HMRC Powers – too many or not enough?

This article was originally published in Taxation magazine on 11 January 2022.

The taxes collected by HMRC run the UK and, as such, it is essential that the right amounts are collected. To this end, HMRC has a myriad of powers to review returns and check taxes have been correctly calculated and paid. For civil cases, these powers include the ability to:

● open and close enquiries;

● request information and documentation;

● inspect business premises; and

● raise assessments for up to 20 years.

Most people will agree, the powers are not ‘bad’, but the way they are used affects how they and HMRC are perceived. Unfortunately, many tax investigations practitioners will have experienced HMRC applying its powers incorrectly or even abusing them.

HMRC’s most recent review of its powers Evaluation of HMRC’s implementation of powers, obligations and safeguards introduced since 2012 was published in 2021 (tinyurl.com/ hmrcevfeb21)and these were discussed by the House of Lords – see ‘Check on powers’ (Taxation, 29 April 2021, page 8).

While undertaking the review, HMRC was applying for further powers to obtain information directly from financial institutions – now part of FA 2008, Sch 36. Thus the impression given was that irrespective of the outcome of the review, HMRC would want (and be given) more powers. The question we should have been asking however is: how are the powers being used? And are more powers necessary, or is there another way to achieve the same end?

In the course of enquiry work, HMRC needs to request information to verify the tax calculations. The information powers legislation contained in FA 2008, Sch 36 is drafted broadly but even so, we see HMRC requesting information that is not reasonably required to check the individual’s – or their business’s – tax position. There are also cases where an officer makes an informal request for information – without quoting Sch 36 – directly to the taxpayer, who provides the information even though there is no requirement for it to verify the tax position in question.

We have also come across a situation where a property valuation was transferred to the Valuation Office Agency (VOA), with the case officer stating that they would have no further part in the discussions until the value of the property had been agreed between the taxpayer and the VOA. Later, the VOA officer wrote to the taxpayer’s surveyors asking for additional information including bank statements, as ‘instructed by HMRC’. So in this case, was the inspector using their ‘HMRC credentials’ to request additional information through the VOA, knowing that had they requested it directly, it may have been refused? Luckily, the surveyors contacted us to ask how to respond – as they had never before received this type of request.

The point here is that HMRC can be seen to be abusing its powers, not only requesting information, which may not otherwise need to be given, but giving assurances of independence and then contravening them.

Legal interpretation

For the past few years, HMRC has been pushing a narrative of ‘anyone who completes a tax return incorrectly is deliberately depriving the general public of essential services’ in order to further its own agenda. Increasingly the department uses the phrase ‘tax avoidance and evasion’ in various marketing and other initiatives, with avoidance and evasion being grouped together. Speaking to the man on the street, it is common to see that individuals do not understand the difference between avoidance and evasion (let alone ‘aggressive tax avoidance’) and HMRC is partly to blame for propagating the idea that they are one and the same.

Further highlighting this is HMRC’s interpretation of the ‘tax gap’. HMRC says: ‘The tax gap is the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid.’ The causes of the tax gap, other than taxpayers making errors on their returns is stated as ‘legal interpretation, evasion, avoidance and criminal attacks on the tax system’ as per the most recent tax gap estimates for 2019-20. Technically, tax avoidance is legal (let’s not go into ‘morality’ just now) and tax legally avoided should not be paid to HMRC. Therefore it should not form part of the tax gap. However, lumping avoidance and evasion together and saying that they both contribute to a tax loss is misleading at best.

‘Legal interpretation’ is the tax due should taxpayers interpret the legislation differently from HMRC. If there is any disparity, then until the interpretation has been defined by the courts, I would argue the tax gap as a result of legal interpretation should not exist. After all, if HMRC loses at the tribunal, the tax gap disappears – Schrodinger’s tax if you will.

Since Ramsay, and as tax avoidance schemes have been brought more into the public domain and in front of tribunals, there has been a growing sense that legislation should be interpreted ‘purposively’. This means looking not only at what the legislation says or what it means but also what the government ‘meant to say’ when preparing the legislation.

Arguably if the government has a particular perspective when preparing the legislation, it should put it in legislation – that is what tax law is for after all. Alternatively, it would be helpful to have a clear documentation of the discussions surrounding the legislation when preparing it; Hansard is sometimes so filled with arguments that it can be difficult to identify what the point of the legislation actually is.

