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WHEN I FIRST saw the letters sent out by HMRC as part of their intervention pilots, words like 'misleading', 'erroneous' and 'inappropriate' were on the tip of my tongue. Then I thought again about what HMRC are trying to achieve with this pilot. The dictionary definition of the word 'pilot' includes 'a guide; acting as guide or control; trial serving to test the qualities or future possibilities of a machine'.
When I analysed the letters, I realised that the mistakes they contain served to highlight the pilot's limitations, and thus could be a way of identifying how interventions could be carried out more effectively and appropriately — exactly what, in fact, pilots are supposed to do. It could even be said that the glaring nature of some mistakes serves to illustrate perfectly what is wrong (and thus, what could be right) with this pilot exercise.
This article reviews a number of the technical issues included in the intervention letters, and considers the HMRC guidance to which recipients are referred. It concludes by asking how such interventions might be more appropriately carried out.
It does not deal with the background to the topic, describe the types of intervention, explain the process which preceded their launch or discuss whether clients should participate. These points have already been well covered in Taxation, most recently by Paul Berwick in 'Interventions on trial' (3 August 2006, page 496) and Mike Truman's 'Interventions Idiocy' (13 July 2006, page 395).
Repairs or improvements
The difference between a repair and an improvement is a question commonly asked of candidates sitting tax exams. It was therefore startling to see an intervention letter which said:
'In our experience [trade type] commonly make errors when they calculate claims for “repairs” entered on their self-assessment returns. Mistakes range from claiming for (a) private repairs to (b) improvements or replacements of premises and equipment.'
How is the unrepresented taxpayer to work out whether his 'repair' was, in fact, an improvement, claimable only when the property was sold? HMRC say:
'You can use the HMRC website to find out how to deal with these items correctly for tax purposes. You may find it useful to use the following site navigation: http://www.hmrc.gov.uk/manuals/bimmanual/BIM46900.htm and http://www.hmrc.gov.uk/manuals/bimmanual/BIM37000.htm.'
What happens when the taxpayer looks at this guidance? The latter reference is to the 'wholly and exclusively' section of the Business Income Manual, containing more than 100 separate and complex chapters; the former is to the index for 'Repairs and renewals', with 11 chapters.
Unless the individual has trained in taxation, it is very unlikely that he would be able to work his way through this material and go on to answer, in a technically correct manner, the question posed by the HMRC intervention letter.
Travel and subsistence
One of the intervention letters says:
'In our experience businesses within your industry commonly make errors when they calculate items which are not allowable for income tax purposes such as … travel and subsistence, particularly expenditure on meals and accommodation. You can use the HMRC website to find out how to deal with these items correctly for tax purposes. You may find it useful to use the following site navigation. http://www.hmrc.gov.uk/manuals/bimmanual/BIM37000.htm and http://www.hmrc.gov.uk/guidance/cwg2-chapter4.pdf ... Please check your records to make sure that you are confident that you are dealing with these issues correctly and return the enclosed reply slip back to me by [date].'
The first problem here is that business travel is an allowable deduction for employers, as is the associated subsistence. There is a serious risk that an individual receiving this letter might assume he had made a mistake — surely HMRC would not send out a letter stating that travel and subsistence are 'items which are not allowable for income tax purposes' unless this was true?
The second problem is with the guidance. Once again, the taxpayer is referred to the impenetrable index of the Business Income Manual. But the manual is unexpectedly supplemented by Chapter 4 of CWG2 (Employer Further Guide to PAYE and NICs). As Chapter 4 deals with 'Special types of employee', it is not surprising that it appears to contain nothing about travel — my computer search facility returned the message 'the find item was not found'.
The third issue is complexity. Even if the correct guidance had been included in the letter, the tax issues are not straightforward. Information on business travel for employees is contained within HMRC's Booklet IR490 (Employee travel: A tax and NICs guide for employers), but this runs to 89 pages of text; the index alone is five pages long. Furthermore, travel that is not allowable for employees could still be deductible in the income tax computation of the business, although it may be taxed on the individuals as a benefit.
Stock valuations
Several intervention letters raise questions about the stock valuation methodology of certain businesses which deal in second-hand goods:
'In our experience [people in your trade] commonly make errors when they calculate closing stock. Mistakes range from the values used to using an estimate, for example where sufficient records have not been maintained to be able to arrive at an accurate stock figure.' (My italics.)
However, the guidance to which the individual is referred by HMRC (BIM33110) says:
'Stock valuation can never be absolutely precise, with a number of practical considerations affecting the accuracy of the estimate.' (Again, my italics.)
The taxpayer who does not locate the guidance might assume, from the wording of the letter, that it is wrong to estimate stock values. Those who read paragraph BIM33110 will be left thoroughly confused as to whether using estimates in a stock valuation is technically correct or not.
