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  • Property-a-holics

    How to avoid a tax investigation

    The taxman (or ‘HMRC’ to give him his full title) is conducting more tax investigations than ever before, and landlords are under increasing scrutiny. Tax investigations can take years (not months!) to resolve, and can result in eye-watering tax bills (after adding penalties and interest to the underpaid tax). Your accountant’s time can also run into thousands of pounds (and you thought their normal fees were bad!).

    The financial ‘hit’ can be life-changing … and not in a good way!

    The taxman looks for ‘tell-tale signs’ to single out the ‘juicy’ taxpayers who are likely to have significantly underpaid tax. Your accountant should therefore be doing everything possible to reduce the likelihood of accidentally triggering a tax investigation.

    This feature provides a few hints and tips to avoid a tax investigation in the first place:

    1. File your tax returns on time

    This applies to both personal and business tax returns. Filing late tax returns suggests you are disorganised – the taxman concludes ‘maybe your accounting records are also disorganised’ … and thus worthy of a review?

    2. Explain anything unusual

    Tax returns, both personal and business, are processed by a computer that carries out analytical checks on the figures to look for unusual items.
    To avoid triggering a tax investigation, explain anything unusual when your tax return is submitted, using the white spaces provided. The taxman is far less likely to start an investigation if you have provided a plausible explanation to explain anything that looks odd, such as a big change in profit margins or much lower drawings by the owner.
    It is vital that your accountant spots these ‘unusual items’ for you and explains them – as this can satisfy a tax inspector so prevent a tax investigation.

    3. Don’t use a dodgy (i.e. cheap) accountant

    Ok, so I’ve got a vested interest here … hands up! But, the taxman knows that taxpayers who use a reputable accountant are unlikely to submit fraudulent or negligent tax returns (individuals and companies). Stands to reason doesn’t it?
    A Chartered Accountant (‘ACA’-qualified) has passed the toughest accountancy exams possible, is regulated by the ICAEW, and has to pay for a (very expensive!) professional indemnity insurance policy to compensate a client if advice provided is negligent.
    The taxman also has a list of ‘dodgy accountants’ … whose clients strangely seem to suffer tax investigations more frequently than others!

    4. Landlords – don’t fudge the figures

    If your rental income is above £15,000 for the tax year, the taxman wants a breakdown of your expenses – for a good reason! Basic checks are performed to ensure that the figures you provide look reasonable (especially given the new requirement to declare the number of rental properties a landlord owns).

    5. Don’t work ‘for cash’

    What does the taxman look like? Young, old, fat, thin? If you’re going to do a job cheaper ‘for cash’ you’d better hope it’s not for a tax inspector. Do you know what all your customers do for a living?
    Make sure you do before you offer to work ‘for cash’ … you would be surprised how often tax inspectors start investigations after receiving a ‘discount for cash’ offer.

    6. Don’t do deals with ‘dodgy’ mates

    Your mate ‘Bob’ is being investigated by the taxman, and mentions that you lent him £10,000 to start a business. The taxman may want to ‘discuss’ with you where you got this £10,000 from, since your tax return only shows an income of £20,000.
    ‘Bob’ may also be declaring expenses in his accounts that should therefore be income in yours … do the two tally up? If things don’t look right, the taxman may decide it’s worth looking into further.

    7. Stay ‘under the radar’

    The taxman has a dedicated hotline for ‘informers’ to call, as well as the HMRC website, to report suspected tax fraud (informers can do so anonymously if they wish). Have you got any jealous neighbours, disgruntled customers, or an ex-spouse you’ve fallen out with?
    Not all accusations turn out to be true but it could be the start of a tax investigation.

