An individual, we’ll call her Becky, approached us at SME Strategies having read a blog we wrote on undisclosed rental income and HMRC’s Let Property Campaign. Becky had a rental property owned in her sole name but which was managed by her former partner, Dave, along with other financial matters as part of the amicable divorce arrangements. Our blog article sowed a seed of doubt in Becky’s mind as to whether the tax on the rental property had been accounted for properly by Dave. We were asked for our help.
The approach taken
Our conversation with Becky quickly ascertained that it was doubtful that Dave had accounted for the tax on the property income correctly. Indeed, accounting for someone else’s tax liability (Becky owned the property in her sole name) is always tricky. Becky assumed that basic rate tax had been deducted by Dave and sent to HMRC. Thankfully, Becky and Dave still get on really well and Dave was more than happy to help sort out any muddle with the rental income.
We created an audit trail of the rental income from the tenant to Dave and then into Becky’s bank account. The trail went via the convoluted but completely legitimate set of monthly payments between Dave and Becky arising from the divorce arrangements for their son, Toby. It soon became clear that the rental income had not been taxed.
An unprompted disclosure through HMRC’s Let Property Campaign (LPC) was chosen as the appropriate mechanism for putting things right with the taxman. We made the notification of our intention to disclose – this protects the taxpayer from the harsher regime of a prompted disclosure if HMRC comes to the taxpayer before the taxpayer goes to HMRC. We got to work in preparing the accounts for the rental income less allowable expenses and superimposing them onto Becky’s previous tax returns. This enabled us to ascertain Becky’s marginal rate of tax and thus the appropriate amount of income tax that was due on the rental income. Interest and penalties then had to be worked out.
Had Becky taken reasonable care?
When making disclosures to the taxman for previous undisclosed income, it is crucial to ascertain the client’s culpability for the omission – ie had the taxpayer behaved reasonably or not and was the mistake even deliberate. Deliberate mistakes can potentially take us into criminal prosecutions and HMRC do prosecute serious tax evasion as a deterrent to us all. HMRC use a complex system for ascertaining a client’s culpability and thus the penalties that are applied. A further complication is that a slightly different regime is used where the taxpayer has submitted a tax return but omitted income from it, to where the taxpayer has not notified HMRC of their need to submit a tax return in the first place. Because Let Property Campaign disclosures often go back several years, it is well possible that a client’s culpability assessment has to be assessed under two different regimes. This was the case with our client. Whoever said tax was simple?
We had to ascertain whether the client took ‘reasonable care’ (as set out in HMRC guidance and in case law – the taxpayer’s own judgement that they did is alone sadly insufficient!). With disclosures of previously unreported income, usually the taxpayer has not taken reasonable care because had they done so, there would not be any unreported taxable income in the first place. Tax advisers in making repairs to tax returns usually therefore go back six years (assuming at least six years of income has not been reported), calculate the appropriate tax (at the taxpayer’s marginal rate for each year), add interest, calculate the penalties and pay the tax. That is then the end of the matter.
In this case, the arrangement for accounting for the rental income had been part of the divorce arrangements which were signed off by the solicitors. There was, in our view, an argument that the client had taken reasonable care but the arrangements put in place by the solicitors were so convoluted that an innocent mistake had taken place.
Proving ‘reasonable care’ has been taken is not necessarily easy. The circumstances here revolved around the status of the professional advice that Becky and Dave had received including the role of their existing accountants with whom they get on well.
The client had also mentioned in passing that they thought they had previously made a tax efficient investment but had no paperwork about it. This was obviously worth following up. We tracked down the investment which was a HMRC approved SEIS investment. We then obtained the appropriate signed documentation from the invested company to submit to HMRC in our disclosure. We spoke to HMRC by phone who were most helpful and we agreed with HMRC on the paperwork and detail to be given in our calculations that we would use in our submission.
We submitted the LPC disclosure online accordingly; we sent all the required documentation by post and paid the amount of tax due by a BACS payment by the due date required under the disclosure window.
HMRC’s formal response took us by surprise. They completely rejected our disclosure for a number of reasons. Not only was our ‘reasonable excuse/reasonable care’ (depending which regime we were reporting under) denied by them, HMRC wished to go back nine years and further HMRC invited us to pay some ‘voluntary tax’ (a technical term with which we were unfamiliar!). HMRC said we had not submitted any supporting calculations. HMRC denied we had made any payment to them and said our interest calculation was wrong.
HMRC have a demanding job to do enforcing tax legislation which can often be complex. At SME Strategies we do not see tax as a ‘game’. We know we should all pay tax to fund our hospitals (Covid-19 has shown us that), schools and other public services. But we need to pay the right amount of tax. Both taxpayer and HMRC need to play fair by the rules which are put in place by democratically elected governments. We wrote a courteous letter of complaint back to HMRC. In fairness to HMRC, an officer from the complaints team rang us promptly and was very constructive.
Having ironed out that HMRC had, after all, received all the information from us, the interest was calculated correctly and our assessed amount of tax had been paid by us, the remaining matter was the assessment of the client’s behaviour. Had Becky taken reasonable care/had she a reasonable excuse? A lot hung on the outcome of that question. If the client had a reasonable excuse we would only go back four years and importantly no penalties would be charged. The correspondence with HMRC continued. Having rather gone round in circles, it was agreed by HMRC to escalate the matter to a senior officer from whence it went to their Technical department.
In our LPC disclosure we had cited case law from the First-tier Tribunal (Tax) which was relevant to our client’s situation where Becky had followed her solicitor’s advice who had acted in a professional capacity.
After review by HMRC Technical, a determination was made by them that our reasonable excuse was accepted and our original LPC disclosure was accepted unamended. It perhaps took longer to reach a conclusion than it should have but we got there in the end to Becky’s obvious satisfaction.
A system is now in place for the correct reporting of rental income which does not muddle it with income for Toby’s trips to Disneyworld!
“David has a rare combination of business knowledge, flair, tenacity and courtesy. His enquiring mind gives him the ability to take a complex business problem, see it differently, identify the key issues, do his research and create a logical but innovative plan of action. He determinedly works through the plan to a successful resolution. Once my problem with undisclosed rental income was in David’s capable hands, all my stress evaporated. He is amazing!” Private landlord, London
If you have undisclosed rental income, a property related tax matter or another business issue, contact David at email@example.com or call him on 07841 215182 for a complementary conversation.