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Tolley's Practical Tax by Louise Pinfold CTA (Fellow) ATT TEP

Louise Pinfold CTA (Fellow) looks at the new regime.Following the creation of HMRC last year, a number of new names and acronyms have appeared in the world of tax investigations. This article looks not at self-assessment enquiries carried out by local offices, but at some of the ‘big guns’ in HMRC that deal with investigations of the more serious kind.

Introduction

Special Civil Investigations is one of the new names that has cropped up since the former Inland Revenue and Customs & Excise merged to form HMRC. Both former departments had civil procedures for tackling serious evasion (the Revenue’s Hansard procedure and Customs’ Civil Evasion procedure). These have been replaced (with the exception of the Civil Evasion procedure applied to travellers at airports and ports controls) with a common Civil Investigation of Fraud procedure, dealt with in the new office (readers will be familiar with its direct tax predecessor Special Compliance Office).

The new procedure has been introduced to ensure that the department’s handling of cases of suspected serious fraud is consistent across direct and indirect tax regimes. It is wholly civil, removing the threat of prosecution for the original tax offence (although HMRC reserve complete discretion to consider prosecution for a materially false disclosure or a materially false statement made with the intent to deceive).

Scope

What do SCI investigate?

Special Civil Investigations (SCI) deal with cases which, because of their size, nature, complexity or seriousness and potential for criminal prosecution, are not suitable for investigation by local tax offices. They handle all cases involving serious fraud, including prosecution cases, where the potential loss of tax to HMRC is substantial. They carry out investigations into—

(a) companies or groups with liabilities spread over several local Areas;

(b) cases of exceptional difficulty or importance in the field of personal taxation;

(c) groups or classes of employees or self-employed persons;

(d)serious PAYE irregularities including failure to operate PAYE or to remit tax;

(e) serious irregularities in the operation of the construction industry scheme;

(f) areas of general avoidance including offshore arrangements;

(g) evasion and avoidance through contrived bankruptcy or liquidation and other methods of shedding tax liability;

(h)falsification of accounts, documents or returns; and

(i) the implication of accountants and other professionals in tax offences.

They are also responsible for a number of specialist areas—

(a) the Foreign Entertainers’ Unit deals with the assessment and collection of withholding tax from non-resident entertainers and sportsmen and finalising their tax liabilities from such activities;

(b) Computer Intelligence Services secures digital evidence from computers using methods acceptable to UK courts;

(c) the Intelligence unit exchanges information with overseas tax authorities and with the police and other law enforcement agencies; and

(d) the Insolvency Group is responsible for detecting, investigating and negotiating settlements in large or complex cases where insolvency or company liquidation is used to avoid tax.

SCI operate either under their own codes of practice (COP 8 where fraud is not suspected and COP 9 for cases of suspected fraud) or, where prosecution is considered, in accordance with the terms of the Police and Criminal Evidence Act 1984 (PACE) and the Criminal Procedure and
Investigations Act 1996 in England and Wales and their equivalents in Scotland and Northern Ireland.

HMRC have published their Regulation of Investigatory Powers Manual, which sets out guidelines for the conduct of covert activities in the course of investigations, to ensure compliance with the Regulation of Investigatory Powers Act 2000 and other recent legislation including the Data
Protection Act 1988 and Human Rights Act 1998.

In addition to conducting their own investigations, they are available to give advice to officers in local offices who are conducting an enquiry or investigation. Tax districts are instructed that avoidance cases of certain types are to be referred to SCI, but unless serious fraud is involved, SCI only take on the investigation if the tax at risk is likely to be substantial.

What constitutes serious fraud?

There is no statutory definition of ‘serious fraud’ and it therefore takes its ordinary meaning of deliberate deception, trickery or cheating, intended to gain an advantage. Features considered by HMRC as indicating serious fraud include—

(a) false accounts have been deliberately compiled;

(b) the taxpayer has conspired with a third party to defraud HMRC;

(c) the taxpayer suspected is a lawyer, accountant or other tax adviser;

(d) a certificate of disclosure or statements of assets signed in an earlier enquiry turns out to be false;

(e) suspected fraud or evasion involving the use of an offshore company; and

(f) phoenixism.

Whilst there is no comprehensive definition of serious fraud, for the purposes of these provisions it expressly covers an offence of which the actual, likely or intended result is either a substantial financial gain to some person or serious prejudice to the proper assessment and collection of tax. A single offence which would not by itself constitute serious fraud may nevertheless be so regarded if there are reasonable grounds for suspecting that it forms part of a course of conduct likely to result in serious prejudice to the proper assessment or collection of tax.