Employee and director costs
HMRC have written to a sample of employees and directors as follows:
'In our experience employees/directors commonly make errors when they claim expenses by including private items such as:
- Home-to-office travel.
- Entertaining.
- Clothing.
- Food and drink.'
To the eagle-eyed professional tax adviser, the key word in this section of the letter is 'private' in the phrase 'private items', which precedes the bullet points. But the significance of this is likely to be missed by the unrepresented, who may believe that the letter is listing disallowable employee costs.
But as every tax adviser knows, entertaining is disallowed in the employer's corporation tax return, not in the hands of the individual employee. Employers who do not have dispensations for entertaining will include reimbursements on the employees' P11Ds; the individuals will then claim the entertaining as a deduction on their tax returns — and will be quite correct to do so.
Likewise, food and drink which is part of business travel away from home are allowable business expenses; so too are uniforms. How is the unrepresented taxpayer expected to realise this?
Furthermore, the questionnaire that is attached to this letter asks:
- 'Please provide me with a breakdown of the expenses claimed on your 2005 return, to show the amounts incurred for each type of expenditure, such as meals, travel and so on.
- 'How did you pay for the costs incurred, e.g. cash/cheque/credit card/other? If “other”, please detail.
- 'Have you retained receipts in support of all the expenditure claimed? If No, please indicate the amounts for which you have not retained receipts.'
The first of these questions reinforces the incorrect assumption that it is the nature of the item ('meals, travel and so on') which is the problem, rather than whether private expenditure has been misclassified as tax-deductible business expenses.
The second question asks about methods of payment — but this make no difference to whether an individual can claim tax relief for an expense.(I also spent a few idle moments speculating what 'other' methods of payment the taxman was worried about: a new generation of Cynthia Paynes, perhaps?)
Finally, receipts: most taxpayers will have submitted all receipts to their employer in order to obtain reimbursement of the costs incurred. However, the question implies that if they have not retained their receipts they cannot claim tax relief for the expense.
Again, there is a serious risk that unrepresented individuals will think they have made an error when they have not.
Round-sum turnover
It is no surprise that sending the taxman a round-sum turnover figure is likely to alert his suspicions. However, individuals who have done this are directed towards http://www.hmrc.gov.uk/pdfs/sabk4.htm to help them establish whether they have made an error.
Unfortunately, this reference takes the taxpayer to a lengthy booklet on self assessment. This is not easily navigated, and it is difficult to see how it would help an individual decide whether his turnover figure was problematic.
Guidance generally
The guidance referred to in the letters is presumably meant for unrepresented taxpayers, as professional advisers will already know where they can find information on tax complexities. But, as the examples above demonstrate, the guidance is too complex to be appropriate for this target group.
Furthermore, HMRC assume that the taxpayer has access to the web, and is sufficiently IT-literate to follow a complex series of links.
The following advice is taken from a letter to estate agents relating to VAT on outputs and how to link to information on this subject on the HMRC website:
'www.hmrc.gov.uk > Home > Quicklinks — Forms Leaflets & Booklets > Leaflets & Booklets Formerly Customs & Excise > Public Notices > Land and Property > scroll down to 741 > Para 4.1'
Tracking this down would be challenging for most of us. However, in the particular example given above, even if the links are followed with great care, the material proves elusive. The VAT Land and Property notice is number 742 (not 741) and paragraph 4.1 is about parking, not VAT on outputs.
Presumably, the correct reference is to paragraph 4.1 ('What is the place of supply of services relating to land?') in VAT notice 741, Place of supply services. Perhaps the letter author — thinking of estate agents — was sidetracked to notice 742.
The poor quality of guidance has been raised with HMRC by the CIOT, and HMRC have agreed to formulate more, and more detailed, help-sheets for those taxpayers involved in the pilot.
HMRC have declined to accept the advice and recommendation of the CIOT, which was that 'the pilot should be suspended and its key elements reviewed in consultation with the profession'.
Form P810
Form P810 has been 'borrowed' for this pilot — it is already widely used within HMRC to collect information about an individual's income. In my view this form could do with a thorough overhaul, but it would be unreasonable to expect this to have been undertaken by those running the pilot. However, an attempt could have been made to amend the text accompanying the form to make it more suitable for this exercise. Instead, recipients of the intervention letters are told:
'If you do not fill in the form, you may pay too much tax or not receive what is due to you.'
This is misleading in the context of a review which is seeking to discover, and then tax, missing income.
The P810 also includes the statement: 'we need you to fill in this form, so we can check if you paid the right amount of tax last year'. This sits oddly with the overall positioning of the pilot as a voluntary exercise.
Finally, the form sent out refers to income for 2005-06. The filing date for the 2005-06 returns is, of course, 31 January 2007; the majority of these returns have not yet been completed. As the purpose of the letters is to challenge income missing from returns, it seems likely that this form has been sent in error, and the one for 2004-05 should have been sent instead.
