Tax investigations: Why you need protection

Every year, Her Majesty's Revenue & Customs (HMRC) carries out enquiries into the tax affairs of an increasing number of individuals and businesses in the UK. Last year HMRC collected £34 billion from tax investigations and enquiries. Since then, there has been a surge in compliance cases opened by HMRC as it ramps up its tax investigation work. 316,000 checks had been opened in the year leading up to 31 June 2023 – up 30% from 247,000 in the previous 12 months.

What is a Tax Investigation?
A tax investigation is when HMRC decides to take a closer look at the tax affairs of a business or individual, to ensure that the correct amount of tax is being paid, both now and historically.

For a business, HMRC has the power to inspect documents and assets at a premises and can make unannounced visits and inspections, potentially going back to investigate matters up to 20 years ago if there is fraud.

For either a business or an individual taxpayer, enquiries often involve a detailed examination of a specific item on a tax return, whilst others may extend to a full review of the individual’s or business’s tax affairs.

HMRC could choose to focus in on one specific financial element in its investigation, examples include: VAT disputes, employment status disputes, Gift Aid inspections or IR35 status checks. Find the full list here.

So why have the number of investigations increased?
There are many reasons that the volume of investigations is surging. Of course, a major motivator for the government is to raise as much tax as it can to service the ballooning deficit. Despite revealing that in the 2022 year, HMRC brought in a record total of £788.8 billion in taxes, up by 10.2% on the previous year, with an overall national debt of £2.537 trillion as of March 2023, it’s hardly surprising to see efforts to claw money back intensify.

During the pandemic, HMRC took a noticeably more flexible approach with a much lower level of enquiry activities, but clearly, the hiatus is over. Its focus has also been influenced by the impact of COVID-19. For example, in respect of the furlough scheme, HMRC estimate as many as 10% of furlough claims were fraudulent and even more will contain errors. Although most of the furlough claimants will not have abused the scheme in any way, some innocent errors will have been made. As always, it will not only be the fraudulent cases that are selected for review.

Another driver of investigations is that the reach of HMRC’s ‘Connect’ database is ever-growing – obtaining more sources of information all the time and now containing over 55 billion data items. HMRC is currently engaging 24 full-time staff and investing £37 million requiring Airbnb, eBay and Uber to provide information on taxpayers using those platforms and generating income to add a further level of data to their knowledge of taxpayers.

This increasing volume of data is giving HMRC the intel it needs to carry out increasing numbers of investigations – it’s a self-fulfilling process.

Who do tax investigations effect?
There is a common misconception that clients will only experience a tax investigation if they have done something wrong, but this is not the case. Most tax enquiries are generated by computer ‘risk profiling’ and in many cases that profiling may sweep up innocent taxpayers, but HMRC’s questions still need to be answered whether the taxpayer is innocent or not.

There does not need to be a reason for HMRC to check a client's tax affairs and any taxpayer who submits a tax return can be picked for investigation any time.

Why is it important to engage a professional?
Many people find an HMRC enquiry disruptive, stressful and ultimately expensive. But it can also be complex and confusing, which is where the guidance and reassurance that a professional can provide becomes invaluable.

What’s more, without the guidance of a professional, individuals and business owners can find themselves in a position where they are supplying more information to HMRC than is necessary. Legally, HMRC can only ask for what is ‘reasonably required’ to check a tax return. Therefore, if it is checking a company's corporation tax return for example, it cannot ask for the director's personal bank statements.

In addition, there have been instances where HMRC has tried to increase the scope of an enquiry beyond its legal limits. Such as asking for information that is outside the control of the taxpayer (which it is not entitled to) or raising an inquiry for a particular period but asking for information related to other periods. It’s therefore crucial to seek the guidance of a professional who can ensure that HMRC is doing its job correctly and is not going on a fishing expedition.

Under HMRC’s ‘Litigation and Settlement Strategy’ HMRC is also required to explain the particular risks that it is seeking to ‘cover off’ in its enquiries. For example, simply saying that it is checking a tax return because a company has claimed R&D relief is not communicating the risk that it’s trying to cover off. Instead, HMRC should perhaps be explaining that the risk is that the company has claimed R&D relief and HMRC believe that some of the costs relating to staff on which the relief has been claimed, were furloughed at the time.

By identifying those risks, a professional can help clients to potentially head off the enquiry in the first instance, for example by letting HMRC know that they have never furloughed any staff and that HMRC’s data is flawed, saving a lot of time and expense on both sides.

What is a Tax Investigation Service?
At Monahans, our Tax Investigation Service is backed by an insurance policy we have taken out in our own name with Professional Fee Protection (PFP) and protects our clients who suffer a tax enquiry. For a small annual fee, clients can join our Service and if they experience an HMRC investigation, our professional fees will be covered. Essentially, it protects clients from unexpected costs.

Every client hopes that the protection will not be necessary, but paying the small annual service fee is a small price to pay considering a tax investigation is often a drawn out and protracted process, that can amount to thousands of pounds in accountancy fees – the average cost of an investigation is £3,100, and over 30% of investigations end with no additional tax falling due.

Joining our Tax Investigation Service provides peace of mind – not only does the service pay our professional fees in the event of a check on tax affairs, but it also enables us to provide expert advice and guidance to clients every step of the way.

If you would like further information or have any questions, read our tax investigations information pack here or contact one of our team today.

Dominic Bourquin