How does the taxman know you've been cheating?

HM Revenue & Customs are using ever more creative means to spot ‘invisible’ income and underpayment of tax.  As the January deadline for Self Assessment approaches, we look at the methods – some high-tech and some very traditional – that HMRC use to snare the unwary.  

Hi-tech surveillance

HMRC have been using a state of the art computer system called Connect since 2010 to investigate any suspected cases of concealment.  Designed by BAE Systems, Connect is used by specially trained analysts who now use it for 60% of the tax investigations undertaken.  It uses a mathematical technique known as social network analysis that ploughs through disparate, previously unrelated information to detect otherwise invisible networks of relationships. It automates analysis that would once have taken months.

Although it cost £45m to implement, the system had already delivered £1.4bn in additional revenue within a year of operation. 

Director of Risk and Intelligence Systems Mike Wells said, “The power of Connect is making it so much harder to hide from us.”

Thanks to Connect, HMRC has a wealth of information about people living in Britain, due in part to its many connections with other databases, such as the Land Registry and the electoral roll.

Access to such comprehensive data does not just allow investigators to spot anomalies. It also makes it much easier for HMRC to check up on individuals’ tax returns.  For example in the case of Inheritance Tax HMRC receives about 300,000 paper returns every year with two thirds of these coming from estates claiming to be below the taxpaying threshold.

HMRC can access information on property transactions, company ownerships, loans, bank accounts and self-assessment records using Connect, to spot where estates might be under-declaring and in raised an extra £26m in inheritance tax.


Mystery Shoppers

In addition to turning up on premises unannounced to review records, HMRC inspectors can now also operate in disguise to uncover payment anomalies.

This has led to inspectors posing as customers needing hair cuts to gain an understanding of how a salon operates and posing as couples out for a meal at a restaurant to see if the transaction is accounted for in the restaurant’s end-of-year books

Gary Ashford, head of tax disputes at RSM Tenon, the accountants, says restaurants are a happy hunting ground because of the large number of small value cash transactions that are involved and regular changes of ownership. “Where they do these reviews they are looking at all aspects of taxation,” says Ashford.

Restaurant owners are also supposed to apply income tax and national insurance to tips, but when tips are paid in cash, waiting staff often pocket them while the proprietor turns a blind eye.



The source of information yielding the biggest returns are tip-offs from the public, including embittered divorcees and disgruntled former employees. 

HMRC regularly receives letters naming people who are concealing revenue.  The letters are kept on file and used to cross reference against other information about the that individual.

Former tax inspector and partner at Watt Bushfield Andrew Watt, recounted one example of a tip-off from an informer was a disgruntled ex-wife of a trader, who told the Revenue about her ex-husband’s offshore account to make trouble for him.

Rewards vary from a few hundreds to tens of thousands of pounds, but are paid only once tax has been recovered – and payments are not a fixed percentage of the tax recouped.


Third Party Info

HMRC can now demand “bulk” information from businesses or government agencies to cross check against the figures that individuals submit.  For example in 2008 it homed in on the medical profession, acquiring information from National Health Service trusts, private hospitals and medical insurance companies to test its suspicions that practitioners were failing to declare fees for consultations, medical examinations and other services.

They also obtained information from the Gas Safe register to target plumbers and heating engineers have also been targeted, resulting in five arrests.

The taxman’s access to Land Registry and DVLA data also means it knows how much someone has spent on their house and can see vehicles registered to each address. For example, possible warning signs might be someone living in a modest property that has just bought a Ferrari. This would flag as a warning sign that might not fit with that individual’s financial affairs in situations where someone might only be declaring an income of £20,000 but their purchasing history would indicate they are living a £100,000 lifestyle, in which case HMRC can call on that individual to pay more.”


Property raids

Tax inspectors now have the power to raid the homes of people they suspect of not paying tax, in certain circumstances. In the tax year 2011-12 they did this almost 500 times.

These property searches, which tend to focus on individuals who run their businesses from home, relate to the Revenue’s aim of increasing criminal prosecutions fivefold by the 2014-15 tax year.

Investigators are also focusing on lawyers, plumbers, teachers and doctors or any other profession who fail to take advantage of recent “disclosure opportunities” to declare income.


Local & online information

The Revenue’s net also extends to local and informal sources of information such as  adverts on noticeboards in newsagents, stories in local newspapers, and even social networking sites, such as Facebook or Twitter.

Once again, inspectors are looking for evidence of a lifestyle that doesn’t match someone’s declared income.  They will also use Facebook and Twitter to find evidence about an individual’s tax affairs if they have doubts. For example if someone puts up pictures of expensive holidays on Facebook yet declares only minimal income. 

Another example could be a report on a lavish wedding in the local paper, but it involves the daughter of someone who claims not to earn very much.  This could also set alarm bells ringing at the tax office.

In a similar scenario, several individuals were caught out after appearing on the Channel 4 television programme My Big Fat Gypsy Wedding spending thousands of pounds of undeclared income on lavish family weddings.


Overseas property owners

HMRC also have a team of 200 employees in their “affluence unit” who specifically target higher-rate taxpayers with properties abroad.  The team is dedicated to checking that those who pay the 50 per cent tax rate, but are worth less than £20m, are complying with tax law.

They use “sophisticated data mining techniques” on publicly available information to identify individuals who own property abroad. It then uses risk assessment tools to highlight those who do not appear able to afford those properties legitimately as well as those who have not declared the correct income and gains from the property.

The affluence unit has been set a target of raising an extra £560m over the next four years. As well as overseas property, other investigations involve commodity traders and people holding offshore accounts.


Offshore bank accounts

Cross-border co-operation is becoming much more common, as more agreements are being struck with tax havens such as Liechtenstein and Switzerland.

HMRC’s access to information from offshore centres is on the increase meaning that international tax borders becoming less of a shelter for tax evaders.

The number of requests for information about taxpayers received by the UK government from overseas tax authorities has also surged in the past year.

Phil Berwick, director at Pinsent Masons, says: “Tax authorities around the world are responding to pressure from their governments to maximise their tax revenues. It is not just HMRC that is piling the pressure on taxpayers.”


Fear and guilt

HMRC’s advertising campaigns have been stepped up to make tax evaders feel bad about cheating the Exchequer when times are hard and to emphasise that the net is closing in.

It also “names and shames” individuals who evade more than £25,000 in tax by publishing lists four times a year on it’s website quarterly include the person’s name, address, nature of business, period covered by the evasion, amount of evaded tax and the penalty for that evasion.

Whereas previous campaigns have focused on individuals in high-risk business sectors, with tax amnesties and taskforces being used as carrot and stick, the current war on tax evaders represents a much tougher and wide reaching approach.

Roy Maugham at accountancy group UHY Hacker Young said “As it stands, HMRC isn’t missing any tricks when it comes to collecting this extra revenue.  The targets it has been set are extremely high, and HMRC is really focusing all its energy into ensuring it meets them.”



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