Have you ever wondered what to do if HMRC enquire into, say, the tax treatment of payments made to employees? HRlaw’s tax experts at Fox Williams gives you a brief overview of the tax enquiry process.
What is a tax enquiry?
In the UK, we have a self-assessment system of paying tax. Very broadly, this requires taxpayers to self-assess whether tax or returns are due, and if so: (i) notify HMRC of their obligation to pay tax or file returns, (ii) self-assess the amount of tax due; (iii) file tax returns and (iv) pay any tax due, in each case within the relevant time limits. So far so simple. However, what happens after we file our tax returns?
For income tax, capital gains tax and corporation tax, HMRC generally have at least 12 months following filing of a tax return to launch an enquiry (after this, HMRC may still be able to make a “discovery assessment” up to 4 years (in the absence of careless or deliberate conduct), 6 years (for careless conduct) or 20 years (in the case of fraud) after the end of the tax year to which the assessment relates).
The purpose of the enquiry is to allow HMRC to scrutinise the information in the return and, ultimately, to allow HMRC to close the enquiry by either accepting the return or amending the return and assessing further tax.
As part of an enquiry into a tax return, HMRC have wide information gathering powers to collect information relating to a taxpayers UK tax liability for the relevant year of assessment. HMRC have publicly pronounced that they will not hesitate to use these powers. This is not simply used as a threat. In our experience, HMRC are prepared to, and are keen on, trawling through taxpayers files, requesting anything they consider is reasonable.
What can a taxpayer do when faced with such a situation?
Take an enquiry notice seriously
The starting point is that taxpayers must take an enquiry notice, and any accompanying requests for information, seriously and act immediately. Whilst a request for information can appear harmless and it may seem easy to send a quick initial response, there are real dangers where the taxpayer does not focus on the process.
As set out above, the outcome of an enquiry can be that HMRC do not accept the taxpayers self-assessment of the tax due and seek further tax, most likely together with penalties and interest.
Preparing for disclosure
Early preparation is key and taxpayers should be armed with all the facts.
Where an enquiry is expected, perhaps following a particular event or transaction, taxpayers should be prepared for an enquiry. Where relevant, identify the key internal participants and any lawyers involved in the transaction (the latter will assist in ascertaining what documents might be privileged, see below), maintain good files of hard copy documents and store e-mails in a way which facilitates easy recovery. This will make responding to any enquiry much simpler if an enquiry notice is received.
In the absence of the preparation above, it will be necessary to obtain all the facts as soon as possible after receipt of the enquiry notice. As explained above, an enquiry (or assessment) may arise several years after the transaction or event. Key personnel may have left, e-mail systems may have changed or e-mails may have been deleted or stored in an unhelpful way and documents may be hard to find or have disappeared. In such circumstances, taxpayers should identify the key participants involved in the transaction and recover their files and e-mails. Where relevant, speaking to key participants to understand the key commercial drivers underlying the event or transaction is also of paramount importance.
Where appropriate, taxpayers should:
- seek further time to comply with requests for information where the time limits in the enquiry notice are not reasonable;
- where the request for information is loosely drafted or too general, seek to refine the document requests;
- consider whether HMRC are within time to issue the enquiry notice.
Controlling and shaping the enquiry
Once armed with the facts, taxpayers should use every opportunity to get on the “front foot”. The effect of careful planning and strategic use of the statutory processes available should not be underestimated.
In particular, tax payers should:
- try to control the document disclosure process;
- resist disclosing documents that are irrelevant to the question of whether there is a tax liability; HMRC are not properly entitled to these;
- as set out above, seek further time to comply with requests for information where necessary and where the request for information is loosely drafted or too general, seek to refine the document requests;
- when producing documents to HMRC, put them into proper commercial context. This may include providing full particulars with any documents (for example by way of cover letter or summary document), setting out the commercial story of the transaction. In this regard, taxpayers should avoid piecemeal disclosure, which risks documents not being put in proper commercial context (and potentially the loss of legal privilege, see below);
- try to ensure documentation reveals the complete picture. In some cases, disclosing more documents will be better for the taxpayer;
- note that tax files should not be the first or only thing that HMRC see as they reflect a tax professionals’ interest in tax and are unlikely to give a proper indication of the commercial drivers for the transaction. Further, they may not be relevant to the transaction in any event or may be subject to legal privilege;
- not accidentally waive legal privilege. Documentation generated for the purposes of obtaining legal advice and/or in contemplation of litigation is protected from disclosure unless privilege is waived. Early, piecemeal disclosure in response to HMRC requests runs the risk of waiving privilege in respect of some or all privileged documents;
- Include a full analysis of the legal position and, where possible make clear to HMRC the appetite for litigation and the strength of the taxpayers case;
- consider pushing HMRC into issuing assessments or taking a formal position (such as through the use of a closure notice to end an enquiry and (if the self-assessment is amended) start the statutory 30 day statutory appeal process);
- consider pushing for face to face meetings; and
- consider instructing tax litigation lawyers as soon as possible.
The objective of the taxpayer should be to make HMRC drop the enquiry or, failing that, obtain a favourable settlement. Failing both of those, the taxpayer should be building its case to bring before the Tribunal or Courts, including identifying key witnesses.