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Opening a letter to discover you’re under investigation by HMRC is a headache every landlord would rather avoid.
Landlords must file a self-assessment tax return to HMRC every year to declare their rental income. All it takes is a clumsy error or misinterpretation of the rules to trigger an investigation.
Tax investigations can happen to anyone, not just those who deliberately evade paying taxes. No matter the cause of the investigation, it’s important to handle your response with care, as the consequences can range from fines and penalties to legal action, depending on the seriousness of the offence.
This guide will explain everything landlords should know about HMRC tax investigations, including what they are and how to avoid them.
What is an HMRC tax investigation?
An HMRC tax investigation (or tax compliance check) is an audit performed by HMRC to ensure that you’re paying the right amount of tax.
There are two types of HMRC investigation: an aspect inquiry and a full inquiry. During an aspect inquiry, HMRC queries a small section of your tax return. However, a full inquiry looks at your whole tax return, your accounts, and your records.
The first you’ll usually know about an inquiry is when you receive a letter from HMRC through the door requesting more information. If you have an accountant, then they may receive the letter first, in which case they will inform you.
Within the letter, HMRC will ask you to send them certain documents and information – this may include bank account statements, sales invoices, expense receipts, and more. They may also request a meeting with you; this could be either face-to-face, by telephone, or via video call. If you need to attend a meeting, you may want to take along an accountant or tax advisor to represent you and help argue and negotiate your case.
What are the possible outcomes of an HMRC tax investigation?
If, after investigating, HMRC find that there is a problem with your tax return, they will probably go back and look at earlier years to make sure that there aren’t more errors. Usually, if you have simply made a careless mistake, they won’t go back further than six years. However, if they believe the error is deliberate, they could go back up to 20 years!
Once the investigation is complete, HMRC will usually declare one of four outcomes.
No further action required – If everything looks in order, the case is usually closed pretty quickly.
Overpaid tax – Every landlord’s preferred outcome! If you’ve overpaid tax, then you will receive a tax rebate plus interest – a result worthy of a little victory dance.
Underpaid tax – If you’ve underpaid tax (a less pleasing outcome), you’ll need to pay what you owe, plus interest, within 30 days. You may also be charged a penalty. The severity of the penalty will reflect the reason for the error.
Deliberate wrongdoing – If HMRC decides that discrepancies in your tax return are not the result of an accident or misunderstanding but of deliberate wrongdoing, then the penalty is likely to be much higher. In addition to paying what you owe, you may receive a penalty that is 15-100% of the amount owed. In very serious cases, you could even find yourself facing criminal prosecution.
If you don’t agree with HMRC’s decision, you have 30 days to file an appeal.
What can trigger a tax investigation?
A tax investigation may seem like it’s happened out of the blue, but often, there is one or more factors at play that has triggered it. Some of the most common triggers include:
- Undeclared rental income – Landlords are obligated to declare all rental income, even that from lodgers, Airbnb, and overseas properties. Assuming HMRC will not discover undisclosed rental income is a big mistake. They have various methods for identifying it, including examining stamp duty land tax records, HM Land Registry, government-approved tenancy deposit schemes, the Electoral Register, and tips from informants.
- Unusually high expenses – If your expenses are much higher or lower year on year or compared to industry norms, this may prompt HMRC to start asking questions.
- A tip-off – HMRC will investigate if it receives a tip-off from an organisation or individual that you have undeclared rental income or are otherwise evading paying taxes.
- Late tax returns – HMRC is more likely to investigate you if you consistently submit your tax return late.
- Discrepancies – Errors, inconsistencies, or unusual patterns can all trigger an investigation.
- Random check – Yes, this can happen. Receiving a letter about an HMRC inquiry through the door can get your heart racing, but unless you know you’ve been up to no good, try to stay calm, as you could just be one of the lucky people selected for a random tax investigation.
Three common self-assessment mistakes landlords make that can lead to a tax investigation
Several errors are made repeatedly by landlords filling out their tax returns due to a lack of knowledge or a misinterpretation of the rules. Make sure that you’re not guilty of these three prevalent mistakes to avoid getting caught out by an HMRC tax compliance check.
Claiming capital expenses
Capital expenses are those that improve your property, like adding an extension or a new kitchen. Revenue expenses are those that maintain your property, like repairs and maintenance expenses. You can claim revenue expenses on your tax return but not capital expenses.
Claiming incorrect petrol allowance
Landlords can claim 45p per mile on the first 10,000 business miles they travel over the tax year. After this mileage limit, the allowance drops to 25p per mile. The petrol allowance covers fuel and general wear and tear of the vehicle but not other costs like MOTs, repairs, or insurance. To claim petrol allowance, landlords must keep accurate records of mileage and the purpose of each trip. They cannot claim mileage for personal travel.
Claiming the full mortgage interest
Landlords can only claim 20% of their mortgage interest as a tax deduction.
