Individuals and companies that pay taxes in the UK could potentially find themselves under investigation by HMRC. If you do find yourself under investigation, there is no need to panic. Unfortunately, many people fail to appreciate their rights when under investigation and potentially open other avenues for the tax authorities to investigate. There are several issues to be aware of if HMRC question your tax returns or open an inquiry under their property discovery powers.
Why might HMRC investigate your tax return?
In this instance, we are looking at the property market, which can be reasonably complex with numerous grey areas surrounding income, taxation and allowances. The use of expenses and allowances in your profit and loss account will directly impact your tax liability. The whole premise of an enquiry/assessment is to clarify whether the correct tax liability was lodged.
There are two different types of investigation that HMRC can undertake which are:-
Each time you file your tax return, HMRC have a 12-month window of opportunity in which to take a closer look at your returns. This type of enquiry does not require a specific reason and may often be picked at random. If, for example, you filed your tax return on 31 December 2020, HMRC has until 31 December 2021 to undertake this type of enquiry. The first you will hear is correspondence from HMRC confirming their investigation with a list of questions.
It is important to note that this type of enquiry is not far-reaching. All of the questions must relate to information in that specific tax return. Where the questions are more wide-ranging, you are not obliged to answer them. Your accountant should write to HMRC informing them of their concerns and asking for clarity.
A discovery assessment
The terms and conditions of a discovery assessment are very different to a general enquiry. A discovery assessment will only be opened where the initial 12-month window of opportunity has closed. There is also an onus on HMRC to have specific evidence proving that an investigation is warranted, i.e. a loss of tax income. While any investigation could result in additional taxation, interest and financial penalties, there is an acceptance that not all errors are deliberate.
There are three specific discovery assessment categories which cover:-
Where there is evidence of an incomplete disclosure, but this is not careless or deliberate, HMRC can go back over the previous four years of returns.
A loss of tax (due to careless conduct)
If HMRC has evidence of a tax loss due to careless conduct, they can look back over the previous six years tax returns.
The loss of tax (deliberate/failure to notify)
This is the most severe discovery assessment category, where a tax loss has been identified. The reason may include a deliberate action, failure to notify a liability or the use of tax avoidance schemes. In this instance, HMRC can go back over the last 20 years of tax returns.
As you can see, all of the potential reasons for issuing a discovery assessment are time-barred. Therefore, if HMRC tried to delve into tax returns outside of these timescales, you are not obliged to assist.
Who foots the bill for an HMRC discovery assessment?
The main concern with a discovery assessment, and general enquiry, is the potential cost. It matters not whether HMRC can prove any discrepancies and loss of tax income. However, as you will need to use the services of your accountant and possibly a solicitor to gather the information and present your case, it can be costly. While some enquiries can be relatively short, some can last for years and lead to tens of thousands of pounds in costs. These costs are not recoverable from HMRC, even if you are proved “innocent”.
Many companies and individuals take out fee protection insurance, often via their accountant, to cover the expenses of an enquiry. As the cost is potentially unlimited, this type of insurance is popular.
What may prompt an HMRC discovery assessment?
Many issues may prompt an HMRC discovery assessment, but there is one key element, evidence. Three specific scenarios that would likely start an HMRC discovery assessment are:-
- Admitting a mistake in your tax return after the 12 month general enquiry period has expired
- Information received via a third party suggesting a mistake/irregularities
- Errors in your tax return suggesting similar issues are likely to have arisen in previous years
In this situation, the discovery assessment would highlight issues already discovered and the impact on your tax liability. It is then a case of either paying the additional taxation, interest and financial penalties or appealing.
Opinion is often divided when it comes to taking advance clearance for particular property/investment-related issues. However, on occasion, it may be possible to approach HMRC and request non-statutory approval for a specific subject. In effect, this rubber stamps your actions, although it is essential to retain a copy of the official non-statutory clearance documentation.
It may be that years down the line, the tax authorities will reconsider historical actions in a different light. Retrospective changes to tax regulations are not common, but they can occur in some cases. However, if you have a non-statutory clearance notice, this is effectively your "Get out of jail free card". You considered a specific action, approached HMRC, and they gave you non-statutory clearance. End of story.
How might HMRC gather evidence for a discovery assessment?
The UK tax authorities can use various tactics to gather evidence when they suspect a loss of tax income. With particular regards to property, they have been known to contact tenants and letting agents directly to confirm rents and other financial issues. While tenants are under no legal obligation to answer these questions, many will reply unaware of their rights. Airbnb recently announced an agreement with HMRC giving the tax authorities access to their books under certain circumstances.
New evidence may also come to light about a tax avoidance/evasion scheme found to be illegal. In this instance, clients would likely be contacted directly with a discovery assessment. There are many more ways in which HMRC can gather evidence to support a discovery assessment.
In September 2016, a computer system known as Connect went live. Funded by HMRC, this computer can access an array of different databases in the UK. Consequently, HMRC can cross-reference bill payments, rates and other property expenses against individuals/companies and their tax returns. If there are discrepancies, HMRC may open an enquiry (within the 12-month timescale) or a more in-depth discovery assessment.
When it comes to rental income and property-related expenses, the chances are that HMRC will be aware of your financials before approaching you. If there have been issues with past rental income figures, it is crucial that you make the relevant disclosures rather than make the situation even worse. HMRC will already know the answers to the majority of questions relating to your income.
While these questions may be part of a more comprehensive investigation, failure to disclose the correct information could lead to additional lines of inquiry. In most cases, questions relating to simple financial details such as rental income are part of a box-ticking exercise. However, where there are discrepancies, this can prove costly!
Be wary of fishing expeditions
While HMRC has a fundamental obligation to have evidence before using their discovery powers, many tax inspectors will attempt "fishing expeditions". For example, you may have offset motor expenses in your most recent accounts. On occasion, inspectors have used this issue as a reason for reviewing earlier tax returns. However, unless there is specific evidence, or a high probability, to back this claim, it is not a valid reason for opening up a full property discovery assessment.
Many people panic when they receive correspondence from HMRC - whether a general enquiry or a more in-depth property discovery assessment. Therefore, you must be aware of your rights and request confirmation from HMRC where you believe you have valid concerns. Legally, HMRC has 30 days in which to reply to your enquiry.
While general enquiries, up to 12 months after your tax return is lodged, are most common, HMRC can also use far-reaching discovery powers. As we touched on above, the tax authorities have numerous ways to gather evidence to support their investigations. Therefore, it is essential to be aware of timescales, your legal rights and the fact that HMRC has to present new evidence to support the use of property discovery powers.
You may find some tax inspectors will undertake “fishing expeditions” often outside of their legal jurisdiction and sometimes unconnected to their core enquiries. Consequently, you must retain your accountant for advice about managing the situation. While you are obliged to answer legitimate questions, being too open about additional issues could lead to further investigations. The cost of these investigations can run into tens of thousands of pounds, hence why many people and companies take out fee protection insurance.
Take advice when looking to respond to HMRC enquiries – failure to do so could prove expensive!