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Overview Of An HMRC Tax Investigation

The following guide considers how to deal with an HMRC Tax Investigation and what may provoke the same so that you can be aware of the issue.

Tax does not have to be taxing but it will be if you cause or permit your tax compliance to fall short of the requisite threshold, so as to generate added interest in your tax affairs. A failure of compliance such as not filing returns on time is likely to serve to highlight a matter for HMRC to consider and can lead to HMRC chasing letters. Accuracy is another key factor. If due to errors in prior returns you have to correct them, then again you may highlight a problem that HMRC may pick up on.

Neither of those matters will necessarily mean that you have pay more tax because neither are direct evidence of an additional tax liability being due. However, you may find that the stress and conceivable cost of an enquiry would be time and money better spent keeping your affairs fully in order on a timely basis, if necessary through deployment of professional advice in the administration of your tax affairs.

Another way that you may find yourself the subject of an HMRC Tax Investigation is if you seek to deploy a Tax Avoidance Scheme.

How To Deal With An HMRC Tax Investigation

Taxpayer’s Burden In An HMRC Tax Investigation

The burden is on the taxpayer and this is a crucial aspect in how to deal with an HMRC Tax Investigation. HMRC is an involuntary creditor by virtue of legislation and reliant upon a regime where tax liabilities are ordinarily determined following a declaration by way of self assessment.

In the matter of Nicholson v Morris (H M Inspector of Taxes) 51 TC 95 the following notable comment was made as to the responsibility that the taxpayer has to HMRC:

… the Taxes Management Act throws upon the taxpayer the onus of showing that the assessments are wrong. It is the taxpayer who knows and the taxpayer who is in a position (or, if not in a position, who certainly should be in a position) to provide the right answer, and chapter and verse for the right answer, and it is idle for any taxpayer to say to the Revenue, “Hidden somewhere in your vaults are the right answers: go thou and dig them out of the vaults.” That is not a duty on the Revenue. If it were, it would be a very onerous, very costly and very expensive operation, the costs of which would of course fall entirely on the taxpayers as a body. It is the duty of every individual taxpayer to make his own return and, if challenged, to support the return he has made, or, if that return cannot be supported, to come completely clean, and if he gives no evidence whatsoever he cannot be surprised if he is finally lumbered with more than he has in fact received. It is his own fault that he is so lumbered.

Duty of Transparency In An HMRC Tax Investigation

There is little or no advantage to be had by delaying or seeking to avoid the progression of an HMRC Investigation, particularly if the information is at your fingertips. If anything, avoidance of reasonable transparency may serve to highlight the issue all the more and conceivably risks generating feelings of uneasiness and disquiet in the minds of the investigating officer. You are likely to generate more interest and more zeal for no stone to be left unturned if you prevaricate. Any investigator does not have the luxury of knowing what the person being investigated knows and therefore has to embark upon a fact-finding mission to discover the truth. If the investigator employed to do such a job is frustrated then sometimes a breakdown in communication can result and relations may become a little strained. It is perhaps of merit to consider an analogous situation where liquidators who investigate directors’ conduct and transactions are concerned because one particular judge commented about this type of problem as follows:

In Re Spiraflite Ltd [1979] 2 All ER 766 at 772, [1979] 1 WLR 1096 at 1100 Megarry J said:

Liquidators are, of course, human, and from time to time there may be liquidators whose discoveries or suspicions in their investigation of a company’s affairs produce in them an excess of zeal; and there may be other failings, too.

If you find an investigating officer overzealous then you can deploy the complaints procedures to bring such matters conceivably into check.Do not fear HMRC, engage with them and do so expeditiously. If you have nothing to hide they will be far more likely to take note of the taxpayer who appears to be trying to deal with the matter than the one who is unascertainable on a routine basis.

Think carefully about the merits of generating a perception of pseudo-participation with gratuitous statements to HMRC about an intention to be fully cooperative. Actions speak louder than words. Pseudo-participation statements may risk triggering suspicion where an experienced investigator is concerned; it risks being perceived as something other than the stated intention.

Know when to stand your ground; contest the significant issues not the trivial. An over-enthusiastic response to an investigator’s minor error(s) is unhelpful to you. Proportionality should be at the forefront of your mind. Minor technical anomalies are unlikely to afford you either a windfall or an escape shuttle.

You will want to resolve the enquiry so do not argue about everything. You may therefore want to avoid a situation where your case generates disproportionate interest for the investigating officer.

