Regular pitfalls taking over an investigation

Information freely provided without consideration

In a bid to cooperate with HMRC, individuals, businesses and advisers often provide information without careful analysis of the consequences. This is because those providing the information are not necessarily aware (and understandably so) of what the consequences of providing that information can be. Information is provided under pressured requests from HMRC and it is frequently assumed that HMRC are entitled to all the information they request. This is not necessarily true.

HMRC come into possession of valuable information often to the surprise of the provider. Tax irregularities can be established through forensic analysis of the information provided. It is possible that unless the provider has the experience and technical knowledge to ascertain the irregularities, the penalty position of any irregularity is worsened.

Assuming that HMRC don’t know

Common situations we have recently come across include:

  1. HMRC will not know about the rental properties (non UK resident):

    The information about who owns a property is recorded at the Land Registry. Electoral roles and council tax information set out who resides at the property. If the tenant is a taxpayer, their residential address will also be held by HMRC. Rent is normally paid by electronic transfer (direct debit or standing order) and therefore banks hold information relevant to the property’s rental yield, which can be compared against similar rental properties found on the internet. HMRC’s Connect system (the award winning software developed by BAE Systems Applied Intelligence) collates most of this information automatically and identifies tax risks and sets out potential tax anomalies to the HMRC officer in a simple to understand format.

  2. HMRC will not be able to detect cash sales because the cash was never deposited:

    A distributor of electrical equipment had made a number of cash sales and given significant amounts to the owner/directors as well as the management team. The funds were always held in cash.

    The funds were used to improve the main residences and a family holiday. Border Agency information was utilised by HMRC as well as social media sites containing the date and location of the family holiday.

    The company had poor stock control and did not undertake a stock take. The amount of stock acquired was not commensurate with the sales being recorded in the books. HMRC had the ability, through their Connect system to compare the business records to those of others in the industry as well as collate information on the directors, which enabled them to ask probing questions and obtain additional information to evidence their suspicions.

  3. HMRC will not be able to ascertain the actual dates spent in the UK:

    A non UK domiciled individual had visited the UK increasingly in recent years to conclude a number of property transactions and was unsure whether he had become resident. HMRC had opened an enquiry and were not challenging this area although they had made a simple comment relating to residence. It appeared, in light of facts, that HMRC may have known all along that the individual was close to his day count despite parking the questions since their opening letter. As previously mentioned, HMRC have direct access to Border Agency information although this information is not conclusive on its own. However, mobile phone records and bank/credit card records can all be analysed to identify the days spent in the UK and those spent in other jurisdictions.

  4. HMRC will not find my offshore bank account:

    A UK business contracted with a connected entity owned by an offshore structure. The entity acted as an intermediary in supplying to the UK business. As such the profits of the UK business were reduced by what were considered commercial transactions with the offshore structure. HMRC considered the expenses of the UK business and established that there was an offshore supplier. HMRC were able to compare the accounting information of the UK business with similar businesses to ascertain whether profits were consistent with these. UK bank records identified transactions to overseas bank accounts. UK bank information can be obtained without the knowledge or consent of the UK account holder. Once transactions were established with an offshore account, HMRC could obtain additional information. This additional information is likely to be more readily available to HMRC following the entering of information exchange agreements with many of the jurisdictions where these types of structures are established. (still being used- previously considered tax havens/inaccessible by UK authorities/HMRC)

Failure to provide information in a timely manner

HMRC caseworkers often only manage a small number of targeted cases at any one time. However, general advisers will have responsibility for a much larger number of clients; day to day tasks can often affect the ability to deal with lengthy information requests accurately and in a timely manner. This could result in a rushed and ill thought through response.

HMRC will often stipulate the time to respond being as little as 30 days. By the time the request is received, considered and additional information requested from a client, the time available is significantly shorter (especially in light of postal services delivery times and HMRC’s centralised postal system). Meeting the prescribed deadline may be difficult. The importance to respond within the time frame to demonstrate cooperation may be considered a priority resulting in a rushed response.

Where persistent failure occurs, HMRC may issue a formal notice to provide information, which will have a direct impact on penalties (if due).

Knowing how HMRC operate and actively managing (the enquiry) whilst ensuring HMRC are aware of services being provided to answer or manage their enquiries can significantly reduce the risks: for example, requesting and agreeing in writing a revised date to respond to information requests.