An interesting discussion can be had for example around the interpretation of ‘commerciality’ in the transfer of assets abroad legislation. This allows a transfer of assets overseas without adverse tax consequence if there is a ‘commercial motive’ for the transaction. In a capitalist society, the maximisation of profits available to distribute to shareholders is not only acceptable but required if a business wishes to survive.

Minimising taxes goes hand in hand with that approach – arguably tax mitigation is a commercial motive. In the same vein, businesses are unlikely to evade taxes not just because of the level of risk, but also the potential downside should the business be caught. The risk of directors being sent to jail, significant financial penalties and also reputational damage all play a part in just how much risk a business is willing to take.

The inherent uncertainty added to the tax legislation by putting morality into the mix erodes taxpayers’ trust in tax authorities. It becomes ‘us against them’ and, since HMRC appears to hold all the cards – being legislation requester, possible drafter, and implementer, the will to work with HMRC instead of against, is weakened.

Another example of the confusion caused by uncertainty is the requirement to notify HMRC of uncertain tax treatment, where uncertainty is defined as an interpretation ‘that is not in accordance with the way in which it is known that HMRC would interpret or apply the law’ (Finance (No 2) Bill 2021-22, Sch 15 para 10(3)). Just because an interpretation differs from HMRC’s, does not mean it is incorrect unless and until proven in court.

Finance (No 2) Bill 2021-22, Sch 15 para 4 states: ‘HMRC’s position on a matter is taken to be “known” by a company or partnership if it is apparent from (a) guidance, statements or other material of HMRC that is of general application and in the public domain.’

Given that HMRC has previously stated in court that its guidance cannot be relied on because it is simply HMRC’s interpretation and may not be a correct analysis of the legislation, it will be interesting to see whether this legislation can be used to support taxpayers’ position in other areas.

In relation to interpretation of legislation and implementation of tax avoidance schemes, we refer to a recent decision by the Solicitors Regulation Authority (SRA), which penalised conveyancers for implementing stamp duty land tax avoidance schemes. The SRA said ‘The firm and solicitor placed “undue reliance” on counsel’s advice’ and that ‘it recognised that [the conveyancers’] misconduct “did not involve dishonesty, lack of integrity or ulterior motivation”.’ If lawyers can implement tax avoidance schemes based on a particular interpretation of legislation without being dishonest or lacking integrity, it is difficult to understand why HMRC is penalising lay taxpayers for relying on counsel’s opinion.

Guilty until proven innocent?

A perception of HMRC long inferred but never really addressed is this idea that tax inspectors believe their ‘customers’ are ‘guilty until proven innocent’. Recently, a couple of cases have been brought to the tribunal, which address this point directly.

Kong’s Restaurant

In Kong’s Restaurant Ltd (TC8169), HMRC made two unannounced visits to the taxpayer on Friday 27 January 2017 and on Friday 30 June 2017. After further correspondence in which various till receipts and other information on the restaurant’s suppliers was provided, HMRC raised VAT and corporation tax assessments on the basis of the figures recorded on those dates. The taxpayer subsequently argued that the assessments had not been made to the best of HMRC’s judgment.

During the investigation, the officers had raised concerns about the number of ‘void’ and ‘cancelled’ transactions on the tills as well as querying ‘dual deliveries’ from suppliers, where one invoice was made out to the restaurant and the other was made out to ‘cash…’. The taxpayer confirmed that the cancelled and void transactions were due to staff errors and that the ‘cash…’ invoices were in respect of purchases made on behalf of staff members or the local community of up to 40 people.

In relation to the till errors, the tribunal stated it did ‘not consider the level of voids and cancellations, without more, to provide any material evidence of irregularities which would support HMRC’s view that there had been long term systematic suppression of takings’. In respect of the additional invoices, the tribunal did not accept that this ‘fully’ explained the cash invoices. It pointed out: ‘There is clearly sufficient here to make the objective reader suspicious, and to require further investigation. But none was carried out, as HMRC considered this to be mere corroboration of the clear view they had formed.’