Engagement With The Tax Inspector In An HMRC Tax Investigation

Engagement is fundamental in how to deal with an HMRC Tax Investigation. Until or unless you engage you cannot dispose of the enquiry. Do not imagine it goes away because you succeed in delaying its progression. It is unlikely that you will endear yourself to the investigating officer if you persistently look to delay matters. The risk is that you may serve to highlight that you have a problem.

Think carefully about how routine misfortune and mishap might be perceived. Causing or permitting your agent to put forward a position as to your unavailability because you (or family members) are for instance unwell or that a series of regular and repeat mishaps seem to sprout just as an investigating officer is due a response, causing delay after delay is unlikely to dispose of the matter. Even though you may well succeed in obtaining extensions of time to deal with the matter, remember two things: 1) you are clocking up interest on your extra tax debt if there is one and 2) the risk might be that any discretion afforded to the Inspector might be exercised differently to the person who does not seem overly reliant on the deployment of what might be perceived as delaying tactics.

However, cases of misfortune do arise. When and if they do, do yourself a potentially huge favour and put the matter beyond any doubt. Consider providing notice as it arises along with prompt notice and evidence to the Inspector of the misfortune causing the delays. You are far more likely to receive sympathy if you do that than if you put forward mere assertion, particularly if you leave it until the eleventh hour before springing notice of this upon the investigating officer.

Your Records And Record Keeping

Another crucial feature in how to deal with an HMRC Tax Investigation is records. If your record keeping is up to scratch, you will conceivably be able to address the enquiry expeditiously and dispose of it without much fuss. However, if your record keeping is in disorder and dissaray, then you will likely either find yourself having to sort it out in a hurry with could lead to error and oversight or alternatively being unable to address the enquiry, which could leave you with an unwelcome series of Assessments or Determinations raised by HMRC.

Once an enquiry is opened get your relevant records in order so that any anomalies and unreconciled balances can be investigated, bank statements obtained and records reconstructed on a timely basis.

Tax Penalties Arising From An HMRC Tax Investigation

There is a penalty regime that is designed to address matters where the taxpayer does not appear to have been fully transparent and compliant. A lack of reaosnable care will produce the lowest level of the three classes of penalty. You could be forced to pay a penalty up to 30% of the extra tax due.

If however the error is deliberate the penalty could then spring up to 70% of the extra tax due.

Finally, if the error is not only deliberate but also concealed then your tax bill could increase by a factor of up to 100% as the penalty.

Indeed you will increase your chances of having no penalty or a reduced penalty if you learn in how to deal with an HMRC Tax Investigation effectively and afford HMRC unprompted disclosure and transparency. The quality of that disclosure can impact on your ability to reduce that penalty right down to 0% of the extra tax you have to pay. By the quality of disclosure, that refers to notification of the error, calculation of the tax applicable and affording reasonable transparency to enable HMRC to arrange for inspection of records (if they so wish) to check your calculations.

Tax Avoidance Schemes

As a general rule we would suggest that the use of notifiable avoidance Schemes is something that you carefully consider. If you do intend to use such a scheme you may find yourself introduced through an existing agent.

You are likely to be introduced to the Promoter of the scheme who may supply a presentation setting out how the scheme operates and how the tax planning works.

A key thing about tax avoidance schemes that might be worth considering is whether the scheme creates transactions purely for the purpose of avoiding tax or whether the scheme is a by-product of transactions that you are proposing to enter into in any event but which you wish to do so in the most tax efficient manner.

The Ramsay Principle

You are certainly not obliged to arrange your affairs to maximise the revenue of HMRC; you are entitled to arrange your affairs in a genuine manner which minimises your contribution to HMRC. In the matter of WT Ramsay Ltd v Inland Revenue Commissioners [1981] UKHL 1  the House of Lords broadcast this notable principle:

A subject is entitled to arrange his affairs so as to reduce his liability to tax. The fact that the motive for a transaction may be to avoid tax does not invalidate it unless a particular enactment so provides. It must be considered according to its legal effect.

