The Start of an Enquiry

We outline the first steps HMRC must take when they launch an enquiry

HMRC must start an enquiry by giving notice to the taxpayer of its intention to do so (TMA 1970, ss 9A(1), 12AC(1); FA 1998, Sch 18, para 24). The notice must normally be given by the first anniversary of the date on which the return was filed. However, HMRC’s enquiry window may be extended if the return was filed late, or was amended.

There is no right of appeal against such a notice. If there is something wrong with it, such as being given out of time, it is not a valid notice. The best option is to discuss matters with the HMRC officer responsible or his manager.

Should this fail, the only practical way to establish whether or not it is valid is in the course of an appeal later in the enquiry process, such as an appeal against an information notice, or an appeal against an HMRC amendment to the return, because if the original enquiry notice is not valid it will invalidate the entire enquiry process. A judicial review is unlikely to be a viable option. However, an error in an enquiry notice will not necessarily result in the enquiry being invalid.

For example, in Mabbutt v Revenue and Customs [2017] UKUT 289 (TCC), the First-tier Tribunal ([2016] UKFTT 306 (TC)) held that an enquiry notice which incorrectly referred to a tax return for the year ended 6 April 2009 was not a valid notice of enquiry into the appellant’s tax return for the year ended 5 April 2009 (following an appeal against HMRC’s later closure notice), and that the notice was not ‘saved’ by TMA 1970, s 114 (‘Want of form or errors not to invalidate assessments, etc’). HMRC was out of time to issue a new, correct tax return enquiry notice, or to raise a discovery assessment outside the normal tax return enquiry window. However, the Upper Tribunal allowed HMRC’s subsequent appeal, concluding (among other things) that the mistaken reference to the ‘year ended 6 April 2009’ did not, in the circumstances, render the enquiry notice invalid.

The formal enquiry notice is normally accompanied by a letter asking for the information that the HMRC officer requires for the purpose of the enquiry. Officers are encouraged to ask up front for everything they are likely to require, although they can, and often do, of course, ask for further information at any time during the course of the enquiry.

The letter will normally give a time limit within which the officer expects the information to be supplied. This is normally a minimum of 30 days.

Please note: This opening letter is not part of the statutory enquiry process. Accordingly, the time limit is not a statutory one: it is a figure plucked out of the air by the officer. No penalty or other statutory sanctions arise if this time limit is not met.

The officer’s only recourse is either to chase for a reply or to issue a formal notice under FA 2008, Sch 36 for the information.

It is obviously courteous to tell the officer as early as possible if his target date cannot be met, and often this will achieve further time if reasons are properly advanced. However, there is no need to panic if the time limit is overlooked or, although the taxpayer or his agent aims to comply with it, he does not manage to do so.

Similarly, the HMRC officer is not entitled to compel the provision of information in response to the opening letter. He will need to use the information powers contained in FA 2008, Sch 36. Accordingly, in reality in his opening letter the officer is requesting the taxpayer to volunteer information, and indeed this will normally be the appropriate response.

That is not to say that the taxpayer should not volunteer to do so but instead insist on the use of the formal information powers. It is pointless to waste time on a statutory procedure when it is clear that at the end of that procedure the information is statutorily required to be provided. It will also clearly irritate the officer, which may well influence his approach to doubtful issues that arise during the enquiry, and any penalty position.

However, it is sensible to consider each item of information requested by the officer in the context of the information powers. If it is clear that the item can be reasonably required under those provisions, then it should be provided. If it is not clear, the taxpayer or his agent ought to consider whether he believes it to be in his best interest to provide it.

For example, a trial balance prepared by the taxpayer’s agent is unlikely to be within Sch 36, as in most cases it is likely to belong to the agent and therefore will not be within the taxpayer’s power to provide it. Nevertheless, it is difficult to conceive of a reason not to volunteer it. Without it the officer will be forced to ask far more questions than he otherwise would have done and may make incorrect assumptions that needlessly prolong the enquiry and thus increase its cost.

Where it is decided to volunteer information, it is sensible to make the point to HMRC that the taxpayer or agent does not believe that it falls within Sch 36, but that the taxpayer has agreed nevertheless to provide it. This indicates co-operation and helpfulness.

