence to support each item. They hope to uncover fraud, errors and confusion about the tax legislation.
Investigations range from questions into one aspect of a return to full-scale criminal enquiries into every aspect of a taxpayer’s financial affairs, although most enquiries are directed at the whole return (including corporate tax, VAT, income tax, PAYE, NIC, Construction Industry Scheme) and the associated accounts and records, etc.
In the past, routine inspections occurred for businesses on average every six years, but varied between three to 15 years. Since the merger of the Inland Revenue and Customs and Excise there has been a change in attitude. HMRC now focuses its resources on taxpayers who are most at risk of underpaying their taxes.
So why are enquiries opened? Information from employees, neighbours, aggrieved wives and girlfriends and loose talk in pubs. Whilst a single complaint may not trigger an enquiry, it may generate an internal examination of a taxpayer’s affairs and prompt a phone call or letter to third parties.
HMRC receives a lot of information, including malicious and unfounded allegations, and undertakes risk assessments so as not to trouble taxpayers unnecessarily. A series of complaints will be seen as more suspicious.
In March 2006, HMRC set up an anonymous tax evasion hotline which attracted 120,000 calls in the first 12 months from individuals keen to ensure that competitors did not receive an unfair advantage. This triggered around 2,000 investigations.
It appears that jealousy and falling out with others can lead to tax problems! If you are under enquiry and know you have done nothing wrong, make sure you stand your ground.
Industry crackdowns
The most common target for investigations are the self-employed, especially cash traders such as pubs, stall holders and taxi drivers.
HMRC also tackles similar businesses where recurring errors have been found on national and regional lines. New sectors are constantly being discovered where mistakes are being made – most recently nail bars. HMRC investigators uses “data matching” techniques but also scans the Yellow Pages for new nail bars rather than waiting for local tax inspectors to report them.
If you are a start-up and are unaware of your tax responsibilities, contact HMRC for advice. If you know that your competitors are not complying with tax law, this is no defence in the eyes of HMRC and errors are likely to be discovered eventually.
Late payment of tax
If tax cannot be paid on time, HMRC should be contacted and suitable arrangements agreed. HMRC has set up a Business Support Payment Service for taxpayers in temporary financial difficulty who are struggling to make tax payments. It is best not to wait until a temporary cash flow problem has become a major issue. Contact the collector as soon as the problem arises.
Late submission of forms
The later the submission of a return after the deadline, the higher the risk of an enquiry and the longer HMRC has to raise an enquiry. If a return is over 12 months late,a compulsory review will occur. Taking a long time to reply to requests for information will also raise suspicions from an inspector.
Being organised, aware of your responsibilities and time limits, and maintaining adequate information and record-keeping systems is vital so that the relevant information is readily available.
Intelligence activities
HMRC receives information from a number of sources, such as banks, the National Lottery, employers, electoral rolls, letting agents, local authorities, Land Registry and other organisations which highlight whether taxpayers are disclosing all their income. Local news reports of high-profile sponsorship or expensive weddings can arouse the inspector’s interest.
HMRC also trawls through the media for adverts and news relating to properties, businesses and other sources of income. Banks give details not only of interest received but also PEPs, TESSAs, ISAs, etc. (so that HMRC can check the source of the capital).
A large number of enquiries are caused each year by careless omissions. HMRC compares returns to earlier years and to a business’s financial accounts. An annual comparison should be carried out with the previous year’s return to ensure all sources of income have been included. For instance, HMRC will look for evidence of stock held or the work in progress at the year end and if it thinks that no adjustments have been made it may start an enquiry.
HMRC also shares information internally between the different specialist tax departments such as VAT, PAYE, NIC, Construction industry, Corporation tax, International and Charities.
In the future HMRC would like to have a “single customer record” which will show all the dealings with HMRC in one place. This will allow HMRC to answer queries quicker, but it will also instantly expose the tax structure and history of a company, as well as providing officials a unified view across all the tax regimes.
It’s also worth noting that if tax is outstanding, collectors have been known to make visits to a taxpayer’s house or business and report on such things as the quality of the cars parked outside.
Use of the additional information box
Modern tax returns are designed to make it easy for full disclosure to be made. There is some debate about whether completion of the “Any other information” box increases or decreases the risk of an enquiry. Although some believe that local inspectors do not read the box, others say it depends upon what information is provided.
For instance, low business profits or drawings prompt questions on what the owner of the business is living off. Therefore,abrief explanation may help to avoid an enquiry, such as the opening of a nearby competitor which will have reduced overall profits.
Errors
If errors are subsequently found in a tax return such as miscalculations, transposition errors, omission of income and reliefs, this gives the impression that the taxpayer is not in control of his tax affairs or sufficiently organised. Tax returns should be checked thoroughly before submission and any mistakes should be notified to HMRC as soon as possible.
Estimates or provisional figures
If a taxpayer does not have sufficient information to complete the return in the time allowed, then he should make a “best estimate”. This will be of interest to the HMRC inspector, as will round sum and provisional amounts, and will result in an extension of the enquiry deadline.
They may suggest to HMRC that accounts have not been finalised because there are problems with the records and systems.
Sometimes the use of estimates cannot be avoided but it is important to provide information in good time and keep adequate records. Where provisional figures are submitted, taxpayers should set out a timetable for the inspector for when the final figures are likely to be available and then make a formal amendment, or confirm to HMRC that the original figures were correct.
Private use adjustments
HMRC looks to see that expenses have been disallowed in tax computations and returns. It is therefore important to show these separately. Although it may be tidier and quicker to “net off ” the disallowable items (such as private motor expenses) HMRC will not be aware that there has been any set off.
Spin offs from other investigations
Frequently, HMRC will uncover information during one investigation which will lead to an enquiry into the affairs of a customer or supplier of the business being investigated. It makes good sense to seek professional advice if you receive a request from HMRC for third party information about your dealings with another business.
Investigations are an unavoidable aspect of the self-assessment system. The areas we’ve covered aren’t a complete list of enquiry triggers but merely highlight the main causes of HMRC concern.
By managing the aspects mentioned, you will help HMRC in understanding your tax affairs and minimising its questions.
HMRC can be aggressive in its enquiries or make requests for information beyond its powers. Using a professional adviser can save you thousands of pounds by avoiding unhelpful explanations, helping to minimise penalties and applying to the General Commissioners to have the enquiry closed where HMRC is dragging its heels.
HMRC has indicated that it intends to reduce the number of enquiries. It will be trialling a “lighter touch” enforcement regime over the next four years in keeping with the overall objective of “significantly reducing the administrative burden in dealing with tax”. However, its tax collection targets are growing each year.
Only time will tell how new rules in relation to the inspection powers and the new penalty regime will affect HMRC’s investigation practices.