    8. Hang on in there

    With effect from 2007/08 onwards, the taxman only has one year after the date you file your tax return to enquire into it (assuming fraudulent or negligent behaviour isn’t discovered). So, mark the date in your calendar, once it’s passed, you can relax

    Part 2 to follow … How to deal with a tax investigation

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    Stephen Fay FCA
    www.fyldetaxaccountants.co.uk
    'The Property Tax Specialists'
    Thanks for this Steve. Really useful and valuable information for all of us!
    This is why I have been flagging up to people doing dodgy NMD/cashback deals that they must consider the tax implications. If you get a large cashback from an illegitimate property transaction, the taxman might look at it as income. Furthermore, it will not stand up to scrutiny as the paper trail is not legitimate.
    I think we will see a lot of property investor's tax returns not standing up to scrutiny in the future. I suspect many will be made examples of. That is why we have always recommended to do everything by the book, and keep a legitimate papertrail of your money movements.
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    In the US the IRS pays 10% of what they collect to the person turning in a tax cheat.
    I can think of at least one guru in the UK who I would like to report for underpaying his taxes. At least he claims to be when speaking from stage. I am curious to find out if he is that dumb (telling 60 strangers how he hides cash payments received) or if he is just telling lies to the naive folks in the audience.
    John Corey
    https://www.ChelseaPrivateEquity.com/blog
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    John Corey 


    I host the London Real Estate Meet on the 2nd Tuesday of every month since 2005. If you have never been before, email me for the 'new visitor' link.

    PropertyFortress.com/Events

    Also happy to chat on the phone. Pay It Forward; my way of giving back through sharing. Click on the link: PropertyFortress.com/Ask-John to book a time. I will call you at the time you selected. Nothing to buy. Just be prepared with your questions so we can use the 20 minutes wisely.

    I agree John. With the transparency afforded by Web 2.0, it is quite amazing that people blatantly post things they are doing that are questionable! I attended an event last year where the "guru" spoke openly from the front of the room about bribing valuers. Somebody asked him how exactly to do that and he answered "Ask if they would like a donation to their favourite charity".
    If you are doing anything remotely dodgy, it is daft to publish it on the web or speak about it in public. You have no idea who might see it or hear it. I know for a fact that a major broadcaster is doing covert filming at property events at the moment, so don't say anything anywhere that you wouldn't want to see broadcast on TV.
    As Seth Godin said, when it comes to Web 2.0, you have to live your life like you are on "Candid Camera" - because YOU ARE! This is why I am so excited that Web 2.0 demands ethics and best practice. It can only be a good thing for business and humankind in general.
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    Thanks for this Steve, a really enjoyable and informative read.
    This is not an approach I am advocating, just something relevent to an investigation and point 5 in particular:
    Recently, a friend showed me a letter he received from HMRC that accused him of not filing a tax return when they had proof he’d been working. The letter contained nothing specific other than a request for him to contact them and fill out a late return. To make matters worse my friends normal MO is to work cash in hand and not give out any invoices or tell anyone his business. This convinced him that he must have been ‘grassed up’.
    My response was to ask him to think again and see if he could remember anything that might have left a paper trail during the tax year in question. “Absolutely not” he replied “I only worked on one job and I never gave them an invoice … all I did was write down my name and the amount I got paid on a scrap of paper for the clients records.” Bingo! I suggested that this was the cause of his problem.
    With this information my friend was able to ‘jump the gun’, call HMRC and offer an ‘excuse’ for not paying his taxes. They accepted his version of the events and told him why he had come to their attention. It turns out that the client had been investigated and the HMRC investigators had found the scrap of paper.
    Not exactly a full investigation by the taxman but shows another way of how working for cash can come to the attention of the taxman.
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    Thanks for the feedback above - I am writing a series of articles (all my own work!), so any feedback on content / writing style etc is warmly welcomed!
    Vanessa,
    It's very likely that HMRC will simply treat the "net price" as the true purchase price (with some rare exceptions). This is a basic "substance over form" treatment, since there isn't true "income" being created - it's a fudge to obtain lending based on the full valuation. Investors who don;t take professional advice and try to use an inflated purchase price in the CGT computaitons may get a shock when HMRC rejects that approach!
    Marcus,
    What many people don;t realise is that HMRC look at the taxpayers lifestyle (house they own, cars they drive, transactions going through bank accounts etc), and then compare that to the declared income. It's actually very difficult to "hide" money (as Al Capone found out!) ... you have to spend it at some point! Tradesmen (Or any other profession) doing the odd deal for cash are unlikely to be caught, but systematic tax evasion is easier to spot than people realise.
    Richard,
    There isn;t a figure as such that HMRC regard as "reasonable", for builders (or any other trade). Odd patterns of income and profit can trigger a review (e.g. £100k turnover, £10k profit ... seems odd to make such a small profit on that turnover). HMRC also look for nice smooth patterns, such as year-on-year increases in icnome / profits.
    My next article will cover (gulp!) how to handle a tax investigation when you are chosen! (Hint: there are many ways to reduce the potential impact ... ).
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    Stephen Fay FCA
    www.fyldetaxaccountants.co.uk
    'The Property Tax Specialists'
    Richard Greenland said:
    I have also heard a rumor, which may be a myth, that sole traders like jobbing builders are less likely to be investigated if they declare net profit of a reasonable amount p/a, which C£10K is regarded to be outside the London area. I really don’t know how true this is.
    Rich
    Rich,
    The tax service is sifting through a high volume of suspect and screening out those who look like they are either within the rules or where the probability is low in terms of effort vs. return on the effort.
    If someone fits a profile they are likely to be in the group paying their taxes. If someone falls outside the profile they might be an exception or someone cheating on their taxes.
    There is no way the service could look at all returns. Similar to how people screen for BMV deals. They miss some crooks and they investigate some who are completely within the rules. They just need to tip the scales towards the areas where tax fraud is most common. People who operate cash based businesses are definitely a focus. Someone with PAYE income is much less likely to be underpaying their taxes.
    Funny enough the folks who under report their income on the tax returns also run into problems when they want a loan for a property investment. The lost deal can wipe out profits that exceed the tax bill if they had correctly reported everything.
    John Corey
    https://www.ChelseaPrivateEquity.com/blog
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    John Corey 


