HMRC Enquiries: Survival Tips (Part 2)

When a tax return enquiry by HM Revenue & Customs (HMRC) is in progress, the natural instinct of some taxpayers (and possibly their agents) is to wonder ‘how can we make it go away?’ and ‘how quickly?’ Managing the enquiry (e.g. dealing with HMRC correspondence promptly) should help to ensure that the enquiry process is completed sooner rather than later.       

Record keeping is an important discipline, both before and during an enquiry. There is a statutory obligation for the taxpayer to keep and preserve “all such records as may be requisite for the purpose of enabling him to make and deliver a correct and complete return” (TMA 1970, s 12B). However, it is also important to keep correspondence and documents relating to the enquiry itself.    

The first part of this two-part article looked in particular at the early stages of a full enquiry by HMRC into an individual’s tax return. The further pointers in this article are aimed at the enquiry as it progresses towards a conclusion. Like the first article, this selection of tips is aimed at individual taxpayers who have made an honest attempt to submit a full and correct tax return. Those who have not should consider seeking expert professional advice with a view to getting their tax affairs in order as soon as possible.

HMRC has a Charter for taxpayers (‘Your Charter’), which sets out (among other things) taxpayer rights. For example, HMRC officers must treat a taxpayer as honest, unless there is good reason to do otherwise, and to “only question what you tell us if we have good reason to”. In addition, the Charter states that HMRC aims to take up as little of the taxpayer’s time and money as it can (see www.gov.uk/government/uploads/system/uploads/attachment_data/file/91888/charter.pdf).

Whilst the majority HMRC officers deal with taxpayers in accordance with Your Charter, others may need to be reminded about HMRC’s commitments in the Charter. Failing that, on the rare occasions where an HMRC officer continues to act unreasonably, do not be afraid to make a complaint about them (see www.hmrc.gov.uk/complaints-appeals/how-to-complain/make-complaint.htm). 

HMRC has the power to issue a written notice requiring a taxpayer to provide information or produce a document which is reasonably required to check the taxpayer’s tax position (FA 2008, Sch 36, para 1). Furthermore, HMRC may enter the taxpayer’s business premises, and inspect the premises (but not any part used solely as a dwelling) and business assets and documents that are on the premises, if the inspection is reasonably required to check that person’s tax position (Sch 36, para 10). 

There is a general right of appeal against a taxpayer notice, but not if the information or document forms part of the taxpayer’s statutory records, or if the tribunal has approved the giving of the notice. HMRC can impose fixed and daily penalties for non-compliance.

However, there are certain restrictions and limitations on HMRC’s information and inspection powers. For example, the information, document or inspection must be “reasonably required” for the purpose of checking the person’s tax position. This can prove a difficult hurdle for HMRC (e.g. see Long v Revenue & Customs [2014] UKFTT 199 (TC)). Be prepared to ask HMRC why information or documents etc. are considered to be reasonably required, if there is any doubt; it is a valid point, and a general prerequisite for a valid information notice.

Even if information or documentation would otherwise be reasonably required to check a person's tax position, there are certain restrictions on what HMRC can require or inspect (FA 2008, Sch 36, Pt 4). These broadly include appeal material, journalistic material, personal information, ‘old’ documents (as defined), legally privileged information or documents, auditors’ statutory audit papers, and tax advisers’ papers giving advice. In addition, an information notice can only require a document to be produced if it is in the person’s “possession or power” (Sch 36, para 18). 

One line of enquiry by HMRC can lead to others. This may be justified in some cases (e.g. an ‘aspect’ enquiry can lead to a ‘full’ enquiry if the taxpayer has made an error in the return). However, HMRC may sometimes seek to extend the scope of a tax return enquiry even though no errors or discrepancies have been made.       

If HMRC is extending the enquiry unreasonably, consideration may be given to applying to the tax tribunal for a direction requiring HMRC to issue a closure notice within a specified period. HMRC must then convince the tribunal that there are reasonable grounds for the enquiry to be allowed to continue. Otherwise, the tribunal must direct that HMRC issues a closure notice within a period of its choosing (TMA 1970, s 28A(6)).

