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I WAS CHATTING to an accountant friend of mine the other day about enquiry work. The accountant (let's call him John Smith) was lamenting how the approach of tax inspectors had changed over the years. He gave an example of how an old, experienced local Inspector of Taxes would pick up the phone to ring him. 'Now then John' he would say, 'What are we going to do about (such and such a case)? Shall we try to sort it out?' After some discussion about any areas of disagreement, the Inspector would often play his part in an amicable, negotiated settlement, usually involving a degree of concession on both sides. There was generally a sense of mutual respect (or at least tolerance!), and the conversation was often less than formal.
I never thought that I would find myself reminiscing about tax investigations! But times have changed. Rather, the approach of HMRC to enquiry work has changed, or so it seems, and not for the better in my opinion. The sentiments of my accountant friend of an apparent hardening in HMRC's approach to enquiry work have been reinforced by other professionals in recent months, including investigation specialists. One specialist opined that HMRC's attitude had become very aggressive, that they seemed to want maximum yield and penalties in every case, and that Inspectors were generally unwilling to listen to reasoned argument. Another chartered tax adviser colleague of mine expressed the view that HMRC's approach had become confrontational, to the point where a change of career was seriously being contemplated!
There has been no official announcement by HMRC of any change of policy or approach in enquiry cases. Nor indeed are they obliged to notify any, particularly if disclosure is not considered to be in their best interests. However, if there has been a lack of communication in this regard, where does that leave future relationships between HMRC and the tax profession? In Richard Curtis' comment article 'Crossroads' (Taxation, 27 July 2006, page 451), some concern was expressed about the future of the Working Together initiative. Richard's article formed the basis for a discussion at a Working Together meeting in Manchester recently.
Playing by the book
The apparent change of HMRC approach in enquiry cases was raised. An HMRC representative at the meeting confirmed that Inspectors were applying the law in accordance with published guidance in the Revenue manuals. This was part of a Government drive to increase tax yield. Applying a 'more from less' approach, HMRC are now being more assiduous in the imposition of penalties. The starting point in the consideration of penalties and abatement will be leaflet IR160 and the HMRC Enquiry Manual. No doubt HMRC will state that this has always been the case. However, practice has differed from the 'official line' over the years in my experience.
Professional advisers at the Working Together meeting were informed that incumbent HMRC Officers are being trained according to published guidance, and instructed to adhere to it. The policy and approach of HMRC to conduct enquiries 'by the book' presumably signals the end of the pragmatic approach previously adopted by the Inspector and my accountant friend at the beginning of this article. It is perhaps unfortunate if HMRC Officers now have less scope to exercise their discretion in enquiry cases than before.
Fine-toothed comb
For example, enquiries into owner-managed companies may result in additions to profits, with a corresponding adjustment to the director's loan account. The loan account may become overdrawn as a result. Three tax charges may therefore arise in respect of the same adjustment (leaving aside any National Insurance issues), i.e. a corporation tax charge on additional profits, a charge on loans to participators (TA 1988, s 419) and an employment income tax charge on the resulting beneficial loan (ITEPA 2003,
s 175). When dealing with negotiated settlements to enquiries in the past, HMRC Officers may hitherto have been persuaded to adopt a 'two out of three' approach, e.g. to pursue the corporation tax and section 419 liability, but not income tax on the beneficial loan.
Those readers who are unfamiliar with this approach need not be unduly concerned, because HMRC will no doubt deny that it ever existed! And of course they would be strictly correct, as there was never any statutory basis for it. HMRC's official line is stated in the Enquiry Manual at paragraph 8610. Recent experience suggests that all three taxes will be routinely applied in the future. Nevertheless, there is anecdotal evidence and practical knowledge of a more flexible approach by HMRC Officers in the past on this issue. Many readers will no doubt have their own experience of agreeing various concessions in enquiry cases, in the 'give and take' of a negotiated settlement. Sadly, those days seem to have gone. As new HMRC Officers are recruited and others retire, past practices may well be forgotten, as Inspectors take a 'fine-toothed comb' approach.
Lost on penalties
In addition, it seems likely that the HMRC Enquiry Manual will feature more prominently in future enquiry work, particularly where penalties are in point. Professional advisers will need to become conversant with the section of the HMRC Enquiry Manual dealing with the calculation of penalties and abatement factors (EM6051 and subsequent paragraphs). Many advisers will need to change their mindsets about the level of penalty that they realistically expect to secure for their clients at the end of most enquiry cases, based on their past experiences. Times have changed and so, it would seem, has HMRC's approach to penalty yield.
This leads me to another point. Professional advisers may also need to lower their clients' expectations in future enquiry cases as to the likely outcome, particularly in respect of penalties. For example, as pointed out in the article 'Decided on Penalties' (Taxation, 23 March 2006, page 635), penalties for technical adjustments are more likely to be applied these days than in years gone by. As one enquiry specialist pointed out in the Working Together meeting, a client subjected to two separate enquiries a few years apart where a similar offence is discovered may be surprised by the difference in outcomes. The need to manage client expectations is therefore one reason why it would be helpful for advisers to communicate any changes of HMRC approach.
Fighting back
The firmer approach by HMRC to enquiry work may not be official, or common knowledge. However, it has apparently not been lost on some advisers. HMRC reported at the Working Together meeting in Manchester that there has been a 'hardening of attitudes' from some advisers of late. Examples given include a higher number of appeals against information notices, and an increasing tendency to refuse requests by HMRC Officers for meetings.
This may be an unexpected and unwelcome development from HMRC's perspective, but should perhaps not come as too much of a surprise. Advisers will wish to maintain their relationships with clients. Most clients will not react too well if their agents do not 'fight their corner'. In addition, it could be argued that the legislation as it relates to enquiries is stacked in HMRC's favour, and that some degree of balance is overdue. For example, readers will be generally aware that if there is a significant delay by an individual taxpayer (or agent) in responding to a request for information, HMRC may issue a notice under TMA 1970, s 19A. This process is underpinned by penalties for non-compliance (s 97A). However, what legislative redress is open to taxpayers in the case of delays by HMRC? A formal complaint to HMRC could be considered under Code of Practice 1, or perhaps a letter to the Adjudicator or the Ombudsman. However, those forms of redress for taxpayers are hardly comparable to HMRC's powers, even before any enhancements that may follow the consultation on 'Modernising powers, deterrents and safeguards'. Besides, the natural reaction to aggressive behaviour is to respond in a like manner.
There have been a number of instances of late in which communications by HMRC have been less than ideal, to put it mildly (see 'Carry on consulting' by Francesca Lagerberg in Taxation, 14 September 2006, page 647). However, the willingness of HMRC representatives at Working Together in Manchester to discuss tax advisers' concerns about their approach in enquiry cases was both heartening and a welcome step in the right direction. It also offers some hope for the future of initiatives such as Working Together and the new HMRC 'Tax Advisers Unit' as mentioned in Richard Curtis' article. However, given that these lines of communication between both sides are already in place, one hopes that HMRC will use them in future when changes of policy or practice directly affecting tax advisers or their clients are being considered.
Bleak future?
In the meantime, I predict that enquiries will become increasingly protracted and adversarial while HMRC's new approach continues; and the days of constructive discussions over the telephone with the 'friendly' local Inspector to resolve enquiries will become a dim and distant memory.
Mark McLaughlin CTA (Fellow), ATT, TEP, is a tax consultant, general editor of TaxationWeb and a member of the Working Together Committee for the Manchester area. He can be contacted by e-mail: tax@markmclaughlin.co.uk.
