Keeping the details of new or existing income sources from HMRC is not wise. It’s tax evasion, is illegal and those that HMRC catch risk ending up paying not just the tax they should have done, but substantial additional costs in interest and penalties too. This is where former Conservative Party chairman Nadhim Zahawi came a cropper. And in very serious cases it could land an individual in jail – as jockey Lester Piggott discovered in 1987 after a conviction for failing to declare income of around £3m.

Missing tax

Each year, HMRC estimates the difference between what it thinks it should collect in tax and what it actually manages to collect. Called the ‘tax gap’, the latest estimates for 2020-21 put this figure at £32bn.

According to Helen Thornley, a technical officer at the Association of Taxation Technicians, the gap comprises different factors, from fraud to differences between HMRC and taxpayers on how each think that the law operates. Within that figure, she says: “An estimated £1.1bn of lost tax is believed to be due to ‘ghosts’ – people entirely outside the tax system. A further £900m is estimated as lost due to ‘moonlighters’ – those who have not fully declared all their income sources.”

Beyond those numbers Margaret Curran, a technical officer at the Chartered Institute of Taxation, says that more than £9bn relates to “taxpayers not getting things right through what HMRC categorises as error or a failure to take reasonable care” – a function of complexity in the tax system. To this she adds nearly £5bn linked to criminal activity.

It’s clear, then, that as Thornley says, “one of HMRC’s jobs is to try and catch up with both types of these miscreant taxpayers”.

Compliance 

To ensure taxpayer observance, HMRC carries out a wide range of compliance activities. In figures that Thornley cites, during 2021-22 HMRC launched 265,000 investigations and yielded an extra £30.8bn in tax. “These figures,” says Thornley, “were lower than usual due to Covid, which restricted HMRC’s abilities to carry out as much compliance work as it would like to as staff were redirected to other roles.” However, she warns staff are now back in post.

She explains that in general, HMRC has 12 months from the date that a tax return is submitted to open an enquiry – called a compliance check – into that return.

But what should worry taxpayers, reckons Thornley, is that during the Autumn Statement last November (2022), the chancellor reiterated the government’s desire to crack down on fraud and error, with “the promise of a package of measures designed to collect a further £1.7bn by tackling tax avoidance, evasion, and wider non-compliance over the next five years”.

What does HMRC know? 

Although most are aware that HMRC can carry out enquiries into their tax affairs, the risk of being the subject of a random enquiry is perceived as low. However, HMRC has access to an enormous amount of information that allows it to make many more targeted enquiries where what a taxpayer has declared doesn’t fit with the information that HMRC has.

In short, Thornley tells how HMRC either automatically receives, or has the ability to request, information from third parties including banks and building societies, financial institutions, letting agents and online cryptoasset exchanges as well as other government bodies such as HM Land Registry, Companies House and the DWP. It can also request data about sales or income from popular online marketplaces such as Airbnb, eBay and Etsy. 

And as she comments, “because of information exchange agreements with other countries, HMRC also automatically receives information from banks and building societies about overseas accounts held by UK residents”. From her standpoint, this can help HMRC to spot undeclared wealth held overseas. 

But with regard to overseas data, Curran remarks that its use by HMRC should come with a “health warning”: that it is difficult for the body to interpret it correctly. As an example, she says: “Discrepancies in the data received from overseas tax authorities may exist due to it often relating to a calendar year, thereby crossing over two UK tax years, which makes it difficult to match it with the figure reported on UK tax returns.”

Beyond that Curran says that matching problems may also exist due to how or where figures have been reported on UK tax returns. This may occur where a total or global figure was included in boxes on the tax return, not a breakdown of that figure. Additionally, income may have been put on the tax return as one type, say interest, but reported to HMRC by the overseas tax authority under automatic exchange as something else, possibly dividends.

Curran’s point is that HMRC may wrongly interpret the data it has about individuals so it should always be checked; at the end of the day, it is the taxpayer’s responsibility to make sure their tax affairs are correct, complete and up to date.

The world of online has society in a stranglehold. While it’s loved and vilified in equal measure, Curran says that with its powers and means, online “has certainly provided HMRC with a wealth of information about taxpayers which it can use in its compliance activities... you just can’t assume HMRC is ignorant of anything these days”.

But apart from raw data, HMRC also gets information directly from whistleblowers, including unhappy business partners, spurned ex-spouses/partners, disgruntled employees and envious neighbours.

However, as Thornley cautions, data is only part of HMRC’s compliance approach. In fact, without proper analysis it’s meaningless and HMRC cannot identify areas of risk. She points out that “since 2010 HMRC has had access to powerful data analysis software called Connect which helps to match information from multiple sources to taxpayers and identify patterns or anomalies which need to be investigated.”

It should be said that just as HMRC is upping its game in terms of data sourcing and analysis, so are firms in hiding revenue. One such example is termed electronic sales suppression (ESS), and Curran details that HMRC is taking steps to counter this threat to the public purse. A consultation on the subject, ‘Electronic sales suppression: a call for evidence’, ran from December 2018 to March 2019. In response, the government said that it is “using this evidence base to explore the issue further and develop more effective policy options for tackling ESS, in conjunction with other measures to tackle non-compliant activity”.