The tribunal was damning in its discussion of how the case had been handled, making comments such as ‘HMRC simply assumed the worst and sought subsequently to justify that approach’ and referring several times to HMRC’s ‘assumption’ and its ‘arbitrariness’, saying ‘we find that assumption to be unreasonable on the evidence before us’. On considering how the correct level of tax might be quantified based on HMRC’s assessments, the tribunal stated that given the ‘inadequate basis of HMRC’s calculations and the paucity of other relevant evidence before us, we can see no way in which we could approach that task sensibly’. “Staff should be trained not only in technical tax matters, but also how to deal with taxpayers as individuals.”

In our view, the officer had been trained to assume the worst, rather than to take an objective view of the evidence before them, resulting in the taxpayer being forced to incur significant professional fees to defend tax assessments based on flawed assumptions. It is incredible that the case managers had allowed the case to go this far and the assessments to be raised without asking further questions.

BJ Trading Ltd

In BJ Trading Ltd (TC8150), the taxpayer was a Northern Irish company with suppliers of second-hand clothing based in the Republic of Ireland and customers in Africa. Payments were received piecemeal due to the customers’ limited access to GBP, but once the orders had been confirmed and there were enough goods to fill a shipping container, the products were sent to Africa. If BJ Trading arranged the shipping, it would use a shipping agent. In other cases, the customer would arrange shipping using its own agent. The majority of communications between BJ Trading Ltd and its customers was by phone as few customers had access to computers (but all had mobile phones). Further, there were no written contracts for the supply of goods.

When HMRC visited the premises, it was advised on the way the business worked and still ‘required further evidence of shipment, namely copies of the customs declarations, contracts, insurance and evidence of communication with customers’. HMRC subsequently raised assessments on the basis that the available documentation was insufficient to permit BJ Trading a VAT deduction and other VAT treatments.

In considering whether HMRC exercised its discretion, the tribunal noted that ‘failure to do so and to consider the alternative evidence renders the decision flawed.’ In relation to the availability of zero rating, the tribunal said: ‘The assessments were made in disregard of the evidence and are not therefore best judgment assessments’ and referred to the ‘normal method of trading in used clothing in…Africa. Albeit it may not be the standard model used in the EU.’ The tribunal went on to say: ‘The estimated assessments should be set aside because they were unreasonable and/or capricious or motivated by hostility and prejudice.’

Officers upholding the law should be objective and their prejudices and preconceptions should not affect their duties. According to the tribunal, ‘it should not be inferred or implied that that the trade involves avoidance or evasion just because the business model is different’. The fact that these two cases were even brought to tribunal without further questions from upper management at HMRC demonstrates an inherent belief that the way these investigations were carried out was correct. Worryingly for the taxpayer, it can be implied that upper echelons of HMRC are happy for ‘guilty until proven innocent’ to be the rule by which inspectors approach taxpayers and the situation becomes all the more fraught. Little wonder that most taxpayers find the idea of tax incredibly stressful.

I reiterate my belief that it is not the individuals who are to blame – I have dealt with inspectors who are fair and commercial – but the system they work within is flawed. The emphasis on yield rather than payment of correct taxes and penalising taxpayers instead of educating them makes taxpayers less likely to want to interact and co-operate with HMRC.

Many officers who have worked at HMRC for almost the entirety of their careers have little understanding of the working practices of different countries. Indeed, the tribunal in BJ Trading said: ‘[The officer] had no experience of the conduct of business in West Africa. His experience involved working as tax specialist handling the affairs of small taxpayers. [The officer] was unable to accept the business model involving oral contracts and the provision of payments based upon trust [and] brought this prejudice to his approach to assessing the evidence.’ There is an implied belief that if an individual is dealing with countries that do not have the same practices, they must be evading tax.

There are no ‘grey areas’ as far HMRC is concerned and providing more powers instead of better training propagates this approach. The legislation allows for use of HMRC’s ‘best judgment’ when raising assessments but the system the inspectors work within appears to discourage it in favour of higher tax yields.

Staff should be trained not only in technical tax matters, but also how to deal with taxpayers as individuals. Every taxpayer is in a different situation, whether it is dealing with a different country and culture or whether it is having different capacities to deal with illness – physical and mental, their own or their family’s. With adequate training and a greater acceptance of use of initiative, I believe HMRC can build a better rapport with tax advisers and their clients even in (civil) fraud investigations cases.

Erosion of taxpayer safeguards

The reduction of safeguards for taxpayers indirectly contributes to HMRC’s powers and directly increases the perception of the department being omnipotent when it comes to tax affairs. Since the loan charge, we have seen more retro-action in HMRC’s arsenal.