Meetings with HMRC - Lack of preparation and experience

HMRC caseworkers will have thoroughly prepared for meetings. They will have considered which interview techniques to apply, the order of questions, the way questions are phrased in order to obtain specific answers and when and if to revisit questions following certain answers being provided to certain questions. Often, HMRC will appear to be friendly, helpful and customer facing. Remember though, HMRC are in the business of protecting and maximising the Revenue yield – their techniques, questions and approach is always with the underlying goal of protecting and maximising revenue.

Understanding HMRC’s expectations is paramount to holding a successful meeting. The purpose of the meeting should be established and steps should be taken to identify what is required, who will be present at the meeting and more importantly what their role is.

In the course of a case we were recently involved with, a meeting was led by a junior although HMRC’s apparent note taker was very senior. This was established almost immediately through persistent questioning. The very senior note taker became a little embarrassed although a successful meeting followed. The alternative outcome could have been much worse.

Providing an answer at a meeting which could be wrong

For some reason, when HMRC ask questions in meetings, it feels compulsory to provide an answer immediately. An answer under pressure and without full reference to the surrounding facts can prove detrimental. Problems can arise where an answer feels necessary and is given as a spontaneous response to an unexpected or delving question.
HMRC will understand and accept that explanations need to be investigated and factually presented. They will also encourage spontaneous answers to leading, prying and awkward questions. However, cooperation can be demonstrated by exerting a willingness to answer the question thoroughly by reference to primary evidence. The situation can often be avoided where an expert is able to preempt the questions that may arise at a meeting and prepare for the answer. The skill acquired by those dealing with investigations on a daily basis is often not possessed by a general practitioner. HMRC questioning can therefore become at best uncomfortable and at worst detrimental to the client's presentation of their disclosures.

Advisers should be able to prepare fully for a meeting, which means identifying all possible representations to be made. This requires knowledge of HMRC’s approach and the ability to step back from the client relationship and view the situation independently analysing the risks and often application of complex legislation and case law. Advisers should not be afraid of assuring HMRC that they will review the situation and revert subsequent to the meeting. An adviser should do this in a manner to demonstrate cooperation and reassure HMRC that the client is prepared to make a disclosure. The continued use of this suggestion could result in HMRC losing faith in the client making an accurate disclosure of the adviser being capable of ensuring the client is best advised to make such a disclosure.

Too much of an informal approach taken with HMRC

HMRC may adopt an informal approach to their enquiries, seemingly being helpful and relaxed about a client or adviser making representations. However, HMRC are in the business of identifying tax irregularities and maximising the fair return to the revenue in such circumstances. Therefore, a relaxed approach should not cloud the actual need to consider the primary evidence and prepare an accurate disclosure.

During a recent case, an inspector enquiry into VAT irregularities appeared exceptionally helpful to the client (not advised at that time). The client was very satisfied that they had the assistance to bring their VAT position up to date although a month or two later they faced a new enquiry into their corporate tax position and the shareholder/directors faced enquiries into their personal tax position. The informal approach adopted by the clients included blaming their accountant for errors. Meanwhile HMRC used the VAT enquiry to gather information relating to corporate and personal taxes resulting in a much more aggressive approach since they had already established a lack of credibility with the client’s accountants.

All enquiries and investigations should be taken very seriously. It is inappropriate to think a VAT or PAYE inspection is routine given HMRC’s technological advantage to process collective information. An adviser (and client) needs to consider all taxes. This can often be a time consuming and onerous task. However, failure to do so could result in escalating enquiries and constraints on the ability to meet HMRC’s requests for information. A general practitioner may have a good broad knowledge of tax however may not be able to readily access knowledge relating to technical challenges.

Being frugal with the truth

Maybe based on the assumption that HMRC don’t know or the fact that a practitioner has not fully reviewed all aspects, it sometimes feels appropriate to limit the response to HMRC. Often this is because it is not understood why HMRC have asked for information. It may be that HMRC are considering say residency status and have asked for credit card statements. It may be that the adviser has no reason to believe HMRC are considering residency status. The information provided ignores addressing the real problem.

