Everything You Need To Know About HMRC Investigations
What do investigations entail and what are the common errors you should avoid?
As landlords, we hear a lot about tax, because, frankly, it’s a large and unavoidable elephant in the rental room. However, what’s rarely mentioned is what happens when it all goes wrong – which sadly, it does occasionally!
Whether a blip in your records, some poor bookkeeping, or a bit of ‘creative accounting’ coming back to bite you, you can guarantee one thing…. a mistake submitted to HMRC – whether intentional or not – will always come back to find you.
So, if you think you might have made an error or are worried about making one, what steps do need to take? We caught up with Chartered Accountant and Chartered Tax Adviser, and Mashroom Show regular, Richard Cunningham, who is going to help us calculate the best way forward.
Could I be investigated by HMRC?
The main topic we’re going to explore is tax enquiries, and understanding how to preferably prevent, prepare for and pay up! But before we get too concerned about this, is there any real risk for a small landlord? HMRC surely has bigger fish to fry – they’re not going to be launching an investigation on every landlord who may make the odd hiccup?
‘When HMRC come knocking, they come knocking. They say right, you’ve claimed that you are earning ‘x’ amount, and we want to just double check that you have an index,’ explained Richard.
‘They want to make sure that you haven’t been trying to fiddle the books, or ‘x’ that should have been on your tax return, and it wasn’t.’
Ok, so ultimately, it really could happen to anyone! But what we’re going to look at today is relevant whether you have one property or a portfolio of 100 properties! How can you prepare for an investigation?
‘I suppose the first thing to say is it can’t happen at random. But they tend to approach this on assessment of risk. And they get data from various sources so it can be banks, land registry, DVLA, that kind of thing,’ said Richard.
‘They will look at what’s on the tax return and they’ll look at the information that they hold. And if it doesn’t match, then that’s when they’ll raise an inquiry.’
Worth remembering then that even if you think you have been smart with hiding assets to minimise tax liability, nothing is invisible. Being upfront and honest is the only way to avoid risking an inquiry!
Common landlord tax mistakes
With visibility of bank accounts, land registry and even the DVLA, it’s clear that huge amounts of ownership and financial data is available to HMRC. It’s easy to see how people slip up and make mistakes that cost them big.
What are the most common mistakes that lead to enquiries being triggered?
‘Loan interest claims’, said Richard. ‘If you go back five to six years ago, a landlord could claim 100% relief for interest on their mortgages. Now, you can only effectively get basic rate relief, but there are still people out there that will claim the full relief, so that will trigger an inquiry.
QUOTE: Also capital expenditure versus revenue expenditure. People claiming capital against income. For example, you may put a conservatory on the back of your buy-to-let, which would be a capital spend. Build an extension on to the back of the buy-to-let, that’s capital spend, and you will get tax relief for those. But when you’ve come to sell a property, you can’t offset that against your rental income for the year.
‘Other mistakes that are really common are late filing of returns. Tax returns need to be filed by the 31st of January. So, if you file late, you’re going to get £100 fine after three months, then it’s £10 a day for 90 days. After six months you’ll get another £300 fine or 5% of your tax, whichever is higher. And after 12 months, another £300 fine or 5% of your tax.
Ouch, those costs would really rack up. So, whatever you do, get that date in your diary (although I’m sure everyone already has that set in stone)!
‘You’ve also got to pay interest for late payments. That’s another common one. You’re also going to be paying 5% of the tax due after 30 days, another 5% after five months, another 5% after 11 months’, said Richard.
‘Up until recently, people were fairly laid back in terms of paying their tax when you looked at the interest that was being charged, but obviously interest rates have gone up significantly. People are paying 1% and you could swallow that, but now the rate is 6-7%, and all of a sudden that’s dramatic. It’s getting more expensive!’
Ok, so we understand the issues, what steps can we take to ensure we don’t get caught in a tax trap? None of us are going to try and fox HMRC on purpose, but is there anything we can do to make sure we don’t do it unwittingly!?
