Taxing times

Taxing times

Key points

What is the issue?

The access to unprecedented levels of information about taxpayers by worldwide tax authorities.

What does it mean for me?

It is important to understand clients’ finances and how to rectify tax irregularities before the tax authority finds them.

What can I take away?

How to recognise and deal with an intelligence‑based tax investigation.

 

Tax authorities around the world have access to significant amounts of data on taxpayers’ financial affairs and regularly use that data to make an assessment of the level of tax they would expect that taxpayer to be contributing. Where there is a mismatch between the tax returns filed by the taxpayer, the data the tax authority holds and the taxpayer’s lifestyle, a tax audit or investigation will often follow.

Tax authorities around the world are coming together to pool their data and pursue taxpayers across international borders. The data to which these authorities have access comes from a surprising number of sources.

OECD

The OECD responded to a G20 request to develop a Common Reporting Standard calling on jurisdictions around the world to obtain and automatically share information on taxpayers from their financial institutions on an annual basis.

This automatic exchange of information has greatly enhanced the information tax authorities hold on taxpayers. In the UK, Her Majesty’s Revenue and Customs (HMRC) regularly issues what have become known as ‘nudge letters’, whereby UK‑resident taxpayers are informed via letter that HMRC holds information that may suggest their tax filings are inaccurate. The taxpayer is then invited to sign and return a ‘certificate of tax position’ either declaring that their affairs are in order or that they will make a disclosure of tax irregularities to HMRC.

Domestic data collection

Aside from the international pool of potential information, tax authorities will also rely on their domestic data collection processes.

Connect

In the UK, HMRC has developed an all‑encompassing data‑gathering software tool called Connect. This software draws in data from a wide number of sources, including the Land Registry, the Department for Work and Pensions, the Driver and Vehicle Licensing Agency, Border Force, banks and insurance companies, the internet, newspapers and reported legal cases.

This vast amount of data is then cross‑matched with all the data held on the taxpayer to identify patterns and connections to find anomalies in the taxpayer’s declared level of income or capital gains, their claim to non‑UK residence and so on.

Information notices

To supplement the data collection under the Connect software, HMRC also has the power to require the taxpayer or third parties to provide it with data under an information notice. These are described by HMRC in its information notice factsheet CC/FS2 as ‘a document that legally requires a person to give us certain information and/or documents to allow us to check their own or another person’s tax position’.

The information requested must be provided, usually within 30 days, unless it can be appealed on the basis that the information is not in the power or possession of the person who is asked to provide it or it is not reasonably required to check the taxpayer’s position.

Failure to comply with a properly issued information notice allows HMRC to issue an initial GBP300 penalty followed by potential penalties of GBP60 per day for continued non‑compliance. Ultimately, HMRC can ask the tax tribunal to order a tax‑geared penalty for persistent non‑compliance and these penalties can be significant. Recently a taxpayer by the name of Sukhdev Mattu was ordered to pay a non‑compliance penalty of GBP350,000 by the Upper Tier Tax Tribunal for a continued failure to comply with an information notice.

International Consortium of Investigative Journalists

Outside of the formal information‑gathering machinery, HMRC may look more widely to gather intelligence. The International Consortium of Investigative Journalists (ICIJ) conducted what it described on its website as a ‘massive cross‑border investigation’ that resulted in what became known as the Panama Papers. It was essentially a giant leak of more than 11.5 million financial and legal records.

This was followed by the more recent Pandora Papers leak, which involved more than 600 journalists from 150 news outlets and unearthed the offshore dealings of 35 current and former public officials and politicians around the world. The papers, the ICIJ claims, have revealed the hidden owners of offshore companies, secret bank accounts, private jets, yachts, mansions and artworks.

Tax authorities around the world, like everyone else, have access to this information and could potentially refer to it or use it as a basis for questioning in a tax investigation.

Regularising your client’s tax affairs

Given the large amounts of data that tax authorities hold on taxpayers, it is always better for a taxpayer with tax irregularities to approach the tax authority before it approaches the taxpayer. Many, if not most, jurisdictions around the world have some form of tax disclosure facility whereby taxpayers who know they have incomplete or incorrect tax filings are afforded the opportunity to approach the tax authority and correct it. The inducement to do so for the taxpayer is usually lower penalties.

In the UK, HMRC offers a digital disclosure service whereby the taxpayer, or more likely their tax agent, will register an intention to make a disclosure and will then be given 90 days to submit the full disclosure to HMRC and pay the tax, interest and penalties.

The extent of any disclosure is driven by the taxpayer’s behaviour and HMRC’s assessment time limits. Generally, where a taxpayer has taken reasonable care but their tax affairs are inaccurate, HMRC is limited to looking back only four years. That is extended to six years where the taxpayer has been careless and 20 years where there has been deliberate fault (the latter two behaviours are for HMRC to prove). Where HMRC has not been told about a source of income or gains (i.e., a failure to notify) the assessment time limit is always 20 years.

The first step with any disclosure to HMRC is to work out the assessment time limit and shape the disclosure accordingly.

Where an advisor suspects a client has deliberately evaded tax (or a client has admitted to doing so), the approach to the tax authority needs to be carefully considered. Using HMRC’s digital disclosure service may not be the most appropriate approach in this case because HMRC will retain the right to prosecute the taxpayer in the criminal courts. In circumstances where a taxpayer has deliberately evaded tax and wants to approach HMRC to regularise their affairs, or where HMRC has written to the taxpayer suspecting serious tax fraud under Code of Practice 9, consideration should be given to using HMRC’s Contractual Disclosure Facility (CDF). If admitted into the CDF, the taxpayer will be required to regularise all of their tax affairs as a result of both their deliberate and non‑deliberate behaviour. If they do that, HMRC undertakes not to prosecute the taxpayer for their deliberate evasion. Where matters have been concluded under the CDF and the taxpayer is subsequently found to have misled or lied to HMRC, it will almost certainly prosecute the taxpayer.

Where a taxpayer has tax irregularities that the tax advisor is aware of, it is incumbent upon the advisor to advise the taxpayer to approach the tax authority and make a voluntary disclosure. It is then critical to approach the tax authority in the most appropriate manner. In the UK, that would mean looking at the taxpayer behaviour, the assessment time limits and the correct disclosure facility to use. Choosing the wrong disclosure facility could have catastrophic consequences for the taxpayer. For example, a disclosure where the most appropriate facility is the CDF may result in a client’s prosecution if a different digital disclosure service is chosen.

Going forward

It is clear that tax authorities around the world have access to more data and will almost certainly know more about your client than you do. The data reach of tax authorities globally is wider now than it has ever been, and the cooperation between governments in automatically exchanging information on their tax residents is unprecedented. That international cooperation is firmly supplemented by national data‑gathering, such as HMRC’s Connect software and information notices. Outside of the formal data‑collection techniques are the data leaks such as the ICIJ’s Panama and Pandora papers.

A taxpayer with incorrect or incomplete tax filings will need to be guided very carefully on how to regularise their tax affairs by approaching the tax authority first. Where the tax authority approaches the taxpayer first, penalties will always be higher and there is the possibility of a criminal prosecution. Choosing the most appropriate disclosure facility is vital to securing the best outcome for the client. Where tax dispute resolution and disclosures are not your main area of practice, consider using an expert in this field.