Why HMRC May Choose Your Business For Investigation

Jennifer Adams considers the different investigation methods and procedures being used by HMRC to close the ‘tax gap’.

 

In the days before self-assessment, HM Revenue & Customs (HMRC) investigations were usually confined to those taxpayers whose activities were either brought to the attention of an Inspector, or because the tax return had taken a long time in being submitted, despite repeated requests. 

 

Fast forward 17 years and life has changed somewhat, not least because HMRC is under pressure to increase tax receipts and close the ‘tax gap’, namely the ‘difference between the amount of tax that should, in theory, be collected by HMRC, against what is actually collected’ (‘Measuring tax gaps 2011/2012 edition’ www.hmrc.gov.uk/statistics/tax-gaps/mtg-2013.pdf.%20%20).

 

Even though statistics show the overall ‘tax gap’ reducing since 2005/06, the amount is still large at 7% of the total tax take. The government has invested £900 million in tackling non-compliance in the tax system, and by 2014/15 expects this investment to generate up to £7 billion per annum in additional tax revenues. This is to be achieved by more specifically targeted investigations.

 

HMRC has the power to enquire into any return and request information to establish whether that return is correct. No reason needs be given, and invariably it will not be disclosed. A tax investigation can be stressful, costly and time-consuming for both sides. Therefore, should a business find itself being the subject of a full enquiry, it will be for a good reason – at last in the Inspectors’ eyes.

 

An enquiry may be:

 

• ’Full’ - checking a return as a whole, including the accounts; or
• ’Aspect’ – looking at specific areas or claims relative to a return, e.g. HMRC may have received confirmation that a property is being let but the owner has not completed the property income pages of the return.

 

Most enquiries into business returns will, by their very nature, be full enquiries, concentrating on areas where there is invariably a high risk of error or evasion using computer programmes in determining the level of risk. 

 

Although HMRC do still select a small number of cases at random, the majority of cases are likely to be selected for one, or more, of the following reasons: 

 

1. The percentage ‘mark up’ and profit is calculated as being less than the trade, industry or local average.
2. The amount taken as drawings appears insufficient to live on. 
3. Capital has been introduced with no explanation as to its original source.
4. Poor history of compliance (not least that the returns themselves have consistently been filed late).
5. Personal savings growing at a rate that cannot be explained by the level of drawings from the business.
6. Business expenses appear high for the type of trade, industry or location.
7. Accounts show a large and unexplained difference in the level of earnings, expenses or net profits by comparison year on year.
8. Information obtained from other sources including for example:

i. Persons who can only be described as ‘informants’ such as a disgruntled

employee, customer or ex-partner. 

ii. Newspaper advertisements showing a trade but no accounts have been

submitted; lists of market stall holders; DVLA records; historical data of

racehorses and their owners. Even estate agents have been asked for all

details of rental properties or house sales that have been completed in the

financial year. Local authority lists can hide a multitude of sins. Planning

applications can easily be found online and may give rise to the question:

'how can they afford to renovate a property whilst drawing so little out of

the company?’

 

The first indication will be the receipt of an HMRC enquiry letter, accompanied by a ‘code of practice’ (COP) leaflet (e.g. COP 11 ‘Self-Assessment Local Office Enquiries’ – see here).

 

The letter must be issued to the correct person, and within certain time limits dependent upon the type of enquiry. Usually, an enquiry must commence within 12 months of the date that the return was filed (TMA 1970, ss 9A, 12AC). 

 

Any amendments to the return following submission and after the due filing deadline, or if the return was filed late, will extend the enquiry window to the ‘quarter day’ (i.e. 31 January, 30 April, 31 July or 31 October) following the first anniversary of the day the return was either amended or filed late.

 

However, HMRC does have the power to raise discovery assessments for earlier years which are outside of the usual 12 months, but only should fraud or negligent conduct by the taxpayer be found, or if HMRC could not reasonably have been aware of the situation that gave rise to the discovery from the information available in the normal enquiry period (see SALF411 ‘Enquiries into Tax Returns: time limits for discovery assessments’  here).

 

The name of the issuing office, and which COP is enclosed, will provide clues as to the nature and severity of the enquiry. HMRC’s ‘Specialist Investigations’ directorate obviously deals with more serious fraud cases.

 

The letter will detail the type of enquiry, the information expected to be provided and the deadline for providing this information. A disclosure report will be required detailing the nature, extent and reason for the tax irregularities, together with supporting evidence. A ‘statement of assets’ may be included, which will enable HMRC to ascertain whether any assets have been acquired of which they were unaware, payment of which might well have been via the use of undisclosed earnings. Details of the procedure during an enquiry can be found in HMRC’s Enquiry manual (www.hmrc.gov.uk/manuals/emmanual/index.htm).

 

1. Well maintained records are a strong line of defence against an Inspector who alleges that the true business results are in fact better than the accounts show.
2. In the majority of HMRC investigations, HMRC will request either a formal or informal meeting, but there is no legal obligation for a taxpayer to attend.

 

The disclosure report will include a ‘certificate of full disclosure’ signed by the taxpayer, to the effect that that they have made a full disclosure ‘to their best knowledge and belief’. Should any additional tax be due, a tax penalty may be levied. In determining the amount of penalty, HMRC will consider the reasons as to why tax has been underpaid, and how much tax is due.

 

As previously commented – investigations cost. Therefore, HMRC are concentrating their investigation efforts on ‘targeted campaigns’ run by ‘taskforces’. Teams formed from across HMRC, including criminal investigations, specialist investigations and local compliance departments, use computer software in the tracing of likely tax evaders. Initially, the aim is to investigate specific trades where there has been evidence of tax evasion, expanding to other types of business. 

 

People who approach HMRC during the tax campaigns typically receive more lenient treatment. After the end of a campaign, HMRC use the information gathered to conduct more detailed investigations and possibly prosecutions of those who have not come forward voluntarily. ‘Taskforces’ are cost-effective to run, and easy to manage. In theory, the taxpayers do most of the hard work by owning up to the tax owed and completing the documentation. HMRC currently has 56 taskforces in operation, ranging from the scrap metal trade to restaurants.

 

 

Practical Tip :

 

Watch this documentary - Channel 4 has commissioned a three-episode ‘fly-on-the-wall’ documentary series about HMRC, to be aired in 2015. The documentary will follow HMRC Inspectors and investigators as they try to collect tax targeting ’high-risk’ sectors, including plumbers, doctors, offshore bank accounts and high net worth individuals.