‘Wherever you’re claiming, declaring income or claiming deductions for an expense, you need to keep a record of what that expense was,’ stressed Richard. ‘So, a copy of an invoice is the most common, but it’s fine electronically. There’s a lot of common mistakes that people can make and sometimes those mistakes will be genuine error and sometimes deliberate.’
‘You can keep them electronically, and I know that Mashroom have some quite good tools for helping landlords maintain their records.’
‘You need to keep records for five years after your filing deadline. For your 2021/22 tax year your filing deadline is the 31st of January 2023. So, you’re talking about January the 28th. That’s normally where people fall down if they don’t keep their records.
‘HMRC do carry out checks into records with your business. If they’re not adequate. You can be hit with a £500 fine if you repeatedly don’t maintain good records and be able to find them up.’
Being able to find records for everything coming out of your business is one thing, but HMRC are just as interested in incorrect reporting of everything that’s coming in.
Another massive red flag that could trigger an investigation is a concern about undeclared income. How often do HMRC look into it if someone were to be a little light on reporting rental income?
‘It’s quite a significant number of investigations,’ warned Richard. ‘I think people need to be aware that HMRC have access to information about land registry. It’s not hugely difficult for them to work out when somebody has a property and doesn’t declare an income.’
‘All they need to do is go into the land registry, find the person and what properties that they’ve got, and check it against the tax return. It’s very easy to identify that gap so they are actively doing quite a bit of it.
And what would be the outcome if they were to find out that there was undeclared income on an account?
‘Obviously, you’re going to have to pay your tax straight away and you’re going to have to pay your interest, but you’re also looking at penalties. And they have a penalty levy which is largely based on taxpayer behaviour.’
So, failing to declare income correctly is a pricey error. Of course, there’s always going to be the odd chancer who tries their luck, but aren’t most errors accidental, down to user error rather than trying to play the system? If this is the case, are you given any leeway?
‘If you’ve been careless, (but spot the error yourself) you’re looking at 10% to 30% of the tax that was due as a penalty’, explained Richard. ‘If it’s prompted by the revenue coming along and saying ‘what’s this?’ and you say ‘sorry, it’s a careless error’ then it’s the lower end, at 15% or 30%.’
‘You’re then getting into deliberate and unprompted. So, for deliberate but unprompted, it’s 20%, prompted it’s 35-70%.’
‘Deliberate and conceal, which is the really naughty end of the scale, you’re talking anything up to a 100% of the tax payable’, warned Richard. ‘I think the employer pays a penalty on top of the tax. So, you will effectively pay double.’
‘I think the important thing to note here is this deliberate behaviour. The onus is on HMRC to demonstrate deliberate behaviour, which can be quite difficult. Where it’s a genuine error, and it’s a ‘first offence’ you’re looking right down at the bottom of that scale. Obviously, for repeat offenders with deliberate behaviour, you’re heading up the other end, although you can appeal these, if you have what they deem a reasonable excuse. They do have the ability to not levy a penalty or even suspend the penalty. But reasonable excuses are fairly few and far between – you’re talking about physical illness or mental illness, that kind of thing where you can clearly demonstrate that you were incapacitated, something like that. That’s a reasonable excuse. Not knowing that that was the law is not a reasonable excuse.’
Don’t bury your head in the sand
Looking at the fines, if you have the slightest inkling that you may have under-declared, being upfront and admitting to HMRC that you think you have made an error is the most sensible option, unprompted disclosure is cheaper, if nothing else!
‘Hold your hands up, come clean,’ agreed Richard. ‘HMRC has what’s called a ‘Let Property’ campaign. Revenue often go through a campaign, on plumbers or something like that, for twelve months and say ‘Look, you’ve got an opportunity to come forward, declare undeclared income, and we’ll go easy on you’. The Let Property campaign has been running for a number of years now and remains open and it’s an opportunity for landlords to come forward and be comfortable that the revenue isn’t going to prosecute them.’
‘With these kinds of campaigns, the more open you are, the more helpful you are with the whole process, the less likely you are to be hit with a significant penalty.’