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How to avoid a HMRC Tax Enquiry

First Published: March 2018 | Available in: Property Articles Your Property Network

By specialist property accountant Stephen Fay ACA

Most property investors are required to file an annual tax return with HMRC, to account for their personal income and pay tax on that income. As this system is on a ‘self-assessment’ basis, and there are over 8 million personal tax returns filed each year, HMRC simply don’t have the resources to check every tax return that is filed – instead, HMRC look at a sample of tax returns each year – this used to be called an ‘investigation’, whereas more recently HMRC call this an ‘Enquiry’ (intended to sound less confrontational!).

This article looks at what a HMRC Enquiry is exactly, and how the risk of an Enquiry can be legitimately minimised.

How does a HMRC Enquiry arise, and what does it involve?

HMRC will write to a taxpayer to inform them of the intention to check their tax return. Occasionally, this could be a simple ‘aspect’ Enquiry, where a small & specific part of the tax return is checked, or more usually a ‘full’ Enquiry, where the whole of the tax return is checked.

For a landlord, a ‘full’ Enquiry will usually require that the following information is provided:

  • Copy tenancy agreements
  • Copy bank statements (business first, possibly personal also)
  • Copy mortgage statements, insurance & service charge bills, utility bills
  • Copies of repairs invoices & receipts
  • Details of assets and bank accounts that may not be included directly on a tax return

It can therefore be a significant amount of work for a landlord with a reasonable sized portfolio to gather together the basic information to respond to an Enquiry – and that is before HMRC then review the information and raise their questions. Most Enquiries are dealt with in around 12 months, though some can go on longer (our office records is almost 3 years!). So, ‘prevention is better than cure’ is the order of the day!

1. Basic compliance – file on time, pay on time

Number #1 on the list is very simple – file tax returns on time, and pay any tax due on time. Nobody likes dealing with their annual tax return, and certainly nobody likes paying tax – but it’s a simple fact of life for self-employed people, and the task doesn’t get easier if left until the last minute. From our experience, there is a clear link between clients with a poor track record of tax compliance, and the incidence of a tax Enquiry.

HMRC’s thinking with late-filers and late-payers is that the taxpayer may be so disorganised that perhaps their business records are also disorganised – so worthy of a check.

2. Review key income / expense ratios – ensure accounts are accurate

Despite often a large amount of data being collected when filing a personal tax return, HMRC often only see 7-8 numbers on the tax return itself (total rents, total mortgages, total repairs, etc). Therefore, a key way for HMRC to identify tax returns that might contain errors and mistakes is to look at the ratios between income and certain expense headings, such as:

  • Repairs: ideally no more than 25-30% of rental income
  • Mortgage interest: ideally no more than 50% of rental income
  • Other allowable expenses: Ideally no more than 10% of rental income

The above are just our experience of having filed thousands of landlord tax returns over the last decade, and the 50-ish HMRC enquiries we have dealt with. While there is no book or manual that HMRC publish which sets out ‘acceptable’ income: expense ratios, it isn’t too difficult to spot the trends which tells us roughly the indicators that flag up a tax return for a potential Enquiry. The rationale for HMRC looking at tax returns with unusual ratios is that costs may be included incorrectly e.g. capital part of a mortgage payment, capital repair costs, sundry expenses that are personal costs etc.

3. Check accuracy of information

It is obviously important to file accurate information within a tax return – which means checking the information you supply to your accountant carefully to prevent any errors. Example of typical ‘accuracy errors’ are:

  • Pension, employment, dividends, interest figures wrongly provided (wrong figure, wrong year, wrong person even!)
  • Rent and expenses figures provided inaccurately e.g. adding an extra digit to a repair bill, simple copying errors when providing data, copying across previous years mortgage payments even though rates changes, remortgages etc

4. Check completeness of information

As with item #3, it is obviously important to file complete information within a tax return – which means checking the information you supply to your accountant carefully to ensure nothing is missing. Example of typical ‘completeness errors’ are:

  • Properties sold but no CGT details provided
  • Missing pension / PAYE / Child Benefit / interest received
  • Missing rental properties e.g. if acquired in the year

A good accountant will do a general review of information provided by a client, to check for obviously wrong or missing information, and prompt the client to minimise the risk of inaccurate or incomplete information – however, there is only so much checking that an accountant can do, and HMRC consider that it is ultimately the taxpayer’s responsibility to maintain good records.

