Investigations, as with any other state-run organisation, are a key part of HMRC's regime, but there are steps that can be taken to avoid this
According to HM Revenue and Customs' (HMRC) Annual Report and Accounts 2018-19, the tax authority brought in £627.9 billion in tax revenue for the government during the period covered by the report (HMRC, 2019). More importantly, and of interest to taxpayers with a mind to play fast and loose with the tax rules, HMRC protected its revenues to the tune of £34.1bn and, specifically through litigation, to the value of £17.5 billion.
Checks and investigations are a key part of HMRC's armoury. Indeed, investigations and penalties are, by definition, the backbone of any state-run organisation for without a punitive regime there would be minimal compliance.
Tax investigations should be avoided. They are not something that many welcome or would want to endure, as they are stressful. Furthermore, if HMRC finds misbehaviour, that taxpayer is bound to receive ‘special’ attention in the future.
HMRC oversees 45 million individuals (of which, 500 000 are officially wealthy), more than 5.7 million small firms, 207 000 mid-sized firms, charities and public bodies and 2000 large businesses, and it is because of this that it has had to up its game. Technology and online data sources have made it much easier for the body to search for tax it is due.
According to a small business advice website, tax audits can be expected every five years, while just a few percent of income and corporation tax returns are investigated (Money Donut, 2020).
HMRC tax investigations are expensive, time-consuming and stressful. They can last an average of 16 months and cost from £5000 in accountancy fees, plus management time and penalties if they find anything wrong (Talk Business, 2020). Fee protection insurance can cover the cost of an HMRC investigation. Offered to members by the FSB, other insurers also operate in this market—often at a discount via a taxpayer's accountant compared to a standalone purchase.
A key problem for taxpayers is that while investigation risk can be minimised through compliance, it cannot be eliminated as some investigations are conducted at random. However, by understanding what triggers an investigation—what the red flags are—taxpayers can lower the risk of trouble.
Avoid simple mistakes
HMRC requires compliance and any mistakes—however small or simple—may lead to questions being asked of the taxpayer. Of course, one small error, especially if voluntarily corrected by the taxpayer, is not going to raise the hackles of an investigator. However, a series of regular mistakes will suggest to HMRC that the taxpayer is either keeping poor records or is unable to follow processes set down by law. It may also suggest that the taxpayer is attempting to commit fraud or evade tax.
The only viable option to lower the risk of a mistake-related investigation is to engage a qualified accountant, one that is a member of a professional body. While a taxpayer will always be responsible for their tax affairs, the accountant will at least advise on processes and statutory returns.
While it is very tempting for a taxpayer to complete tax returns without professional help, a good accountant lowers the risk, in HMRC's eyes, of hidden monies and transactions, as well as reducing the risk of mistakes caused by inexperience and a general lack of knowledge of the tax system. It is important to remember that good recordkeeping is a legal requirement. Furthermore, a lack of understanding or knowledge is no excuse.
Of course, accountants charge for their services, but the right accountant will save far more in tax and time than they will cost.
» Employers wanting to give staff a little extra should take advice about giving some form of tax-exempt bonus—trivial gifts are a good example «
Be consistent
Some businesses, but not many, will see wildly fluctuating figures over a period of time. However, most will see a gentle series of peaks and troughs over time. However, if one year the profits are reported at, say, £200 000, but the following at £20 000, HMRC would be within its rights to ask why there is such a variation. The response may be simple and reasonable, but taxpayers should expect HMRC to ask. To forestall the chance of an investigation, the taxpayer would be advised to tell HMRC via the notes box in the tax return why profits fell so dramatically; the report should be honest and the excuse will need to be proven.
Similarly, it is quite reasonable for a business to take time to get off the ground. However, if the business is considered to be well established, it is also reasonable for HMRC to ask where the profit is—no business can run for long without a profit—and, after all, businesses not earning a profit will pay no tax. Again, where this situation arises, the taxpayer would be advised to pre-empt HMRC's questions and state on the tax return why there are no profits after several years of trading.
Note sector norms
With HMRC having a long and storied history, it is obvious that it is going to have statistics on what the average business in any given sector should be declaring in terms of expenses and profit.
