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Tax Investigations - Out of The Blue?

22nd Jul 2019
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By John Groves, former HMRC Compliance Officer.

Very few taxpayers’ lives are affected by contact with HMRC. For most, tax is deducted from their incomes, pay or pensions before it’s paid to them. However, around 9 million taxpayers will file a tax return annually - usually online - then receive a tax calculation and bill for any tax/NI due.

End of story? Not quite. Thousands of people each year are impacted by what HMRC euphemistically call compliance checks. In the current climate, these ‘tax investigations’ as they’re known to accountants, are bound to increase.

The driver behind this change is HMRC’s Risk and Intelligence Service (RIS) and with a recent increase in staff and data-capturing capability, RIS can now analyse much larger quantities of information, far more quickly. 

Identifying businesses for investigation

RIS creates profiles of businesses and trades, focusing on risks associated with cash, credit, and debit transactions, as well as the types of services or products they provide. 

Using this data and a system known as Connect - which links all HMRC systems and other agencies, such as Land Registry - RIS can identify and create or package cases suitable for investigation by compliance teams. This also helps them identify localised geographical hotspots with high numbers of risks and target resources accordingly. 

Each case comes with a price tag. This is the yield or tax that is expected to be recovered and is how HMRC measures the success of each case. 

Some of the risks HMRC will consider:

  • Clients filing nil liability tax returns

There could be credible reasons for this, but it signifies high risk for HMRC. Assessing a client’s ‘means’ is a key trigger for further enquiry. RIS will examine data to create a profile of the client’s means. It may not be a totally accurate picture, but they’ll be able to find information on loans, mortgages, savings, investments, who the client lives with, whether they could be supporting the client or if they’re dependants. On top of that you have all the normal living costs. 

  • Clients recording trading losses

Similar to nil liability cases, but focusing on how they’re funding the losses.

  • Low comparative turnover

Compared to traders of a similar type nationally or locally.

  • Significant increase in profit

This is particularly relevant in the case of sole traders or directors with no evidence of labour costs and represents a cash-in-hand risk.

  • Suppression of sales

In recent years, changes in legislation have given HMRC access to what is called Merchant Acquire Data, providing information on credit/debit sales. Comparison checks with this data and what is returned by the trader can easily identify discrepancies.

  • Suspicious Activity Reports (SARs)

SARs highlight potential money laundering and tax evasion cases. HMRC are the biggest recipient and user of SARs.

So, before the initial Section 9A is issued to the accountant and their client, HMRC will have undertaken many months of research and preparation. 

A client may have been selected for a random mandatory enquiry, but realistically that's a small percentage of cases. When an S9A enquiry letter is received the assumption should be that HMRC must have 'something on them'.

Addressing the issues of HMRC investigations for accountants

The key is to put processes in place that mitigate these potential risks. It’s essential that accountants are proactive before a potential Section 9A enquiry into a client’s return is made. Having a robust client database, linked to all relevant client documentation and accounting activity is a good start. While the need to conduct electronic AML checks goes without saying. 

Anti Money Laundering (AML) regulations require accountants to identify activities where there are serious concerns, improve records and - where necessary - correct tax returns. Recently the National Economic Crime Centre, which brings together regulators in the legal, finance and property sectors, identified 42 businesses as having potential compliance failings related to money laundering. 

“Businesses in the accountancy, legal, and property sectors need to understand that criminals prey on weaknesses, so it’s vital they take all steps to protect themselves. The money laundering regulations are key to that, but there’s still a minority of businesses who ignore their legal obligations. These inspections are a wake-up call that if you continue to trade illegally we will come knocking.” - Simon York, Director of HMRC's Fraud Investigation Service

Identifying the risks which could attract HMRC attention can have costly implications on your resources and time. But, having a robust AML system in place will save you money in the long run. You’ll avoid protracted HMRC enquiries and reduce problems during regulatory bodies’ compliance checks. Plus, one immeasurable benefit - reduced stress for all concerned.