What to do if HMRC is investigating you
If you’re being investigated, it’s important to face the problem head-on and not bury your head in the sand; prompt action is essential. Start by gathering all relevant records and documentation to submit to HMRC. At this point, you’ll thank yourself if you’ve been keeping accurate and organised records, as this will make the process smoother and less stressful.
You need to respond very carefully, so unless you are confident that you know the tax rules inside out, you may want to speak to an accountant first. An accountant will have expert knowledge of the tax laws and be able to review your tax return and records to spot any errors and suggest the best course of action. They can also negotiate with HMRC on your behalf if necessary and provide recommendations to help you avoid being investigated again in the future.
What is HMRC’s Let Property Campaign?
HMRC’s Let Property Campaign basically offers landlords who have not been declaring rental income a way to ‘fess up and come clean. While they will still be liable to pay penalties, the consequences tend to be less severe if you own up than if you’re found out. When you make your disclosure, you get the opportunity to tell HMRC how much penalty you believe you should pay. The amount you may pay will depend on why you have failed to disclose income. Landlords who have simply misunderstood the rules are required to pay less than those who have deliberately evaded paying. Once you’ve made a disclosure, you have 90 days to work out and pay what you owe. The Let Property Campaign offers landlords the best possible terms to get their tax affairs in order.
Tips for avoiding a tax investigation
Even if you’re confident that you’re doing everything right, you’ll want to do everything you can to avoid a tax investigation, as the process can be time-consuming and stressful to navigate. Unfortunately, it’s not always possible to avoid being investigated, as you may still be selected at random, even if you’re doing everything right! However, implementing the advice below can help minimise your chances of receiving an unwanted letter through the door.
Know your tax rules inside out
There’s no denying that reading about tax rules is enough to send anyone to sleep, but if you’re running a rental business, it’s your responsibility to know your stuff when it comes to working out what tax you owe. Ensuring that you’re well informed about what records you need to keep and which expenses you can and cannot claim are basic stuff. If there’s anything you’re not sure about, take the guesswork out of it by contacting HMRC or an accountant to make sure you remain compliant and get your tax return right.
Always declare all rental income
You must declare everything you earn from your rental property. Honesty is always the best policy, especially when HMRC is involved!
Keep meticulous records
Staying on top of your bookkeeping is crucial. It’s far easier to maintain accurate records if you update them regularly rather than letting receipts pile up and trying to sort everything out in one go, which can lead to confusion and errors. Use a separate bank account for your rental property business so that personal and business income and expenses don’t get muddled. Record every income and expense on a spreadsheet or using an accounting software program. Keeping organised records will help to minimise the risk of making mistakes that could attract HMRC’s attention.
Securely document evidence
Bills, receipts, invoices, contracts – you need to keep the lot for at least six years. We recommend using specialist landlord software like Landlord Vision to digitise all your records and store them securely online. Going paperless is environmentally friendly, helps you stay more organised, keeps your records safe and secure, and makes it easier to organise and retrieve information when you need it. If you are investigated, these documents are invaluable evidence to help fight your case. If your documents are kept secure and organised, the process of responding to a tax investigation will be much simpler and less stressful.
Submit your tax returns on time
Submitting your tax return on time will help you avoid attracting attention and keep you off HMRC’s radar. Consistently submitting your tax return late could cause HMRC to wonder what other rules you’re not complying with. Again, software like Landlord Vision can help with this by producing accurate tax reports and reminding you when it’s time to get ready to submit your return.
Triple-check your tax return before submitting
Although it’s tedious, it’s worth going over the figures on your tax return with a fine toothcomb before pressing submit to save yourself a headache later down the line.
Provide additional information
If you know that there is something legitimate within your tax return that could look suspicious without further information, then use the ‘additional information’ section within your self-assessment form to provide context or proof. It’s much less hassle to be transparent and proactive when explaining yourself rather than waiting for HMRC to question it.
Use an accountant
Knowing the tax rules inside out and keeping meticulous records can help you to avoid an investigation. However, if after some research, you’re still not clear on the rules, or if your tax obligations are more complicated because you have a large portfolio of rental properties, then you may benefit from employing the services of a qualified accountant to keep your records straight and complete your tax return accurately. An accountant will also be able to advise you on any tax relief that you’re eligible for.
Use specialist software like Landlord Vision
The Landlord Vision software makes keeping accurate and organised records and accounts simple, which makes filling out your tax return a breeze. With Landlord Vision, you can use live bank feeds for quick and easy reconciliation, record property income and expenditure, scan in receipts and invoices, produce tax reports for easy tax returns, and get automatic reminders and early warnings so that you never miss a tax return deadline!
By keeping meticulous records and taking a proactive, honest, and informed approach to completing your self-assessment tax return, you can minimise your chances of being investigated by HMRC.