It will know, for example, what the average Chinese takeaway sells and what it buys as raw ingredients and packaging. Investigators have been known to sit outside of restaurants counting customers and then extrapolating information to see if this tallies with what has been declared. Clearly then, if the business's declared numbers are well off the mark of the sector norm, then HMRC might seek answers via an investigation.
Avoiding this scenario is not easy. Being honest is the first step, but also trading via the right form of business entity may help too. Sole traders often earn less than limited companies—businesses likely to earn little would be best advised not incorporating.
Earn more than staff
It should be apparent to anyone with a grain of common sense that management and owners should be earning more than those that they employ. While the superrich can afford to give away blocks of shares or work for a token £1, the majority in business cannot, so to declare an almost non-existent income is likely to lead to interest from HMRC; it will suspect that some form of tax avoidance scheme is being employed and there are not many that are permitted.
Taxpayers should aim to not rock the boat; they should maintain the employment hierarchy, which is best illustrated by expected pay structures.
Employers wanting to give staff a little extra should take advice about giving some form of tax-exempt bonus—trivial gifts (which are not contractually due, given with no tie to performance, not convertible into cash and below £50 in value) are a good example.
HMRC uses technology to check on taxpayers and look for any evidence of fraudulent activity
Do not hide income
In the modern age, it should not come as a surprise that HMRC uses technology to help it check on taxpayers. Back in 2010, it started on development of its Connect database, which cross-references the tax records of individuals and businesses against other databases, looking for evidence of fraudulent or undisclosed activity. In 2016, the system was connected to British Overseas Territories databases and, in 2017, it was linked to systems in some 60 OECD countries.
HMRC does not just look at taxpayers or businesses in isolation, it actively compares and links records of anyone that is linked to taxpayers too. Any temptation to ‘forget’ payments or receipts should be resisted as transaction records, by definition, have two sides—the payer and payee. Whether a client, supplier or bank, HMRC can trace these. The odd record on its own may not lead to an investigation, but over time the risk of discovery will rise.
Whistleblowing to HMRC
Lastly, it might seem obvious, but it does need pointing out. HMRC does, from time to time, receive information about dishonest taxpayers breaking the law. While it does not have the resources to investigate everything it is told, situations considered to be serious will merit attention.
As to who might tip off HMRC, it is fair to include upset partners (personal or professional), irritated (former) employees wanting revenge, someone with knowledge of a cash-only deal or someone who is jealous that an individual is living beyond their declared means.
While living beyond declared means can be easy to disprove if there is private unearned wealth from, say, an inheritance or investments, this private wealth still needs reporting—especially if non-cash assets are involved. Taxpayers should be above board in tax matters and, where possible, avoid taking cash—cash carries a cost to deposit and a risk of loss, while card payments can carry relatively little cost and remove the risk of cash loss in transit.
In summary
HMRC uses technology to gather in tax it is entitled to. But it is important to not lose sight of the fact that it is run by people. Using just a modicum of common sense is key to having inspectors give a taxpayer the benefit of the doubt. However, ultimately, complying with the law is the safest way to avoid an investigation.
Panel: cosmetic surgeon and his son found guilty of £50 000 tax fraud
According to a September 2018 report in the Plymouth Herald, a former cosmetic surgeon, David Waghorn, and his son James, were found guilty of setting up a string of bogus businesses in a £50 000 VAT fraud (Abel, 2018).
The pair had faked tax returns to claim rebates on non-existent business expenses. They registered different companies selling books, clothes and medical supplies and then claimed back the VAT on what they spent—but the money went instead on funding their lifestyles.
David Waghorn was struck off in 2013 for performing illegal procedures.
HMRC launched an investigation when it discovered anomalies in the string of companies set up by the Waghorns. Letters were sent to David and James Waghorn at their different addresses but there was no response—so their homes were raided.
No business documents were found on either paper or computer. Company bank accounts were examined and again no transactions could be found.
David Waghorn was sentenced to a 12-month community order and was ordered to complete 120 hours of unpaid work. James Waghorn was sentenced to a 12-month community order and must carry out 200 hours of unpaid work.