When HMRC becomes aware through losses at tribunal that its interpretation of tax legislation is incorrect, it changes the legislation with retrospective effect. This has the dual effect of preventing people with open enquiries having their day in court with respect to the legislation in force at the time the potential tax loss arose and also without any recourse to claiming back costs sunk in legal fees.

Examples include the legislation on:

● TMA 1970, s 8 notices and penalties issued by computers – any open appeals against automated penalties or appeals on the basis that notices to file were invalid because they were automated are now moot; and

● HMRC’s new policy that the high income child benefit charge is (and has now always been) assessable as income (unless the taxpayer appealed HMRC’s assessment on or before 30 June 2021; see tinyurl.com/2p8ceavv). This will be legislated for in the next Finance Bill.

Taxpayers are fine with the law changing prospectively. If the legislation can be changed retrospectively at any time, then reliance on the law is reduced and this is a very slippery slope.

Further, the government has legislated for financial institution notices, which means HMRC can request information from various financial institutions in relation to taxpayers without advising the taxpayers and without permission from tribunal. The House of Lords criticised this measure in respect of the policy principles as ‘poorly targeted, disproportionate in their effect on UK taxpayers and lacking necessary safeguards and rights of appeal’. HMRC ignored the feedback from its consultation and also the notes from the House of Lords, reinforcing the idea that HMRC is a law unto itself and its ‘customers’ have little to no say.

HMRC needs powers to penalise those who evade tax, but there is widespread concern across the tax community that the powers implemented in respect of the few are being used against the many.

A recent report found that the perception of small business owners is that HMRC ‘is “taking an increasingly aggressive line” in chasing overdue tax’. Meanwhile HMRC asserts that it ‘is taking an understanding and supportive approach to dealing with those who have tax debts, and wants to work with businesses to find the best possible solution’.

A disparity is to be expected, the concern is the level of the difference in perception of how HMRC are behaving. Another common complaint I hear is that ‘HMRC just does not understand how real life works’. As mentioned earlier, some tax inspectors have spent their entire careers at HMRC and do not have practical experience of the ‘outside world’. It is a pleasant surprise to come across those with commercial knowledge because then cases become easier to resolve.

HMRC’s research has found that ‘fear caused participants to develop highly inefficient processes which took up unnecessary amounts of time’. The research also noted that ‘participants generally viewed HMRC as a punitive organisation more likely to issue penalties than provide support, with correspondence often felt to adopt a threatening tone’ and recommends that HMRC should ‘act more supportively … hand-hold through changes… [and] speak the customer’s language’.

It will be interesting to see if and how these recommendations are implemented.

Does HMRC need more powers?

Unsurprisingly, my answer to this question is ‘no’ – because of the way the current powers are being used. I would suggest better training for the enquiry staff in the first instance.

The people at the top of HMRC management and the Treasury also need to be selected independently of the government – for example, the financial secretary to the Treasury should not be an MP as well. HMRC can then request powers and if independent of government, the lens through which these requests are made may be more objective.

In HMRC’s consultation on ‘raising standards in the tax advice market’ it was disappointing that HMRC does not seek to apply these standards to itself – several clients have complained that HMRC’s website is littered with suggestions to obtain independent advice as HMRC’s guidance cannot be relied on. If a taxpayer cannot rely on advice from the tax authority (see ‘Up the garden path?’, Taxation, 4 July 2019, page 8) how can HMRC say the standards in the tax advisory market are lax?

If taxpayers could rely on HMRC, in particular those on a budget, their finances would not limit the quality of the advice. If we look at those caught by the loan charge, many individuals say they spoke to HMRC which told them the arrangements were not subject to the disclosure of tax avoidance schemes regime. Raising standards of advice given by HMRC would greatly reduce the tax lost as a result of taxpayers being duped into using schemes. I would respectfully suggest that before accusing tax advisers of poor quality work, HMRC should perhaps consider the quality of customer service it provides.

Overall, taxpayers need to have more certainty in relation to the tax system and the way they are treated by HMRC. It is difficult for advisers to say to clients that any planning done now could be useless if retroactive laws are implemented in ten years’ time.

The irony is that most taxpayers feel unfairly treated one way or another, so I suppose that’s fair…

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