If the taxpayer or agent does not believe that the information requested falls within Sch 36 and he chooses not to volunteer it, there is nothing to prevent his declining to provide it. It is sensible to do so politely, such as telling the officer that its relevance to the tax return is not readily apparent and asking why he believes it to be relevant.

Each enquiry obviously depends on its individual facts. It is accordingly not possible to list what may or may not fall within FA 2008, Sch 36, para 1. Information that belongs to third parties, such as the taxpayer’s spouse or children, or to his agent, clearly does not fall within these provisions (but might fall within FA 2008, Sch 36, para 2).

Consideration should generally be given to challenging requests for certain types of information, such as the following:

• An analysis of drawings or of a proprietor’s capital account or a director’s loan account.
• There are things that do not impact on the quantification of profit. They relate to how the profit is spent and how funds to finance the business are raised. Normally, neither of these things has any relevance to the enquiry into the tax return, which is a return of income. HMRC often argues that if drawings are minimal that may be an indication that income has been diverted from the business. However, that is far too wide a generalisation. The proprietor’s or director’s spouse may be generating the income to meet living expenses; parents may be helping to support an adult child whose business acumen is such that he cannot generate adequate income; a person may be living off borrowings such as a bank overdraft or may be realising past savings or using an inheritance to supplement his living expenses. It is hard to see a justification for HMRC to pry into a taxpayer’s private life on the off chance that he may be diverting income from his business. Many taxpayers strongly resent such an intrusion and it does not seem right to ask them to submit to it merely to seek to prove the negative that income has not been diverted. Where a business does not handle cash at all but receives all of its income by cheque, diversion is clearly improbable, as banks do not allow a cheque made out to one person to be banked in the account of another, but that fact does not seem to deter HMRC requests for analyses of drawings or loan accounts. Furthermore, even if such information is volunteered, this may not necessarily satisfy HMRC, and it may go on to raise further questions on the information provided because the officer is searching for the possibility, no matter how remote, of some other theoretical source of undisclosed income.
• Personal bank statements of a sole trader or partnership where he keeps his personal finances separate from those of his business, or personal bank statements of a director of a company Again, these have nothing to do with the tax return under enquiry and have probably been requested on the off chance that something in them may suggest diverted takings. In this connection it needs to be appreciated that if such bank statements are volunteered the officer will often take the stance that, as it is for the taxpayer to disprove an assessment, he intends to assess every single receipt in the personal bank account as diverted business income and leave it to the taxpayer to prove that it is not. Very few people can identify – and evidence – the source of small payments into their bank accounts two years earlier. In most cases, these are things like refunds from utilities or from mail order or online retailers for goods that are no longer available, receipts from friends for their share of a restaurant bill, premium bond or online gambling winnings, insurance claims, and cheques as birthday or wedding presents and similar day-to-day personal receipts. It is, of course, highly improbable that if a person were to divert money from his business he would divert (say) £8.46 or some other tiny sum, so the likelihood of such an item in a person’s personal bank account representing diverted income is inherently improbable. However, such an improbability does not seem to deter most HMRC officers from making the allegation which, in appropriate cases, should be firmly resisted. Sometimes an HMRC officer will put forward a non-business reason for needing to see personal bank statements. In such cases, it is worth considering whether there is an alternative means to do what the officer says that he is trying to do.

Example:private bank statements and dividends

In the course of an enquiry into an individual’s tax return, the enquiring HMRC officer stated that he needed to see the taxpayer’s personal bank statements, to check the receipt of dividends from quoted companies, and to check the amount of bank interest earned.

However, the taxpayer’s agent submitted to the HMRC officer the dividend counterfoils that his client had retained. It was pointed out that they provided far better evidence of the dividends than the bank statements, particularly as the receipt of a dividend warrant is a receipt of income even if the warrant is not banked or is banked in a later year.

In the case of interest, most banks give a figure of interest for the year as a note on the first bank statement after 5 April, or provide a certificate of interest paid. Thus that one document or statement, rather than all of the statements for the tax year, will evidence that figure. A letter from the bank might be an alternative source of evidence.

The provision of such alternative evidence does not prevent HMRC from claiming that in the particular circumstances of the case the personal bank statements come within FA 2008, Sch 36, but it is likely to make it difficult for HMRC to convince an appeal tribunal that the information is ‘reasonably required’ for that purpose when it already holds better evidence of the item that it has said that it wishes to check.

