Contractors' guide to penalties – iv) HMRC enquiries

This is the fourth article in a four-part guide for contractors exploring the various penalties and sanctions applied for filing late, paying late and sending inaccurate information to the taxman, writes Sumit Agarwal, managing director of contractor accountancy firm DNS Associates.

You can check back to read part one, part two and part three of this contractor penalty guide prepared exclusively for ContractorUK.  

This final article in the series looks at the ‘enquiries’ and ‘investigations’ carried out by HM Revenue & Customs under Schedule 36 Compliance Checks and the more serious investigations conducted under HMRC’s Special Compliance Office (SCO), under Code of Practice (COP) 8 and the recently applied Contractual Disclosure Facility that, since January 2012, applies to all COP 9 tax investigations.

Enquiries can take various courses, ranging from questions about entries on personal tax returns, reviews of VAT and/or payroll records under Schedule 36, through to detailed enquiries of business accounts and returns and investigations of suspected serious fraud under COP 8, or extended investigations into all tax affairs under the Contractual Disclosure Facility using COP 9.

Tax avoidance and tax evasion

Remember, there is a big difference between tax avoidance and tax evasion: the former is legal, although some aspects are now heavily scrutinised by the tax authorities under COP 8, while the latter is definitely illegal and eventually, undoubtedly will attract unwanted attention under the Contractual Disclosure Facility using COP 9.

Penalties for incorrect returns – how much you’ll pay

First of all, penalties for all incorrect returns are assessed according to whether the error is deemed:

  • Negligent;
  • Concealment; or
  • Mistake.

Penalties for non-compliance range from £300 for failure to comply, up to £60 a day for continuing failure; tax-geared penalties where an individual seeks to pay less tax as a result of the failure and, in the extreme cases involving concealment and/or destruction of documents, a possible prison term of up to two years.

Disclosure – Prompted & Unprompted

Unprompted disclosure – that is when you go forward of your own accord to HMRC – carries a penalty depending on the type of error made: was it careless, deliberate but not concealed or was it deliberate and concealed?

  • If you voluntarily inform HMRC of an error that was careless you will pay between 0% and 30%: if it was genuine error you will pay nothing; but if you did not take “reasonable care” expect to pay something within that tariff.
  • If you voluntarily inform HMRC of error that was deliberate but which you had not tried to conceal, you will pay a penalty of between 20% and 70% depending on the seriousness.
  • If you voluntarily disclose an error that was both deliberate and you tried to conceal it then you may be fined from 30% to 100% of the “potential lost revenue”

Prompted disclosure – that is, when HMRC comes to you – carries penalties as detailed above, but higher, so, was it careless? Deliberate but not concealed or was it deliberate and concealed?

  • If you were simply careless you will pay between 15% and 30%; if it was genuine error you will pay nothing but if you did not take “reasonable care” expect to pay something within that tariff.
  • If the error was deliberate but you did not try to conceal it you will pay a penalty of between 35% and 70% depending on the seriousness.
  • If your error was both deliberate and you tried to conceal it then you may be fined from 50% to 100% of the “potential lost revenue”.

Contractors, please note - all the above penalties can be enforced simultaneously. For example, if your tax return is late and you pay your tax late and there is an irregularity in your return, then you could end up paying all three kinds of penalties.

Schedule 36 Compliance Checks

The next level of enquiry by HMRC may be the outcome of their initial enquiry under Schedule 36 or could be issued on the ‘suspicion’ of an HMRC officer. The procedure for COP 8 is similar to that described above, but the powers of HMRC are extended so that they can remove paperwork and computers from your premises, and even close down your company if fraud is suspected.

Beware, even if you’re innocent…

There was a case recently concerning a perfectly innocent drinks distributor whose company was accused of attempting to avoid paying duty to HMRC. The company and the directors were brought to the brink of bankruptcy and they are still in the process of recovering the millions of pounds they are owed by HMRC in legal bills and lost income, not to mention damaged reputation.

HMRC enquiries

Code of Practice 8 (COP 8) cases are dealt with by HMRC’s Fraud and Avoidance department within the Special Investigations Office, although from the outset fraud is probably not suspected. A COP 8 enquiry is carried out when there is a suspicion of tax avoidance, for example as a result of tax planning arrangements that might go beyond the boundaries of the law. The objective of a COP 8 investigation is not to bring a criminal prosecution but to recover all the tax, interest and penalties due to HMRC.