Powers

SCI do not use HMRC’s powers and procedures under the self-assessment regime, but employ in particular TMA 1970 s 20 as their main information power. An inspector may issue a notice in writing requiring a person (the taxpayer)—

(a) to deliver to him any documents which he (the inspector) reasonably believes to contain, or possibly to contain information relevant to the actual or possible tax liability of the taxpayer or the amount of such liability; and

(b) to supply such particulars as the inspector may reasonably require as being relevant to the taxpayer’s liability or the amount of it.

This power is intended to be used to require the taxpayer to provide written answers to questions on issues of fact. In addition to the power to require production of documents from a taxpayer (first party notices), an inspector also may, for the purpose of enquiring into a taxpayer’s liability, by means of written notice, require any other person to deliver to him documents which, in his reasonable opinion, contain or may contain information relevant to any tax liability to which the taxpayer is, or may be, or may have been subject, or to the amount of such liability (third party notices).

HMRC have a number of additional powers which can be used in cases of suspected serious fraud, including power—

(a) to obtain a warrant to enter premises and to seize documents; and

(b) to obtain an order for the delivery of documents.

In respect of (b) above, HMRC have the power to obtain documents for use as evidence in a criminal investigation of suspected serious tax fraud without the need in many cases to seek authority to enter and search premises to obtain documents. The powers are generally used to obtain documents from banks, lawyers, accountants and others who have business connections with the taxpayer but are unaware of the suspected fraud, and reduce the need to enter premises to obtain documents (so-called ‘friendly’ raids).

Previously, HMRC sometimes found it necessary to obtain warrants to search their premises, as well as those of the suspect, to seize evidence. HMRC have said— ‘The use of a search warrant can be a source of considerable commercial embarrassment to [those subject to a search] as well as a cumbersome procedure for the Inland Revenue’

Procedures

Cases of serious fraud not expected to result in prosecution, where the investigation is started after 1 September 2005, are worked in accordance with HMRC’s Civil Investigation of Fraud (CIF) procedure and under the terms of Code of Practice 9 (2005). All investigations started before 1 September 2005 will be worked to conclusion under the former Hansard procedure. The use of these procedures is restricted to SCI.

Under the CIF procedure, the taxpayer is offered one opportunity to make a full disclosure of all irregularities and is told at the outset that he is guaranteed immunity from prosecution provided that he does so. However, HMRC retain the right to prosecute where the taxpayer makes a materially false disclosure (including deliberately false statements during the course of the investigation or furnishing false documents at the conclusion of the investigation). If the taxpayer decides not to cooperate, HMRC conduct their own investigation, using statutory information powers where necessary. If irregularities are discovered, they issue formal assessments and pursue collection of the unpaid tax and associated interest. HMRC say that any penalties due in these circumstances are likely to be significantly higher to reflect the fact that the taxpayer did not take the opportunity to make a full disclosure.

Former procedure under Hansard

The taxpayer was referred to the Board’s practice regarding the institution of criminal proceedings in cases of serious fraud where the taxpayer was offered immunity from prosecution on condition that he made a full confession of all tax irregularities. This process was commonly referred to as Hansard, a reference to the Revenue’s statement of practice in this area contained in a parliamentary statement read by the Chancellor of the Exchequer and recorded in Hansard, the official record of parliamentary proceedings.

In versions of Hansard prior to 2004, the Revenue gave no definite undertaking to refrain from prosecution, even in a case where a full confession had been made. A revised Hansard statement was issued following criticisms of the procedure made in the case of R v Allen [2001] STC 1537 HL, where the House of Lords considered the human rights implications of the Hansard procedure, and the risk of self-incrimination. Following the decision in the case of
R v Gill and anor (2003) STC 1229, when the Court of Appeal held that tax fraud involved the commission of a criminal offence and that therefore when SCO investigated tax fraud, they investigated a criminal offence (and thus code C of the Police and Criminal Evidence Act 1984 applied to the Hansard interview), SCO amended their procedures for Hansard meetings. Every interview conducted under the terms of Code of Practice 9 began with a police caution and a tape recording was made of the interview.

The investigations process

Under both the new CIF procedure and the old Hansard procedure, the steps followed are broadly the same. The investigation begins with the issue of a letter to the taxpayer inviting him to attend an interview. This letter is accompanied by Code of Practice 9. If no code of practice is enclosed, it may be an indication that HMRC are considering criminal prosecution.

Under the new CIF procedure, where suspicions of irregularities cut across both direct and indirect taxes, one single meeting is held to cover all issues. During the meeting it will be made clear to the taxpayer whether the questions are relevant to direct taxes, indirect taxes, or both and if necessary, the meeting will be structured so that each tax is covered separately using the powers appropriate to that tax.