It goes without saying that entirely separate accounts should be maintained for business and personal transactions, and that great care should be taken to ensure that such transactions remain separate. Failure to do so may leave the taxpayer open to an HMRC information notice requiring private bank statements to be produced, on the basis that they constitute statutory records. There is no right of appeal against an information notice requiring the production of a document that forms part of the taxpayer’s statutory records (FA 2008, Sch 36, para 29); for example, see Beckwith v Revenue and Customs Comrs [2012] UKFTT 181 (TC).

• Appointment diaries: Most people do not keep their business and personal life separate. Appointment diaries therefore invariably contain personal data for which the taxpayer is entitled to privacy. Furthermore, the author’s diary is not necessarily an accurate historical record. It is merely a reminder of future engagements. If a client does not turn up for an appointment it does not get crossed out of the diary. If a client phones for an urgent appointment in a couple of hours’ time, it will probably not get put in the diary. Some of the appointments are of meetings that the author will attend if he has time, but not if he is too busy at the time, and those that are missed may well not be crossed out. The diary is therefore a wholly inappropriate tool as a basis for HMRC to assume that every item in it should have generated a fee and, if it does not, to assume that income has been diverted. Electronic diaries tend to delete past entries on a monthly basis. Clearly, whether a diary is kept manually or electronically can have no bearing on the accuracy of a business’s accounts. If accounts can be assumed to be reliable if the diary is electronic and does not retain past data, they ought to be assumed to be equally reliable if the diary is kept in a different manner. In Long v Revenue and Customs Comrs [2014] UKFTT 199 (TC), the First-tier Tribunal held that a doctor’s appointment diaries did not need to be produced to HMRC, The diaries contained clinical and personal details, but no financial information whatsoever, and the information included in them did not enable a calculation of income to be made from the patients identified in them. It was therefore impossible for the tribunal to hold that the business appointment diaries were ‘reasonably required’ in order to check the taxpayer’s position.
• An accountant’s working papers: These may be the property of the accountant and if so not in the possession or power of the client to obtain. However, see 16.193 as to the possibility of information notices requiring accountants to provide information or produce documents such as working papers.
• A statement of a director’s or proprietor’s personal assets and liabilities: Such a statement has no bearing on the tax return of a company or on the profits of an unincorporated business. Even where the individual has non-business income it is hard to see how a statement of assets can say anything about his income.
• Joint bank account: This is altogether much more difficult. Whereas the joint account holder is entitled to privacy and it may be unclear whether or not the bank statements of such an account are in the possession or power of the taxpayer, it is quite likely to be the case.
• Income of spouses or children: These are not normally in the possession or power of the taxpayer. They may be if the child is a minor and the taxpayer is the child’s guardian, but this is unclear.
• Assets not producing taxable income or gains: Investments such as premium bonds or National Savings certificates which do not produce taxable income or capital gains will not feature in tax returns.
• Assets held by the taxpayer as a trustee: It is not clear whether these are in a taxpayer’s possession or power in relation to his personal affairs. In the case of information or documents held by third-party trustees, HMRC may argue that a settlor has the power to influence and require the trustees to comply with lawful and reasonable requests, such that the information or documents are considered to be in the settlor’s possession or power (H A Patel & K Patel (a partnership) v Revenue and Customs Comrs [2014] UKFTT 167 (TC)).
• Overseas assets and income of a non-UK domiciled taxpayer where there have been no remittances of the income generated by such assets: It is hard to see how these can have any relevance to his UK tax return.

It does, however, need to be borne in mind that whether or not something is relevant depends on the circumstances. Although the above items are rarely relevant when an officer opens an enquiry, if during the course of the enquiry it were to become apparent that the business accounts are unreliable and the only satisfactory way to arrive at the taxable profits is to reconstruct what probably happened from some other source, then it clearly becomes relevant to look at whether one of the above sources provides an appropriate means to do this. However, this becomes the case only when the accounts are unreliable – what HMRC used to call ‘breaking the accounts’.

A handful of small errors or a few small unexplained items do not necessarily suggest that the accounts are unreliable as a basis for measuring the profits for the year.

This extract was taken from the HMRC Investigations Handbook 2017/18, edited by Mark McLaughlin and published by Bloomsbury Professional