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HMRC Self-Assessment (SA) enquiries - how they work

An HMRC Self-Assessment enquiry can be a stressful and potentially costly experience, with tax penalties for individuals whom HMRC successfully challenges often running into thousands of pounds.

Fortunately, contractors who are willing to take simple mitigating steps can all but eliminate their risk of attracting the taxman’s attention, as founder and head of tax at contractor accountant Abbott Moore James Abbott explains:

“Our advice to our contractor clients is to prepare for the worst but hope for the best. HMRC singles taxpayers out for SA enquiries largely based on anomalies in their tax returns, many of which can be legitimately explained. Contractors who take some basic preparatory measures will have nothing to worry about.”

How does HMRC target people for SA enquiries?

HMRC doesn’t have the resources to carry out routine checks on individuals, and so SA enquiries are undertaken on a risk-based approach. If there’s an inconsistency in your tax return, HMRC will examine it and decide whether it’s worth investigating.

“HMRC often has some of your financial records at hand, and can easily pick up on an inconsistency,” notes Abbott. “It could be something as simple as filing a different figure for your benefit in kind (BIK) in your personal tax return to the figure you filed in the P11D under the company’s reference. Or it could be your expenses are considered excessive for somebody in your line of work. If it looks suspicious, HMRC might act.”

Fortunately for contractors, HMRC inspectors will rarely use their resources to carry out an enquiry unless they believe there is a significant risk that something unusual is going on and tax is being underpaid.

Beware of HMRC’s data gathering powers

Beware though, HMRC’s data gathering powers are extremely far reaching, thanks in large part to its ‘Connect’ computer system. Connect uses big data to cross reference tax records with other public and government databases to quickly identify fraudulent activity without the need of human intervention.

Abbott shares two examples of how an investigator may use the information at hand to spot a non-compliant taxpayer using sources of information that Connect has access to – Facebook and DVLA databases:

“Suppose you’re on Facebook boasting about how successful your business is, but your tax returns suggest that you have very little income. Connect may spot this.

“Or DVLA records may show that there’s a car registered under your company name, yet your company accounts contain no mention of a company car. The taxman could well act upon this.”

How might a HMRC inspector issue an enquiry?

The taxman usually has one year up until after the tax return is submitted to HMRC to ask any questions. However, under certain circumstances HMRC may be permitted to investigate as many as four years after the end of the tax year, under what’s known as a ‘discovery assessment’. This will extend to six if they suspect you have been negligent or dishonest, and up to 20 years in cases of fraud.

Very few enquiries are books and records checks, and in most cases HMRC will contact you by writing, posing questions on a particular aspect of your tax affairs. For example: “Can you tell us why your tax return states that your bank interest is X when your bank says it is Y?”

“In extreme cases HMRC may request a face-to-face meeting, which you are by no means obliged to accept,” adds Abbott. “As long as you’re not obstructing the investigation, you’re perfectly within your rights to answer queries in writing, which helps ensure you don’t fall prey to an inspector’s leading questions.”

How to avoid an SA enquiry

Abbott notes that the obvious advice is to avoid tax return inaccuracies, but acknowledges that mistakes happen. However, he does share several tips to help dodge this scenario:

  • Hire a professional adviser: Having a professional either check or complete your return ensures that any anomalies are identified and addressed. They can also help you navigate an enquiry if you are unfortunate enough to be targeted.
  • Make sure they are reputable: Enlisting an accountant with a poor reputation could increase the chances of inaccuracies in your tax return. If they are known to HMRC as being particularly poor, being part of their client base potentially lifts your risk profile. Asking for recommendations from your network or quizzing the accountant on the approaches they take will help in this regard.
  • Make use of the white space disclosure: This white box on your tax return gives you the opportunity to add narrative explaining any peculiarities with your return, and HMRC is required to check these before considering an enquiry.

How to respond to an SA enquiry

For contractors who are unfortunate enough to be targeted for an SA enquiry, Abbott has some advice:

  • Enlist the help of your adviser: HMRC may ask leading questions to get a desired outcome. Professional representation will ensure you don’t fall into any of the taxman’s traps.
  • Get insured: Not being in the wrong won’t necessarily guarantee a quick enquiry, and there are fees involved whether or not you win. Most accountants offer schemes which cover fees for fighting your corner.
  • Be prepared: Prepare for the questions to be asked about your figures. This means if something is odd, potentially in four years’ time you’ll be able to explain the reasons why.

If errors are found – SA enquiry penalties and interest

If HMRC finds inconsistencies that can’t be explained, the inspector will calculate the ‘uplift’ that should be added to your tax bill. As well as interest on late payment, they may also consider other years and penalties.

“The SA enquiry penalty regime is tax geared, and in most cases its set at a minimum of 30% of the tax owed. It’s upwards from there depending upon the reason for the error. So you could easily wind up paying as much as a 100% penalty of what you owe.

“There are occasions where a contractor is investigated having made a genuine mistake, and the penalty system is structured so that these individuals receive lighter penalties, or none at all.” Abbott concludes: “This may provide contractors with some comfort, but an SA enquiry can still prove costly. Taking precautions is essential.”

Updated: Tuesday, October 31, 2017

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Contractors handbook