5. Check year-on-year consistency

One of the checks that the HMRC computer is set up to look for is unusual trends in income & expenses on a year-on-year basis. While there is often a natural fluctuation from one year to another in a self-employed person’s income, wild fluctuations in total income or certain expenses could be looked upon as worthy of review. So, within the bounds of what can be done legitimately, all things being equal is it preferable to have a consistent pattern of income over the years in order to avoid an Enquiry.

6. Make a ‘white space disclosure’ – if warranted

There are large blank white boxes dotted around the tax return itself, to allow for simple plain English explanations to be provided of any unusual or one-off items within the tax return. A good accountant will firstly know what kind of items are worthy of explanation, and then provide a suitable wording to enable HMRC to understand the item.

The HMRC computer is programmed to pick up certain anomalies or fluctuations in a filed tax return, but generally before a full Enquiry is launched a HMRC Officer will review the tax return manually, to look for any obvious explanations that has caused the HMRC computer to target the tax return – a plain English explanation of such an anomaly may be sufficient to head off the Enquiry before it begins.

7. Avoid amendments if possible

Once a tax return has been filed, try not to change the tax return unless there is a significant tax impact in doing so e.g. avoid adding in trivial amounts of extra expenses, for example, once the original submission has been made.

In fact, the Chartered Institute of Taxation (CIOT) has a recommended threshold of £200 tax impact (as an isolated issue) before a amendment to a tax return is required (instead, the following year’s tax return can be updated). HMRC tend to look more at amended tax returns because they feel there is an increased risk of error than in a return that didn’t need to be amended.

8. Don’t take the mickey

In a ‘self-assessment’ system, it is tempting to think that as no-one is ‘watching’, then any old figures can be filed, without any consequences. Although the UK tax code is very substantial, in the real world, HMRC do recognise that estimates and judgements have to be made, however these should always be of a ‘reasonable’ nature, which a good accountant can advise on (part of the role of a good accountant is to stop clients ‘pushing the envelope’ more than they should, even if the client doesn’t realise where the edge of the envelope is!).

9. Use an accountant!

Anecdotally, using an accountant (or, as HMRC call us, a ‘Tax Agent’) to file a tax return results in a lower incidence of HMRC Enquiry. Presumably this is because a Tax Agent is likely to file a higher quality of tax return than an unrepresented taxpayer i.e. less likelihood of errors, omissions, unexplained unusual items etc. Although, there are no guarantees!

10. If you do get an investigation – try not to get another!

Lastly, if you do receive notice of a HMRC tax Enquiry, it’s a good idea to try to ‘pass’ the Enquiry by responding promptly, providing all the information requested, and answering whatever questions arise as clearly and straightforwardly as possible. If all goes well, it’s unlikely that HMRC will raise a subsequent Enquiry for a long time, because if after a thorough review nothing significant has been found, HMRC are unlikely to target that taxpayer again unless something changes significantly.

On the other hand, if the Enquiry goes badly, HMRC can charge additional tax, interest, and punitive penalties (especially if the taxpayer was not cooperative during the Enquiry). And, the taxpayer may then be placed on the ‘Managing Serious Defaulters’ HMRC programme, which means that HMRC can ‘enquire’ into every filing that the taxpayer makes for 5 years – which is to be avoided if at all possible! more details here:

Managing Serious Defaulters

Summary

Dealing with a HMRC Enquiry is not a fun period in a person’s life! However, HMRC have the legal right to look at any tax return that they choose to – but HMRC has limited resources to do so, and so certain flags are looked for, which might indicate that a tax return contains errors or mistakes. Working with an experienced property accountant can reduce the likelihood of a HMRC Enquiry – and if an Enquiry happens, an experienced property accountant can deal with the Enquiry, to generate the best possible outcome for the client.

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