Getting ahead of an HMRC investigation

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No one wants an HMRC investigation, but for those in the spotlight, there are ways to mitigate the worst of the pain.

It’s become the subject of many tired old jokes – the taxman letter arriving on the doormat informing the recipient that they are under investigation. HMRC retains the power to investigate and prosecute individuals and businesses for a range of misdemeanours, and as the tax code has evolved so too has the Revenue’s powers to investigate and penalise those it believes are falling outside the rules of lawful or reasonable behaviour.

Any claims made outside the normal tax return will come under a Schedule 1A inquiry, with any inquiry in the returns itself coming under section 9a. With these, HMRC will typically pick up a discrepancy and issue a notice, request information and go forward from there. These days many of the inquiries will be instigated by the automated HMRC Connect system that trawls scores of databases to detect anomalies and potential tax offences.

Let HMRC do the work

David Wase worked for HMRC in a variety of enforcement and compliance roles for almost three decades before crossing over into the profession in the last few years. He now serves as a tax investigation specialist at PKF-Francis Clark in Truro. He says the key principle for anyone under investigation is to find the right balance between cooperation with HMRC and giving up too much information.

“When it comes to an inquiry notice into a tax return, then you want to be limiting what you’re providing HMRC to the year of that return, and not straying outside of it,” he says.

Of course, as with any type of inquiry, HMRC has the right to request a whole range of documentation that might relate to the case. Wase says that understanding what it can and cannot demand is where an experienced accountant can come in handy.

“What HMRC has to demonstrate is that the records are broken,” he explains. “It has to show a weakness in the records so that either all the turnover is not there on the return or there’s excessive expenditure there that’s not been demonstrated.

“In the event that HMRC can prove there is substance to their investigation, then it is likely they can request access to a whole range of supporting records. In that case, it’s open season on the bank accounts,” says Wase.

Given that, Wase always advises clients to always have dedicated bank accounts for separate income streams. “So if they have rental income then put that in the rental income account and don’t pay it into a personal bank account, because that personal account then becomes a prime record and HMRC is able to request prime records.”

Wase also points out that under the current investigatory regime, until HMRC has demonstrated that there’s an incorrect return – and it counts as careless – then it can’t go back into earlier tax periods as the time limit on inquiries comes into play. “So don’t be providing earlier years until HMRC can demonstrate that it’s made a valid discovery; if it has, then those earlier years are up for grabs.”

Under-resourced and under pressure

Increasingly, there is a feeling that HMRC simply doesn’t have the resources to carry out that kind of investigation anymore. Quite often, these nudge letters, and inquiry notices too, are generated by an automated process.

“What happens these days, I’m led to believe, is that inquiries come packaged and the notice goes out, and only then does it go to the individual inspector. That means you don’t get any inspector oversight before any of it goes out.”

As someone brought up in old school system where the inspector would generate the inquiry and only take a case forward when there was a reasonable chance of success, Wase believes the new, more speculative, ‘nudge’-type investigation approach lacks nuance and puts a lot more emphasis on self-reporting.

“The system will harvest this information, and it will see that John Smith on his return has put some property income. We’ve got some information here that’s clashing against your return, against what’s held on Connect that says you’ve got some offshore trust income: what’s this? So therefore, out goes the nudge letter and then we’re effectively doing HMRC’s inquiry job for them.”

And Wase points out that the internal dynamics at HMRC – continued pressure on resources, greater focus on efficiency, avoiding drawn out and costly cases – all play into the revenue’s current modus operandi.

Helping the process along

“Where HMRC has gone now is fast churn; it’s not interested in having inquiries lasting for years. Provided you give them the response they’re looking for, then you can get the thing settled quite quickly.”

And, as has long been standard practice, HMRC does reward those who respond to investigation with co-operation. “I always emphasize that we’re making a fulsome disclosure and I always look to pitch the penalty correctly. That means looking at their guidance on penalties.”

In short, if HMRC starts the ball rolling, then any response is counted as a ‘prompted disclosure’, with the penalty rate beginning at a minimum 15%. With an unprompted disclosure – where the taxpayer themselves go to HMRC to rectify an error – a lower rate of penalty applies.

Wase says that most accountants and investigation advisers will typically look to make a fulsome disclosure: “We explain what we’re providing them with and how this came about. We put it down to a careless inaccuracy and we afford the client maximum abatements, to keep it at the bottom of the range – 15-30% usually.”

Christian Doherty is a business journalist and freelance writer for AAT.

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