At the interview (which is usually conducted by two SCI investigators), HMRC will not disclose the reasons for their concerns, but will put the following specific questions to the taxpayer—

(1) Have any transactions been omitted from or incorrectly recorded in the books of any business with which you are or have been concerned whether as director, partner or sole proprietor to the best of your knowledge and belief?

(2) Are the accounts sent to the HMRC for each and every business with which you are or have been concerned whether as director, partner or sole proprietor correct and complete to the best of your knowledge and belief?

(3) Are all the returns or each and every business with which you are or have been concerned whether as director, partner or sole proprietor correct and complete to the best of your knowledge and belief?

(4) Are your personal returns correct and complete to the best of your knowledge and belief?

(5)Will you allow an examination of all business books, business and private and bank statements and any other business and private records in order that HMRC may be satisfied that your answers to the first four questions are correct?

These questions are notified to the taxpayer in advance of the meeting. They are said to be without limit of time, but can generally be accepted to cover a 20-year period. In cases where irregularities are acknowledged, the investigator will invite the taxpayer, at his own expense, to authorise his advisers to prepare a report which will represent the taxpayer’s full disclosure. In cases where the taxpayer denies irregularities, HMRC will proceed with their own enquiries, probably with a view to a criminal prosecution.

Areas to be covered in the report are—

(a) a brief business history;

(b) the nature of the irregularities and how they came about;

(c) the extent of the irregularities;

(d) steps taken to verify amounts with supporting documentation and any assumptions made; and

(e) a detailed schedule of the irregularities for each period involved for each tax.

Where it has been indicated in the meeting that it is considered that both direct and indirect tax offences have been committed, a single disclosure report should be submitted. A timetable for the compilation of a comprehensive report will be agreed and the final report needs to be formally adopted by the taxpayer as his full disclosure. SCO will then review it in detail to check for omissions and inconsistencies and once they are satisfied, a monetary settlement will be negotiated.

Prosecutions

Wherever possible, HMRC deal with fraud by use of the cost-effective Civil Investigation of Fraud (CIF) procedures. Criminal investigation is reserved for a minority of cases where HMRC need to send a strong deterrent message or where the conduct involved is such that only criminal sanction is appropriate.

HMRC have published their prosecution policy which they have summarised as follows—

‘HMRC reserves complete discretion to conduct a criminal investigation in any case and to carry out these investigations across a range of offences and in all the areas for which the Commissioners of HMRC have responsibility.’

Examples of the type of circumstances in which HMRC will generally consider commencing a criminal, rather than civil investigation are cases involving—

(a) organised or systematic fraud including conspiracy;

(b)importation or exportation breaching prohibitions and restrictions;

(c) money laundering;

(d) the use of false or forged documents;

(e) theft, or the misuse or unlawful destruction of HMRC documents; or cases where—

(f) an individual holds a position of trust or responsibility;

(g) materially false statements are made or materially false documents are provided in the course of a civil investigation;

(h)where deliberate concealment, deception, conspiracy or corruption is suspected;

(i) the perpetrator has committed previous offences / there is a repeated course of unlawful conduct or previous civil action;

(j) there is evidence of assault on, threats to, or the impersonation of, HMRC officials; or

(k)there is a link to suspected wider criminality, whether domestic or international, involving offences not under the administration of HMRC.

Following the merger of the Inland Revenue and Customs & Excise to form HMRC in April 2005 an independent prosecuting body was created under the Commissioners for Revenue and Customs Act 2005. The Revenue and Customs Prosecutions Office (RCPO), accountable to the
Attorney General, is responsible for prosecuting all HMRC criminal cases in England and Wales. (In Scotland, the prosecutions function is carried out by the Procurator Fiscal and in Northern Ireland by the Public Prosecution Service.)

Previously, criminal proceedings for fraud were handled by SCO on behalf of the Board and the decision whether to prosecute was made by the Board on the advice of its solicitor, who conducted the prosecution.

RCPO has reported that in the six months following launch, it concluded 885 cases (about 25% of these were tax cases) and achieved an 88% conviction rate.

International aspects

With growing pressure on authorities to attack tax evasion across the globe, there is an increasing international dimension to tax compliance work. HMRC practice and UK compliance legislation are having to incorporate an international perspective in order to remain effective, and co-operation with overseas authorities is now a significant feature in the work of HMRC.

An increasing feature of tax compliance work generally, and of fraud investigations in particular, is the exchange of information between the UK and other jurisdictions, especially EU Member States, and specialist expertise has been developed within HMRC to look at recovery of tax evaded by those using offshore structures (see below). HMRC are also involved in working with other tax administrations to share ideas and discuss ways of improving the effectiveness of tax compliance activities.