Scope of the pilot
On 10 July 2006, HMRC issued a press release stating that the intervention pilots would be:
'... lighter touch approaches to tax enquiries, particularly for those likely to make mistakes in relation to their tax, rather than those who are deliberately trying to pay less tax than is due.'
Some of the interventions go well beyond this light touch — most worrying, perhaps, is one relating to property purchases.
This reads as follows:
'Our records indicate that you recently purchased a property, but that your known taxable income may not have been sufficient to fund it … There are many ways to finance such an investment which do not depend on taxable income, but I would like you to look again at the purchase of the property and, having done so, complete the attached questionnaire and return it to me by [date].'
The questionnaire then asks:
'How did you fund the purchase of the property? For example:
- mortgage;
- proceeds from sale of previous property;
- existing savings.'
The questionnaire then continues,
'Having looked at the guidance, are you satisfied that the amount notified to HMRC as total taxable income is correct? If No:
- 'What sources of taxable income were we not aware of?
- 'What are the amounts involved?
- 'What periods are involved?'
This is a fundamental enquiry into missing income and a review of the individual's capital resources, and is well beyond the scope of a 'light touch' pilot.
Finally, the tone of the letter is likely to be regarded as insulting by at least some recipients. They may feel that they are being indirectly accused of funding their property purchase via the black economy, or through an illegal activity, such as drug dealing or theft.
Use of agents
Of course, many of the problems set out above are less serious for those with tax agents. But not everyone who gets these letters has a professional adviser. The unrepresented may try in vain to follow the guidance, and then call the HMRC helpline to ask whether they should pay a professional to help them. The relevant HMRC 'frequently asked question' (FAQ) runs as follows:
'Do I need to get an accountant to deal with this/do I need to involve my accountant?
'If at any time you feel you want to use an accountant, we will deal with them if that is what you would prefer. We do, however, expect that the area that we are looking at can be resolved easily without an accountant.' (My italics.)
Although this latter statement may possibly be true of a small number of intervention issues, such as the accidental omission of bank interest from a tax return, many of the letters cover complex and difficult issues, for which independent advice should be obtained.
Drawing conclusions
So, is there a silver lining? Can anything be gleaned from these intervention letters that could be of use when considering new HMRC compliance methodology? I believe there are three main learning points.
Clearly defined target
First, the tax issue targeted needs to be precisely defined. A good example is the 'rent-a-room' scheme letter, which focuses on specific mistakes such as 'the accommodation is not part of the landlord's only or main home' or 'the accommodation is let unfurnished'.
In contrast, a letter which says that people 'commonly make errors when they calculate the VAT rate which should be charged' leaves the recipient completely in the dark as to the nature of the problem.
It may be that HMRC do not have enough information to narrow down their questioning — perhaps all they can tell from their risk assessment is, for example, that the travel claims look high. But the next step should then be a questionnaire asking for an analysis of that travel — say between home and office; travel to clients' sites; travel related to client entertaining; non-business mileage and other. HMRC could also ask if there was any reason why the business had particularly high travel costs in that year. The results of this questionnaire would then allow HMRC to narrow down the targeted letter to a particular problem area.
Guidance
Secondly, appropriate guidance should be provided in the letter itself, with web references only as backup — and any such references should be to particular paragraphs and not to a broad index. Of course, this is easier to do with narrower, discrete items such as home-to-office travel.
Independent advice
Thirdly, the intervention letter should include a paragraph about independent advice, perhaps 'If you would like independent help, you can ask a friend, a professional adviser or an organisation like Citizens Advice to help you'. This sentence is already included in booklet COP26, What happens if you have paid too much tax credit.
The FAQ suggesting that professional advice is probably unnecessary should be withdrawn.
Other issues
This article has not commented on taxpayer appeal rights; interaction of these interventions with existing enquiry powers; the impact on tax credit claims; the interface with National Insurance payments and records; or what happens if prior years' returns are incorrect.
These important questions also need detailed consideration.
After this pilot
The intervention pilot has produced some useful learning points. But that does not mean that HMRC can jump from this exercise straight to draft legislation. The letters must be refocused into much more precise and targeted interventions; the issues listed in the previous paragraph must be considered, and the wider background questions should not be ignored. These include 'what is wrong, and what is right, with the current enquiry process?' and 'who should decide what powers HMRC need?'
In short, far more work is needed, and this pilot is only the end of the beginning. If HMRC do not allocate the necessary time and effort, there is a risk that their relationship with both taxpayers and advisers could run aground.
Anne Redston CTA (Fellow), FCA is Chair of Personal Taxes at the Chartered Institute of Taxation and a Visiting Professor in Law at King's College London. The views expressed in this article are her own.
Anne can be contacted by e-mail at: aredston@ciot.org.uk.
