The initial problem
A taxpayer made some mistakes in his tax returns (filed under self-assessment) by omitting a P60 and some P11Ds and by being oblivious to the High Income Benefit Charge (HIBC).
Although it is obviously always wrong to omit a P60 from a tax return, the omission of both income received and tax paid can sometimes mean there is no net loss of tax to HMRC unless the omitted income causes:
- the taxpayer to move to a higher tax bracket (ie to become a basic rate, higher rate or additional rate taxpayer); or
- the taxpayer to lose some or all of their Personal Allowance (which happens when income reaches £100k pa); or
- if affects entitlement to child benefit.
HMRC’s new powerful computer spotted an inconsistency between the client’s submitted tax returns and the information on their database. HMRC therefore launched a multi-year investigation into the taxpayer.
The taxpayer had previously used an accountant when they ran their own business. However when their tax affairs became simpler by becoming a PAYE employee, they thought they no longer needed an accountant and could do their own tax returns with ease. This proved a short-sighted decision as they painfully came to realise.
The taxpayer found SME Strategies via Google and after talking with us, we were appointed to act for the taxpayer and deal with HMRC’s investigation.
The problem though got worse
A significant complicating factor then arose. Our new client and his wife also jointly owned a rental property which they had let out for several years. When this property was first let out, the client’s wife had contacted their then accountant for advice on the taxation of the rental income.
The previous accountant had given written advice which the client’s wife reasonably (but incorrectly) interpreted as meaning that all the rental income should be included on the wife’s tax return as she received rental income into a bank account in her name. The advice from the accountant should have made reference to taxation following the beneficial interest entitlement. Half of the rental income (and associated expenses) should have been reported on the tax returns of each husband and wife.
HMRC then widened their enquiry to include the rental property income. They brought into tax the client’s share of the undisclosed rental income. As the client is an additional rate taxpayer this was a significant additional tax liability.
HMRC refused to accept that the client had taken reasonable care regarding their disclosure of the rental income for two reasons:
- HMRC argued that the written advice the client received from the accountant said that the rental income was to be disclosed on a 50-50 basis (between husband and wife). HMRC’s interpretation came about because they (HMRC) interpreted the ambiguous advice already knowing the answer to the question.
- HMRC then further argued that the professional advice was taken by the client’s wife (and not by the client) and therefore the client could not benefit from claiming that professional advice was taken. HMRC argued that the client had to ask the same question again before he could claim he had acted on professional advice.
We argued strongly against both points to HMRC. In particular, we pointed out that HMRC naturally understood the written advice in a particular way because they already knew the correct answer to the question. The taxpayer (in their legitimate ignorance) did not have the benefit of knowing the answer to the question or they would not have asked the question in the first place.
We also argued that it was facetious for HMRC to say that the advice taken by the client’s wife could not be relied upon by the client as well. If we took that attitude the whole administration of tax will be ground to a bureaucratic halt if we can’t rely on advice for one situation to be true also for another identical situation.
HMRC then undertook their own detailed analysis of the rental income accounts. It is fair to say that HMRC took ‘detailed examination’ to new heights of examination even to the point of requiring a £35 adjustment of an invoice from one year to another.
Certificate of full disclosure
HMRC then asked the client to sign a ‘Certificate of full disclosure’ which made reference to ‘Tax offences’. This is an important document with legal consequences. In the ordinary use of English ‘tax offences’ are often considered to be tax evasion which is a serious criminal matter. Careless mistakes whilst obviously wrong are of a very different magnitude to intentional tax evasion. It seems inappropriate for any client who is guilty of a careless mistake to be labelled as a quasi-criminal. Our client works in the Financial Services sector and we therefore advised our client to sign the ‘Certificate of full disclosure’ with a caveat of denial of tax evasion. We also included a link in the disclosure to our own extensive work which showed not a shred of evidence inferring tax evasion by the client. HMRC accepted the amended disclosure.
Light at the end of the tunnel
Eventually the tax enquiry drew towards a close.
HMRC did finally agree to accept that the client had taken reasonable care regarding the rental income. This meant that an assessment to tax would be raised only on the previous four years of rental income. The earlier years dropping out of further assessment to tax altogether. It also meant that no penalties would be charged on any of the tax arising on the rental income over the previous for years (a not insignificant amount of penalties).
Penalties and request for suspension
HMRC then assessed the penalties on the tax arising from the client’s errors (other than errors arising despite taking reasonable care). We then made a request for the penalties to be suspended. Suspension of penalties does not often happen very often. To be successful, the client must demonstrate that they have put in place a SMART system that would ensure that the errors would not occur again. The appointment of an accountant as tax adviser is expressly considered as inadequate to meet the SMART test. We therefore created a SMART protocol to be followed to ensure that in future the client would submit his tax returns correctly. The protocol followed in detail the SMART principles set out by HMRC. After due consideration, HMRC accepted our proposal, and the penalties were suspended.
It is an obvious condition that when HMRC agree to suspension of penalties that the agreed SMART process is followed. Should it not be followed then the suspended penalties are reinstated and must be paid in full. In this case therefore the client will wish to ensure that the SMART protocol is followed to the letter.
The moral of this case is that careful completion of our tax returns is vitally important. Failure to exercise due care is likely to cause a tax enquiry to be opened which will often be very time-consuming and require detailed responses to HMRC to agree the best outcome. It is often stressful to the client. It can also lead, as it did here, to the tax enquiry being widened in scope and it brought the client’s wife’s tax affairs to HMRC’s attention. However, by fighting the client’s corner regarding the omitted rental income and avoiding all penalties completely, the client’s final tax bill was many thousands of pounds less than otherwise it would have been. Avoiding having a tax agent can be a false economy.
If you have a tax enquiry from HMRC with which you need some help, do give us a call at SME Strategies.
David Eaton Mobile – 07841 215182 Email – firstname.lastname@example.org