Code of Practice 9 (COP 9) is another matter. This is launched by HMRC under the Contractual Disclosure Facility. Take note that this allows HMRC (pretty well uniquely) to consistently handle both direct tax and indirect tax cases involving suspected serious tax, VAT and/or duty fraud. COP 9 tax investigations are conducted with a view to punishing evaders by imposing significant financial penalties associated with tax fraud. The primary objective of a COP 9 investigation is to recover tax, interest and penalties owed to HMRC, and while a criminal prosecution cannot be brought while the Contractual Disclosure Facility using COP 9 is in progress, criminal prosecution can follow if it is suspected that a full disclosure has not been forthcoming.

What if contractors receive a COP 9 letter from HMRC?

On receipt of a COP 9 letter there are three options:

  1. Disclosure is that you accept you have committed serious tax fraud and that your conduct has been fraudulent. You cooperate and enter into a Contractual Disclosure Facility contractual arrangement with HMRC and disclose all tax frauds.
  2. Denial is that you do not accept that you have committed serious tax fraud but you wish to engage and cooperate with HMRC’s enquiry.
  3. Non-cooperation is that you deny having committed serious tax fraud and are not prepared to cooperate with the investigation under the Contractual Disclosure Facility.


The individual has 60 days to decide whether to disclose any tax fraud with which they have been involved. In exchange, HMRC will not pursue a criminal tax investigation with a view to prosecution if tax fraud is proved, but instead will work towards a civil monetary settlement for tax, interest and a financial penalty. As part of this undertaking the individual will be required to complete two stages of disclosure:

  1. ‘Outline disclosure’ of tax frauds; and
  2. Provide a certified statement that they have made a full, complete and accurate disclosure of all tax irregularities and submit certified statements of assets and liabilities including bank accounts and credit cards. Additional information will be required to complete the investigation, such as full details of the nature, extent and reason for the irregularities, together with supporting evidence. This will then be compared with the information held by HMRC.

The amount of additional tax, interest and penalties due will then be agreed and the individual will be encouraged to begin making payments on account of the potential liability.


Fraud should be denied only if the individual is certain that they have not committed any tax fraud. Specialist advice about the potential consequences of making a denial is essential. If HMRC verifies and accepts the denial, confirmation will be sent to that effect. But note that HMRC retains the right to criminally investigate with a view to prosecution and is not obliged to advise whether it has commenced a criminal tax investigation.


In the event that your denial is not accepted and the case does go to court, HMRC would argue that non-cooperation hampered proceedings. The individual’s denial letter may be used in court or tribunal proceedings as evidence! The outcome can only be bad if you are guilty of fraud and deny it, and in these cases, the individual would be entirely defenceless having missed the opportunity for disclosure.

Filing untruths with Companies House

Finally, in relation to your company accounts filed with Companies House (as detailed in part one of this series): inaccurate information will very likely see you struck of the register; it will definitely affect your company’s credit rating and probably mean the end for your business when suppliers don’t want to deal with your company. You can end up in prison, could be the target of in-depth HMRC investigation and you will likely never be able to be a director of a company again.

Final recommendations

To conclude, without any shadow of doubt, I would stress that filing an inaccurate return or committing fraud is the biggest mistake a contractor taxpayer can make, so avoid doing so. It should be borne in mind that HMRC has invested an additional £900 million to fund interventions, enquiries and investigations to tackle tax evasion and avoidance, which it is hoped will raise £7 billion through tax annually by 2014/15. The raft of powerful legislation across all taxes and initiatives – from a new penalty regime to ‘naming and shaming’ as well as all-embracing powers to inspect taxpayer records and records, potentially through the Business Record Checks programme - underpins the new regime.

Contractors - avoid (and insure against) tax investigations

Tax investigations are lengthy, uncertain and open ended - and one of the worst things about being investigated by the tax authorities, particularly since HMRC have been given new powers to inspect premises and other property, is the stress and pressure it will put you under. You and the other directors of your company will have to dance to HMRC’s tune; don’t forget that tax investigators are specially trained and while they are scrutinising every aspect of your business they certainly will exploit their powers to delve into your private affairs too. They will keep you under pressure by constantly requesting information and evidence in a deliberate attempt to unnerve and investigate you, their target.

If you don’t have insurance to cover this potential nightmare, then you certainly should strongly consider it because, without it, you will feel lost. Paying an accountant specialist in this area to collate all the information required by a probing HMRC will be prohibitively expensive without any insurance. So my recommendation is that all businesses should take out cover to help them in the unenviable event that their tax affairs become subject to investigation.

Tuesday 19th Feb 2013
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Written by Sumit Agarwal

Sumit Agarwal ACA, ACMA is the Managing Partner of DNS Accountants, a multi-award-winning accounting practice. Sumit has helped thousands of businesses to grow with his strategic support and guidance, and has developed many businesses successfully.
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