HMRC will increase the number of enquiries into whether or not adequate tax has been paid. We examine many business tax areas that may be the subject of an HMRC investigation. Whereas HMRC traditionally focused on bigger organizations, the increased need to recover cash may result in an increase in HMRC enquiries into smaller private enterprises that may have been neglected earlier. The following are considered hotspots:
Disposal of Business Assets
HMRC appears to be reviewing Business Assets Disposal Relief (Entrepreneurs’ Relief) requests more thoroughly and more often than in the past. According to tax observers, these enquiries do not appear to be directed at specific customers, but rather at acquiring proof that the applicable requirements for Business Assets Disposition Relief (Entrepreneurs’ Relief) have been satisfied.
In certain situations, such inquiries may have overlooked information included in the return’s extra information box. However, given the present economic context, it would be unsurprising if HMRC expanded the scope of its investigations in order to crack down on relief, particularly when the claim is for a transaction above the £1 million lifetime limit. Additionally, it is probable that the number of non-statutory certifications verifying that the company qualifies as a ‘trading company’ for the purposes of Business Assets Disposal Relief would decline – whether as part of disposal or a winding up.
HMRC has previously tightened its standards in this area – on determining whether banned activities are substantial (enough to exclude an individual from Business Assets Disposal Relief) and on determining whether cash-rich businesses are actually trading. Due to the likelihood that inquiries will continue, it is critical to adequately document trading activity, accounts, and the reasons for maintaining substantial cash amounts.
Acceptable justifications for cash balance retention include growth plans or intentions to buy land for the trade. What can happen is that proof of such preparations is lost, making it more difficult to convince HMRC that a transaction exists.
Share repurchases
HMRC may also conduct additional investigations into the handling of buybacks from distributable reserves. When a firm buys back its own shares from an individual shareholder using distributable earnings, the purchase price is considered to be a dividend. For tax reasons, the purchase price is separated into a capital component and a distribution component. The capital component denotes the initial payment made to the corporation for the shares (i.e. the subscription price).
The distribution factor is the remaining balance of any purchase price paid. As a result, the default position is that income distribution occurs. However, in some instances, this classification may not apply to buybacks by private limited businesses. If these rules apply, you are automatically recognized as receiving a capital payment and may be subject to tax on any resulting chargeable gain. Section 1044 of the Corporation Tax Act 2010 provides for statutory approval that this payout should be considered as capital rather than income.
HMRC will undoubtedly conduct a more detailed examination to see if the statutory requirements for capital treatment are met. Additionally, HMRC is likely to be less eager to affirm that a planned transaction does not need the issuance of a counter-notice under section 684 of the Income Tax Act 2007. Because this provision has the potential to reverse capital treatment when the objective was to get an income tax benefit, the number of HMRC counter-notices is anticipated to grow in the coming months.
Looking ahead – other places where HMRC may be able to collect revenue
Reforms to the private sector’s off-payroll working restrictions (commonly known as IR35) have been deferred until 6 April 2021. Although this appears to be good news for such organizations, problematic concerns may arise in the meantime if businesses have previously established that a contractor is actually an employee in anticipation of the guidelines. In such situations, it is possible that the personal service firm may under-report tax to HMRC. Inquiries into this grey area are anticipated, since HMRC may reconsider the standard for truly self-employed individuals.
It remains to be seen whether the government, like France, would implement laws to prolong the investigation windows, giving HMRC a broader chance to probe revenue payments and collect unpaid taxes.
What to do if you get an HMRC enquiry
HMRC has the authority to conduct an investigation into a complete return, any changes, or any claim that is not included in a return. This effectively empowers HMRC to conduct investigations into any transaction. HMRC has considerable tax enforcement authorities, particularly where it is suspected that a transaction or structure was performed for criminal reasons or with the intent of evading tax.
A tax enquiry is a detailed inspection by HMRC to ensure that the information on a tax return is accurate and comprehensive. They accomplish this mostly by questioning you about your return, conducting meetings, requesting proof, and conducting a check of your records. It is critical, therefore, to maintain precise records of decisions made and their justifications.
Prior to responding to HMRC, it is usually advisable to get specialist tax counsel. Contact us if you require assistance.