Taxpayers should beware of the ‘presumption of continuity’ (or ‘spreading’) in tax enquiries. Spreading is particularly applied by HMRC in the context of business profits. 

For example, if an adjustment for the year of enquiry results in an increase in a self-employed individual’s taxable profits, HMRC may presume that the circumstances resulting in the increase continued in other tax years as well. HMRC could therefore seek to increase taxable profits for earlier tax years, and possibly later ones, in addition to the year of enquiry. The authority given by HMRC for spreading is the case Jonas v Bamford [1973] STC 519.  

However, this presumption of continuity can be rebutted. For example, the taxpayer may be able to demonstrate that the event giving rise to an increase in taxable income for the year of enquiry was a ‘one-off’ event, and was therefore not repeated in other tax years. Furthermore, there have been several cases in which the tax tribunal has expressed reservations about the scope of spreading (for example, Barkham v Revenue & Customs [2012] UKFTT 519 TC). Therefore be prepared to challenge HMRC if it seeks to apply the presumption of continuity where it appears inappropriate to do so.            

If HMRC’s enquiry results in one or more adjustments to the tax return, the question of penalties for errors may need to be addressed. However, it is important to note that HMRC cannot impose penalties for errors where the taxpayer has taken reasonable care (FA 2007, Sch 24, para 3(1)(a)). There is no statutory definition of ‘reasonable care’, and each case therefore needs to be judged on its merits. HMRC’s Compliance Handbook manual features examples of inaccuracies despite taking reasonable care (CH81131). It should be remembered that HMRC’s guidance on penalties does not carry the force of law.

If reasonable care has not been taken, a penalty may be due for a ‘careless’ error in the tax return. However, such a penalty may be reduced by HMRC, according to the quality of the taxpayer’s disclosure (n.b. ‘disclosure’ broadly involves the taxpayer ‘telling’ ‘helping’ and ‘allowing access’).  The level of penalty will also depend on whether the disclosure was ‘unprompted’ or ‘prompted’ (FA 2007, Sch 24, paras 9-10).   

Aside from the penalty reductions for disclosure, HMRC has the power to reduce a penalty under special circumstances (FA 2007, Sch 24, para 11). ‘Special circumstances’ are not defined in the legislation (at least not in positive terms), so the question of whether circumstances are ‘special’ will depend on the precise facts of each case. HMRC’s guidance includes examples of when special circumstances may (CH170800) or do not (CH170900) exist. The old adage “if you don’t ask, you don’t get” may be apt in appropriate cases.

In addition to the statutory power allowing penalties to be reduced because of special circumstances, HMRC has the power to suspend all or part of a penalty in cases involving careless error (FA 2007, Sch 24, para 14). HMRC instructs its officers to consider the suspension of every penalty for a careless inaccuracy (CH83131), although a gentle reminder may be needed in some cases. When the suspension period has ended, if HMRC is satisfied that the suspension conditions have been satisfied, the suspended penalty is cancelled. However, a penalty cannot be suspended unless a condition can be set that would help the person to avoid becoming liable to a further penalty for careless inaccuracy in the future.   

The taxpayer will naturally want HMRC’s tax return enquiry to close as soon as possible. Unfortunately, disputes with HMRC can sometimes prolong an enquiry. However, requesting ‘alternative dispute resolution’ (ADR) could help to resolve such disputes in suitable cases. ADR is a mediation process, which broadly allows someone who has not been involved in the dispute to act as a neutral third party mediator, and work with the taxpayer and the HMRC officer dealing with the enquiry.

ADR is voluntary; so it is possible to withdraw at any point with no negative implications. ADR is also non-statutory, so it is important for the taxpayer to appeal or ask for a statutory review as well as requesting ADR, to preserve their legal rights (although taxpayers can ask for ADR before HMRC have made any decision). Further guidance on ADR is available on HMRC’s website (www.hmrc.gov.uk/complaints-appeals/how-to-appeal/adr.htm).