    I host the London Real Estate Meet on the 2nd Tuesday of every month since 2005. If you have never been before, email me for the 'new visitor' link.

    PropertyFortress.com/Events

    Also happy to chat on the phone. Pay It Forward; my way of giving back through sharing. Click on the link: PropertyFortress.com/Ask-John to book a time. I will call you at the time you selected. Nothing to buy. Just be prepared with your questions so we can use the 20 minutes wisely.

    Steve,
    Regarding the articles, very clear and well written so please ‘keep ‘em coming!’
    Sorry but can't resist sharing another story, hope it's not too much. This one concerns a bloke being called in for an interview by his local tax office to explain his irregular income. It's something I’ve mentioned elsewhere but I can’t find the link - seems relevant.
    The bloke in question arrived promptly for his interview and was asked to wait until his number came up. Ticket in hand he nervously sat down next to an equally concerned looking chap and exchanged one of those ‘glad I’m not alone’ looks. After a short while the two struck up a friendly conversation that allowed them to compare notes. It was also a perfect opportunity for them to get their facts straight before being interviewed, to practice their story on a ‘fellow sufferer’ and to clean up the parts of their stories that sounded 'less than convincing'.
    After a while the bloke checked his watch and realised that his allotted appointment time had come ... and gone. He’d missed it and it was his fault, all because he’d been deep in conversation with his new best mate.
    Panicking, he looked at his new best pal and expressed his concern, “Damn, I’ve missed my interview slot.” “No you haven’t” the chap replied “We’ve just finished!” Ouch!
    With that the chap stood up, walked back into the office, sat behind his desk and never spoke to the bloke again. Slippery bugger…
    Not sure what the outcome was but again, shows the lengths the taxman will go to if they suspect fraud.
    Looking forward to the follow-ups.
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