However, a difficulty may arise where you enter into transactions that have no proper purpose other than the avoidance of tax. The problem that could arise is that many taxes in question are a product of some form of trading but a trade that has nothing more than tax avoidance at its heart may have a difficult hurdle to vault to survive HMRC challenge. In the case of Barclays Mercantile Business Finance case) in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46, para 35 the following was broadcast:

Cases such as these [IRC v Burmah Oil Co Ltd [1982] STC 30 (HL), Furniss v Dawson [1984] STC 153 (HL) and Carreras Group Ltd v Stamp Comr [2004] STC 1377 (PC)] gave rise to a view that, in the application of any taxing statute, transactions or elements of transactions which had no commercial purpose were to be disregarded. But that is going too far. It elides the two steps which are necessary in the application of any statutory provision: first, to decide, on a purposive construction, exactly what transaction will answer to the statutory description and secondly, to decide whether the transaction in question does so. As Ribeiro PJ said in Collector of Stamp Revenue v Arrowtown Assets Ltd [2003] HKCFA 46 at [35], (2004) 6 ITLR 454 at [35]: ‘[T]he driving principle in the Ramsay line of cases continues to involve a general rule of statutory construction and an unblinkered approach to the analysis of the facts. The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.’

The Rangers EBT Case

In more recent times these principles have now been ventilated in the Rangers decision on Employee Benefit Trusts (“EBTs”) as follows in the matter of Court of Session [2015] CSIH 77 XA128/14

In assessing the liability of a transaction to taxation, it is imperative in every case to determine the true nature of the transaction, viewed realistically:Barclays Mercantile Business Finance Ltd v Mawson, [2004] UKHL 51…

HMRC has had some success in attacking Employee Benefit Trusts (“EBT’s”). Such schemes, permissible when their purpose was employee incentivisation and reward. The problem commonly arose where owner managed businesses with few directors, set about entering into such schemes and still sought to maintain that they were entered into bona fide on the grounds of incentivisation, yet few (if any) of the ordinary employees might have been included in the EBT. Such arguments submitted about employee incentivisation could be considered threadbare given the owner managed directors would likely have a number of pre-existing incentives without the need for EBT’s. For instance it is axiomatic an owner managed Director is unlikely to need to be incentivised in the same way that an ordinary employee might need to be. Directors duties means that they have a duty to promote the success of the company in any event and to act in the company’s best interests.

The virtues of tax avoidance schemes can be troublesome where they may create transactions which if the scheme fails, may actually increase the tax burden. Tax avoidance throws up a whole different aspect in how to deal with an HMRC Tax enquiry.

A notable feature of many schemes is that the small print of the Promoters engagement letter, may afford an insight into what can go wrong. Many such engagement letters do caution the taxpayer about risks involved but this perhaps has not deterred many people from still signing up to such schemes and with the very significant fees that can be applied.

Case study

Oliver Elliot has recently had a situation in which we were seeking repayment of VAT in a liquidation. Unfortunately, the Directors of this Creditors Voluntary Liquidation did not leave the company’s affairs in good order. VAT on purchases paid for prior to the company’s incorporation were recoverable but went unclaimed. The VAT on this amounted to a tidy sum of almost £20,000.

The problem was that the VAT returns had not been submitted so that when Oliver Elliot’s CEO, Elliot Green, attempted to reclaim this input VAT, it was long after the relevant VAT quarter had passed and the company was in liquidation. Not only was the company compliance in disorder but procedurally the process triggered opening of a informal enquiry by HMRC by way of a records inspection procedure.

However, it is worth remembering in this case HMRC owed the company in liquidation money, not the other way around. HMRC clearly wanted to be certain in safeguarding the public purse that the company was entitled to the VAT repayment. It also wanted chapter and verse as to how the error had arisen in the first place.

The matter culminated in HMRC agreeing to repay the company in liquidation the sum of almost £20,000.

Transparency rewarded the company in liquidation; it did not hinder it.

We mentioned earlier to fight the battles that need to be fought. This was no easy task although it should have been but deployment of the correct procedure where HMRC is concerned can sometimes be challenging and then once they accept the position, we still had to keep pushing for them to bring their systems into line with our thinking. We were confident of our position so we pushed hard but fair for the resolution we sought without alienating anyone.

Oliver Elliot puts transparency at the forefront of its values, alongside the Oliver Elliot ‘flagship’ value that pervades through all that we do, which is acting with integrity.


For a free no obligation chat about any of the matters detailed above, please do get in touch for help. An expert will call you back or if you prefer exchange emails.

We can explore your situation and consider the best way to help you and your business needs. You can call us 020 3925 3613 or fill in the form below and will get back to you quickly. We Know Insolvency Inside Out.

Author: Elliot Green
Last Updated: April 13, 2024

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Disclaimer: How To Deal With An HMRC Tax Investigation

This page is not legal advice and is not to be relied upon as such. This article How To Deal With An HMRC Tax Investigation is provided for information purposes only. You should take independent advice on the facts of your case. No liability is accepted for reliance upon this post.

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