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KEY POINTS
- Dishonesty differentiates tax evasion from tax avoidance.
- The usual pattern of the opening interview.
- The follow-up report must be a detailed and complete document.
- Advisers who act dishonestly may be prosecuted by Revenue and Customs Prosecution Office.
The civil investigation of fraud has evolved over the last few years. It is fair to say that HMRC are more aggressive, equipped with more powers, and more proactive in this area than used to be the case.
HMRC are also increasingly blurring the distinction between civil and criminal. This article examines a few of the complexities and pitfalls involved.
Who investigates fraud?
Since the merger of Customs and the Inland Revenue in 2005, the Revenue Special Compliance Office (SCO) and the law enforcement investigation section of Customs have been combined into a new HMRC office, Special Civil Investigations (SCI).
The SCI now uses a new civil investigation of fraud (CIF) procedure. There are also teams of specially trained officers formed by HMRC in local and national compliance who will also use the new CIF procedure for smaller cases.
A new Code of Practice 9 has been written to reflect the new CIF procedure and applies to all investigations started after 1 September 2005. The most significant change is the removal of the underlying threat of prosecution which was an integral part of the old Hansard investigation carried out by SCO.
Where HMRC decide to investigate using the CIF procedure, the taxpayer will be told right at the outset that HMRC will not seek a prosecution for the tax fraud that is being investigated.
Consequently, SCI interviews are not held under caution and are not tape recorded as was previously the case with SCO interviews. There is also a single meeting under CIF to discuss both direct and indirect tax matters.
What is fraud?
This is sometimes a difficult question to answer as HMRC frequently refer to tax avoidance and tax evasion interchangeably. There is, however, a crucial distinction between the two. Tax evasion is unlawful and the essential key difference is dishonesty on the part of the taxpayer (and/or his adviser under certain circumstances).
The major offences are under VATA 1994, s 72 for VAT, which applies to anyone knowingly concerned in the fraudulent evasion of VAT by himself or another; and for direct taxes cheating the public revenue, a common law offence, and fraudulent evasion of income tax, a statutory offence under FA 2000, s 144.
Typical examples of fraud are submission of false accounts and/or omissions in a return and suppression of invoices.
Cases dealt with by SCI
Cases are either taken up for investigation directly by SCI or are submitted to SCI by local tax offices because there are prima facie indications of serious fraud.
Enquiry officers in tax offices are under strict instructions that as soon as serious fraud is suspected, the case must be referred to SCI immediately. There is no bottom line figure for the amount of tax that has to be at stake for SCI to look into the case.
However, in practice, it is unusual for SCI to be directly involved where the tax involved is less than £500,000.
The first indication that a taxpayer and his adviser will usually get that the case has been taken up for investigation by SCI is an invitation by letter to attend an interview. This will be accompanied by Code of Practice 9.
The taxpayer is free to attend the interview or not, but best advice should be that he does, because of the seriousness of the investigation and the background possibility that, if the taxpayer fails to co-operate, HMRC will consider a criminal prosecution.
The interview will follow a standard pattern with the investigator introducing himself and any colleagues. The investigator will outline the function of SCI in relation to investigating suspected tax fraud and will put certain formal questions relating both to direct and indirect taxes to the taxpayer. These questions ask:
- whether any transactions have been omitted or incorrectly recorded in the books of any business with which the taxpayer is concerned;
- whether accounts sent to HMRC are correct;
- whether tax returns of any business sent to HMRC are correct;
- whether the taxpayer's personal tax returns are correct; and
- whether the taxpayer will allow an examination of 'all business books, business and private bank statements and any other business and private records in order that HMRC may be satisfied that your answers… are correct'.
Normally the formal part of the opening interview is over once the above questions have been answered by the taxpayer. Assuming that the taxpayer has disclosed significant irregularities, matters can be brought to a conclusion on the basis that a report will be prepared by the adviser quantifying the irregularities.
A subsequent meeting will usually be held between the investigator and the adviser to sort out the nature and extent of the report to be prepared by the adviser and how long this should take. The investigator is also likely to ask for a payment on account of estimated tax lost.
Careful thought should also be given as to whether the adviser allows his client to answer any detailed questions at the preliminary interview.
Care should be taken that the client does not give answers of which he is not sure and which may need to be researched further.
The report
The report is of crucial importance. There is no standard format, but HMRC will expect to see certain items covered in detail. In particular, the report should cover the history of the business, how the irregularities arose and their extent, a summary of the steps taken to verify the amounts of irregularities, details of the assumptions made and a schedule of tax under-declared for each tax period.
In a tax investigation, many tax technical and general tax issues may also have to be considered. The report may range over, for example, under-declared sales and purchases and false invoices; the deductibility of provisions; whether an item or items are capital or revenue; add-backs for entertainment expenditure and the use of offshore companies and trusts as well as perhaps residency and domicile.
The report will have to contain detailed analyses of any business capital accounts or directors' loan accounts, as well as private bank accounts.
Once the report has been drawn up, it will need to be submitted to HMRC with:
- a certificate signed by the taxpayer adopting the report as the full disclosure;
- a statement of assets as at the closing date of the review period; and
- a statement of all bank and building society accounts operated in the period covered by the review.
It will then be examined thoroughly by HMRC and any assumptions made will be tested. Very few reports are accepted without further enquiry by HMRC and the investigator may wish to examine some or all of the supporting documentation used in compiling the report, for example bank and building society statements, documentation relating to purchases and sales, evidence of gifts, loans and legacies etc.
Penalties
HMRC will also be seeking, in addition to tax lost and interest, penalties. The new regime, introduced by FA 2007, applies to direct and indirect taxes for returns in respect of any period commencing on or after 1 April 2008 which are completed on or after 1 April 2009. Until then the old regime will apply.
There is not the space in this article to examine the old and new penalty regimes, but advisers must be clear which applies and then carefully consider and negotiate with HMRC in order to reduce penalties to the lowest extent. To this end, the adviser will wish to stress that the taxpayer has been co-operative (if applicable) and put any other mitigating factors to HMRC on his client's behalf.
Adviser beware
Drawing up a report is a time consuming and cost intensive matter. At all stages the adviser will need to weigh up the competing interests of his client and HMRC — his obligation to protect and serve the client's interest and the necessity of making full and frank disclosure to HMRC and the dangers if he does not.
The adviser must bear in mind at all times that the dishonest accountant or tax adviser is seen by HMRC as a 'centre of infection' and if it can be proved that the adviser has acted dishonestly, for example by withholding information relevant to the report from HMRC, the matter may be referred to the Revenue and Customs Prosecution Office for consideration of criminal proceedings.
The case of R v Cunningham, Charlton, Wheeler and Kitchen [1996] STC 1418 illustrates the criminal sanctions that can be imposed when a tax adviser does step over the line. This is a specialised area of work where the adviser needs to tread carefully.
Jonathan Levy is a partner with Berwin Leighton Paisner and can be contacted by telephone on 020 7760 4452, or email jonathan.levy@blplaw.com.
