HMRC have the power to “enquire” into any tax return from a company, a partnership, or an individual. They do not have to give a reason for the enquiry.
Anyone who submits a self assessment tax return may face an Enquiry – each Tax Office opens a certain number of random Enquiries every year.
This is not the place for a detailed examination of how to deal with a tax investigation, but there is one vital piece of advice – do not attempt to deal with it yourself! In particular, if you receive a notice from the tax inspector to say he has decided to “Enquire” into your return, seek professional help immediately – in the first instance, from your accountant, though in serious cases he may well want to call in a tax specialist like me.
If it is found that tax has been underpaid, then penalties may be due:
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Mr Burke is a sole trader, and when his return and accounts are investigated, it is found that he has failed to include £10,000 income for the year – the rent from a property he owns.
The inspector explains that Mr Burke should have paid £4,000 income tax on this income, and so Mr Burke will have to pay:
(in reality, it is also likely that the settlement would include tax, interest, and penalties for previous years in which the rent had been received and not declared, but I have ignored this for the sake of simplicity)
Mr Burke agrees to this, pays up, and that is the end of the matter.
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You will note that Mr Burke pays penalties of £1,000. There is a standard way to calculate these penalties. The calculation starts from the amount of the tax that has been wrongly underpaid – this is the maximum possible penalty.
This maximum is then “mitigated” according to a formula:
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Maximum mitigation |
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Disclosure |
20% (25% in special cases) |
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Co-operation |
40% |
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Size and gravity |
40% |
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Total |
100% |
Disclosure refers to whether the taxpayer “owned up” to the tax irregularities, or whether he denied everything until he could no longer think of any more excuses. Broadly, a taxpayer who “puts his hands up” and admits everything immediately the enquiry begins will get 20%.
At the other extreme, the taxpayer who denies and denies, perhaps forcing HMRC to go to the Tax Commissioners – an independent tribunal that decides disputes between HMRC and taxpayers – would get 0%.
The “extra” 5% to make up 25% is only for a taxpayer who voluntarily approaches HMRC and confesses, and then only if he “has no reason to fear discovery”.
Unfortunately, this does not mean you can get a repayment of 5% - the extra 5% is used to mitigate the penalties under the other two headings!
Co-operation – this is fairly self-explanatory, and is why you should never drag your feet during an investigation, but you will need a good tax adviser to help you understand the difference between lack of co-operation and insisting on fair treatment and arguing technical issues.
Size and Gravity – this seems to cause the most arguments in settlement negotiations. The mitigation ranges from 40% for cases of muddle and mistake involving small sums, to (theoretically) 0% for serious fraud involving forgery, conspiracy and large sums of tax – though at this end of the scale, it is more likely that there would be a criminal prosecution. A Tax Adviser will be particularly on his guard with an inexperienced inspector here – they always seem to think that their investigation targets are more “heinous” than anyone else’s!
If we go back to Mr Burke in our Case Study:
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Penalty Calculation |
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Mr Burke had concealed £10,000 income (by not declaring rent he received from a property). His penalties were agreed as:
Disclosure 15% - Mr Burke initially denied it all, but quickly realised this was stupid and admitted he had been receiving the rent
Co-operation 30% - Having admitted to the rents, Mr Burke quickly produced a schedule showing the amounts and dates, which proved to be an accurate one when the inspector checked it. However, he also tried to make a claim for some repairs, but had to withdraw this when he could not produce any invoices
Size and Gravity 30% - Mr Burke simply did not include the rent in his return – he did not produce any false documents, no-one else was involved, and the money was not hidden in offshore accounts or anything of that sort. On the other hand, £10,000 is a lot of money and it is clear he deliberately did not declare it even though he knew he should have done.
The total of Mr Burke’s mitigation was 75%, and that is why the penalty was 25% as shown in the Case Study.
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Finally, here are the golden rules for dealing with tax enquiries:
- DON’T try to handle it yourself – get advice before you reply to the initial letter from the inspector, and at all costs DON’T ring the inspector up to “have a chat and sort this out”
- DON’T ignore it and hope it will go away – remember the mitigation of penalties for co-operation and disclosure
- DO be honest and upfront with your Tax Adviser – only then will he be able to help you
DO talk to your accountant about taking out insurance to cover the fees for a tax investigation – the professional fees can be very expensive