Cross-border tax evasion may involve a different approach from other types of evasion. Offshore structures may simply be used as a means to hold money derived from some form of evasion. Alternatively, money may be used to purchase assets or services within or outside the UK for the direct enjoyment of onshore business proprietors. This may or may not be combined with the use of structures available outside the UK to divert to an overseas location a businesses or profits that would otherwise have come through the UK.

Whilst there are a number of legitimate uses of offshore bank accounts, eg by non UK domiciliaries or in conjunction with a non-UK lender, it is known that offshore structure have been used to evade UK tax. HMRC have always been keen to tackle offshore fraud by gathering information or by prosecuting individual cases.

Exchange of information

In recent years, new agreements and legislation have come into force which require or facilitate the exchange of information and so are of great use to HMRC. A specialist unit with SCI, SCI Intelligence, handles the majority of exchanges of information with overseas tax authorities and disseminates details as appropriate.

Some attempts by HMRC to obtain information and mount investigations relating to the use of offshore structures have in the past been thwarted, as certain offshore centres structure themselves to provide secrecy and anonymity of funds. Recent legislation which has increased the exchange of information with other jurisdictions, particularly EU member States, has therefore been particularly helpful to HMRC.

HMRC consider that a major threat of serious fraud arises from the use of offshore accounts and structures and they point to increasing numbers of more complex arrangements involving higher values of fraud and growing evidence that taxpayers have exploited the services offered by financial institutions to conceal funds offshore. In a three-year period, approximately 25 per cent of the serious fraud cases investigated by SCO (now SCI), involved the use of offshore structures and accounts to evade tax.

Offshore Fraud Project Group

In 2003, the Offshore Fraud Project Group (OFPG) was established in response to the NAO’s recommendations and as part of HMRC’s stated determination to use their information powers to target third parties in the UK, such as banks, to obtain information about taxpayers (whose identity may be unknown to HMRC) seeking to evade tax by the use of offshore structures.

The group’s aim is to identify undeclared offshore bank accounts and the tax evaded by those who have used the accounts to conceal untaxed profits. It therefore looks particularly at the source of the deposits which might represent undeclared income from a business, including a foreign business. OFPG is part of SCI and is based in Bootle. It is the fastest growing unit in HMRC, with a targeted yield of £2 billion. The group has no special powers, but uses existing legislation to identify particular types of evasion and particular organisations which may hold funds that have not been properly declared.

The information power contained in TMA 1970 s 20(8A) allows a third party notice to be issued with the consent of a Special Commissioner where HMRC do not know the identity of a taxpayer, or class of taxpayer, provided there are reasonable grounds for believing that the taxpayer may have failed or may fail to comply with any provision of the Taxes Acts. The scope of s 20(8A) is wide and by issuing such notices to financial institutions, OFPG has recently been successful, in several widely-publicised cases, in obtaining details of overseas bank accounts and credit cards belonging to customers with UK addresses where the cards are funded from offshore bank accounts.

Where OFPG opens an investigation, the taxpayer may be challenged under COP9. If so, the revised Civil Investigation of Fraud procedure guarantees that if a full disclosure is made of all irregularities, the case will be dealt with by civil settlement. Alternatively, OFPG may decide to prosecute. The group has also built strong links with overseas fiscal authorities who actively help each other to counter tax evasion on an international basis.

Conclusion

HMRC are becoming much more proactive in searching out potential tax fraud and the drive against offshore fraud is a key strategy. Their ‘enabling’ initiatives have been extended this year to taxpayers identified as holding an offshore bank account which has not been declared on their tax return. After recent Special Commissioners’ decisions, UK residents with overseas assets will come under increased scrutiny and HMRC are likely to make more use of s 20(8A). A significant number of offshore fraud investigations are also likely to result from the extensive exchange of information which now takes place.

As a separate matter, the powers of the former departments have evolved differently over a period of time to reflect their different functions and responsibilities, and on the merger which created HMRC, these powers were ring-fenced. Consideration is now being given to more integration of the regimes. A document entitled HM Revenue and Customs and the taxpayer –
Modernising Powers, Deterrents and Safeguards was published in April 2005, followed by a further consultative document in March 2006 on the developing program of work. Among the suggestions made are current year checks of business records, and changes to the direct tax enquiry and penalty regimes. Work is ongoing to produce a single management act (See page 100).

It will be another interesting year...

Louise Pinfold CTA (Fellow)
June 2006

This article was originally published in Tolley’s Practical Tax, LexisNexis Butterworths leading information service for small to medium sized tax and accountancy practices. It provides the day-to-day information needed to deal with all tax compliance issues and general client problems. For more information or to order this title please visit www.lexisnexis.co.uk/taxationweb