One-to-many ‘nudge’ letters 

So, using information obtained from automatic data exchanges and with the help of Connect it means that instead of a specific, tailored enquiry into an individual, HMRC often now starts by issuing a standard letter to a number of individuals or businesses which have been identified as potentially under-declaring tax. In Thornley’s view, “these ‘one-to-many’ letters act as a cue for taxpayers to review their tax affairs and take appropriate action.”

As for recent examples of HMRC’s targeted activity, Thornley gives two.

By using data from Companies House records, HMRC was able to identify changes in the ‘person of significant control’ (PSC) for a number of companies. PSCs are, broadly, individuals who own at least 25% of the company’s share capital. Where Companies House records for 2020/21 showed someone had ceased to be a PSC but there was no evidence of a share disposal on their tax return, HMRC wrote to ask if they had disposed of shares and needed to report any capital gains tax.

And using data from cryptoasset exchanges, HMRC was able to identify around 8,000 individuals who were transacting in cryptoassets but had not reported any cryptoasset transactions on their tax return.

Not everyone who receives a one-to-many letter will necessarily have under-declared tax – there could be other factors such as available reliefs, or expenses which mean there is no tax to pay. However, Thornley states that “individuals in this position should not just ignore these letters as generally income must be reported and reliefs/expenses claimed officially via a tax return”. She continues: “It is important to read the letter carefully to see what action is needed and to take appropriate professional advice on how to respond as HMRC will normally want taxpayers to confirm that they consider their tax position is correct. If no action is taken, or HMRC does not accept the response given, then HMRC may move on to open a formal enquiry.”

Indeed, Curran says the same and advises taxpayers to “tell the truth and co-operate with HMRC and seek appropriate advice if they think they need it. If HMRC decides to open a specific compliance check into a taxpayer’s affairs, you can look at HMRC’s Tax compliance checks guidance on gov.uk and on YouTube which explain what’s involved”.

Can a timely response lead to an investigation being closed quickly? Not necessarily in Curran’s opinion as that “will depend on what the investigation is about, how complex it is, and also how quickly HMRC can deal with the correspondence”. She reminds that some areas of tax are very specialised, so “it may be appropriate to seek advice from a tax adviser who specialises in that particular area”. While CIOT and ATT have online directories to help those looking for tax advice, Curran says that those on a very low income can seek help from organisations such as the charity TaxAid.

Curran emphasises that HMRC doesn’t have the right to demand anything, but it does have broad formal powers to obtain information from taxpayers and third parties if it thinks it’ll assist the investigation: “There are safeguards in place, though. For example, HMRC can ask for information but only if it is ‘reasonably required’ for checking a tax position; a taxpayer can challenge that if they don’t think the information is ‘reasonably required’.”

Some describe nudge letters as “scare tactics”. However Curran says that “it depends on the letter. Generally the purpose is to educate people about their obligations and get them to comply”. Interestingly, in recent years she has seen HMRC work on the tone and content of the letters to make them less threatening and to make it clearer why they’re being sent and what taxpayers should do next.

Coming clean 

Ultimately, if a taxpayer knows that they have undeclared income, Thornley reiterates the advice to seek professional advice and get in touch with HMRC to declare and pay the tax as soon as possible. She details that penalties are calculated as a percentage of the underpaid tax - potential lost revenue (PLR) – and can be anything from zero to 100% or over 100% for offshore income or gains. “Penalties,” she says, “will be lower where the taxpayer voluntarily comes forward to HMRC, and if the taxpayer is cooperative. Taxpayers are scored on how much they ‘tell, help and give’ to HMRC during the enquiry. The highest penalties are therefore reserved for uncooperative taxpayers who had sought to conceal their income.”

Curran expands the point noting that there are also penalties of fixed amounts such as £100 for filing a self-assessment tax return late. But of those based on a percentage, she says that there will be no penalty if the error was made ‘despite the taxpayer taking reasonable care’, an ‘innocent’ mistake if you like. Not quite the line that Nadhim Zahawi took with HMRC.

Careless or deliberate errors will, says Curran, attract a penalty. “For careless errors the penalty is 30% of the ‘PLR’. For deliberate but not concealed errors, the penalty is 70% of the PLR. And for deliberate and concealed errors the penalty is 100% of the PLR.” 

She adds that the penalty will be reduced to reflect the quality of the disclosure – that is ‘telling’, ‘helping’ and ‘giving access’ – and the amount of the reduction will depend on whether the disclosure is ‘prompted’ or ‘unprompted’, that is, whether the taxpayer came forward voluntarily or HMRC asked first.

Another consideration is the need to look back. Thornley states that where income has been under declared as a result of an innocent error then, broadly, any returns for tax years (or periods of account for companies) ending no more than four years ago will need to be corrected. This can be extended to six years if the understatement was careless, and up to 20 years if the understatement was deliberate.

She caveats her point: “It is important to check that undisclosed income doesn’t have a wider impact; there may also be tax consequences over more than one tax – for example, a business which has not declared all of their sales will not only have paid insufficient income tax or corporation tax, but they could also have under-declared VAT – or missed that they should have registered for VAT.”

In summary 

Once a taxpayer knows or suspects that they have under-declared tax, they should act quickly to correct their position with HMRC. In the long run, this will be the most cost effective, and least stressful approach. With so much data on individuals and businesses, it’s only a matter of time before it finds missing tax.

HMRC isn’t going away and so ignoring tax obligations or the authority isn’t an option.