The client may believe that the enquiry is routine and that HMRC are not interested in the one or two areas where there may be tax exposure. Avoiding dealing with it could mean the issue goes away whilst not dealing with it could result in substantially higher penalties.

The key is preparation – an adviser needs to consider all potential aspects almost to the extent of simulating the situation of the client having tax irregularities. This exercise will allow an adviser to examine the possible outcomes and prepare responses. It will also permit the adviser to have a direct communication with the client and invariably protect their own position from claims that “my adviser failed to consider”.

Over explaining

Would you want a chatterbox to speak with HMRC? Under pressure would you feel inclined to provide more information about the circumstances even where further investigation into the facts is required? If you have not prepared for the meeting or do not understand why HMRC have a particular line of enquiry, you could inadvertently release information or share a view, which could later be detrimental or incorrect. Where explanations are desired although a response cannot be provided accurately and concisely, it is better to defer the explanation until the area of interest is fully reviewed.

This situation can often arise where a client attends a meeting and is answering questions. An adviser may feel it improper or difficult to interrupt a line of questions to defer the answer. An adviser should establish a protocol with the client ahead of a meeting whereby the adviser is able to fully control responses to HMRC. This is achieved by simulating a meeting with HMRC and guiding the client to always refer (either by eye contact or verbally as appropriate) to the adviser.

Unprepared technical responses

If during a meeting a technical analysis is going to ensue, a client and adviser should be fully aware of the arguments for and against. Again preparation is the key. If HMRC start a technical discussion in the meeting, an adviser needs to ensure they are aware of the primary evidence that supports their position and present it robustly or defer the discussion until a full review has been undertaken.

By way of illustration, during a historic managed service company case, a third party made representations that certain entities were legally unconnected as well as stating that contractual arrangements supported a self-employed status. HMRC took on board these comments whilst discussions continued along another route. After a while the Inspector revisited the two points, first presenting information that financially connected the entities and secondly asking for commentary at the meeting on a contract that was passed across the table.

The evidence provided by HMRC, which was obtained under two separate “routine” VAT inspections, somewhat challenged the third parties representations making it very difficult to refute the challenge. The inspector would have at this point concluded he was correct and persuading someone to a new viewpoint in these circumstances is more difficult.
Had we been involved at this stage, we would have reviewed arrangements and financial transactions ahead of the meeting. As it turned out, the contract that HMRC chose to present was one of a handful, whereas others were very much different. The financial connection was vastly more complicated and involved an offshore structure so HMRC’s representations at the meeting were a key direction to considering the overall position and more importantly, which entity could be regarded as a managed service company promoter. The negotiations upon receiving this knowledge concentrated on whether an entity was a promoter, the application of debt transfer provisions and more interestingly whether the host employer rules prevented the application of the managed service company legislation. The technical arguments created a situation where it was commercially appropriate to consider a compromised settlement.

Change of Facts

We recently took over the handling of an enquiry where the client had drafted responses to HMRC and the accountant had sent them out with little consideration to the consequences. The client argued that interest was paid. The inspector therefore sought tax at source. The client changed tack and argued interest was not actually paid.

The client also contended that a deduction should be allowed against profits for legal expenses in establishing a new entity. The inspector challenged this point and the client accepted the challenge. The invoice for the expenses clearly related to advice and was not a capital expense of establishing an entity – the client had assumed what the expense was in relation to without checking. Enquiries escalated with the most likely reason being that the inspector could not rely on the books and records or the treatment of entries.

Getting annoyed

To finish this guide, we refer to one of our favourite stories. The client had suffered a long standing enquiry into his personal and business affairs. Neither he nor his accountant could understand why the inspector kept pursuing their line of enquiries. The client did wonder whether a lady he had an affair with was related due to a common surname although we doubt that was a factor. The accountant had sent all primary records in a box to HMRC and the inspector would regularly find something with which to ask more questions – these couldn’t be answered properly since the accountant didn’t keep a copy of the records. Anyway, the client with increasing frustration tore off his shirt and threw it at the inspector across the table proclaiming “You may as well have the shirt off my back!” This was followed with a sharp exit by all parties.

HMRC deserve to be treated with respect and whilst at times matters may be frustrating there are processes in place to deal with these, for example mediation (our managing partner is an accredited mediator). Clients and advisers should maintain composure.

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