HMRC has changed its approach to ensuring employers are compliant when it comes to employment taxes. Susan Ball and David Daly explain the new regime and provide a cautionary case study.
Historically, HMRC used to ‘knock on the doors’ of an organisation approximately every six years and undertake the laborious process of going through the PAYE records. Recent years however have seen a major change in approach by HMRC to its compliance activity in this area. Instead of undertaking ad hoc PAYE audits, the focus has now moved to targeting resources at those organisations that are perceived to represent the highest risk.
The new approach to inspections
Larger organisations (dealt with by the old HMRC Large Business Unit) should have all received a formal risk rating by HMRC on its overall tax compliance; corporation tax, VAT and employment taxes, and this will determine the approach HMRC takes to the business in respect of employment taxes going forward. This filtered down to medium-sized organisations over the last 12-18 months (those with more than 250 employees) that fell within HMRC’s Local Compliance (Large and Complex Unit) and now the principles are equally filtering through to smaller businesses.
Depending on its size, an organisation is allocated a Customer Relationship Manager (CRM) or a Single Point of Contact (SPoC). Both CRMs and the SPoCs however have the task of being the point of contact for the organisation in relation to all HMRC matters.
Even if a business does not currently have a CRM or SpoC allocated, the new approach is filtering down to all smaller businesses.
This new approach, especially when considered alongside HMRC’s new information (2007) and inspection powers (2008) and the new penalties (2009)[1], fundamentally changes the compliance landscape.
For CRM cases
HMRC will generally request an introductory meeting in order to learn more about factors that will influence whether it is low risk. This is often referred to as a ‘walk through’ – HMRC asks to be walked through the processes the organisation has in place to see if they believe they are sufficient to capture the right information, in order to pay the right amount of tax. HMRC will use the information gathered at the meeting, along with information it already holds to complete a Business Risk Review Summary Template (further information can be found here).
For SPoC cases
The SPoC will be responsible for preparing the Business Risk Review together with the specialists in each area of taxation. Their review is however a desktop review (in not as much detail as the CRMs) undertaken without the involvement of the organisation and will not automatically be communicated to them.
Following the review the business is allocated a risk rating – 'low risk' or 'non-low' (to us high risk). This determines HMRC’s approach going forward.
The normal review cycle for a low risk organisation will be every two to three years. In between HMRC will expect to be able discuss matters with the organisations on an ongoing basis, and reserve the right to review risk rating if necessary. Having said this, those organisations with low risk will be able to influence the degree of interaction with HMRC and will have the fundamental benefit of early certainty of its tax liabilities. HMRC may still include these however in any national targeting campaigns.
In contrast, those organisations badged as ‘non-low risk’ will remain in an annual risk review cycle, with greater HMRC compliance intervention. There will be less certainty, and greater risk of penalties being imposed. It is therefore imperative that those affected in this way establish how they can improve their risk profile. Reviews could consist of significant issue interventions or be general and more a wide ranging.
What can you do to achieve a low risk rating?
The easiest way is by demonstrate a good level of compliance by filing all returns and paying any tax due on time, by communicating with HMRC and disclosing errors as they arise.
The key is to proactively manage tax compliance in order to control the risk exposure.
Therefore we would recommend that organisations undertaking an internal employment taxes review, often standing back and looking at employment taxes in this way can highlight areas of concern with the processes in place or identify any potential compliance exposures.
What are HMRC’s current ‘hot topics’ in employment taxes?
HMRC’s focus is identifying areas of high risk and collecting additional tax; let’s face it they are short of a penny or two![2]
The top ten include:
- Employment status – have you treated the worker correctly? Are they in business on their own account?
- Officeholders – do you need to operate PAYE? How do you treat the expenses paid – is the officeholder correctly treated as being based from home?
- Termination payments – has tax been paid on all contractual payments? Did you correctly apply the £30,000 exemption?
- Entertaining – have you correctly coded business, staff entertaining and subsistence? Do you have adequate records of who was entertained?
- Company cars – has any (no matter how small) private fuel been paid for – are the process for making good the cost or the reporting of business mileage robust?
- Expatriate tax issues – Does the business have a Short Term Business Visitors? Have you an agreement from HMRC regarding tax/NIC regarding those employees not working in the UK but on the payroll?
- Construction Industry Scheme – Is the business adhering to the new rules? Have you captured all the information required and checked the status of the workers?
- Salary sacrifice schemes – Do you have a reduction or deduction? Is the scheme available to all, where appropriate? Does the paperwork demonstrate a sacrifice has actually taken place?
- Expenses – are your mileage records sufficient, do they detail start and finish locations and include the reason for the visit? Are expense claims authorised by a third party? For personal bills paid on an employee’s behalf have you applied the correct NIC treatment – it will depend on who contracted for the item or services?
- Dispensation/PSA – do you have them in place? Are they up to date? Have you reviewed them recently? Do they still meet your needs?
What penalties can be charged?
When HMRC believes a penalty should be charged this will be calculated as a percentage of the underpaid revenue at stake. The percentages are as follows:
- 30% for failing to take reasonable steps to notify HMRC;
- 30% for careless action (failure to take reasonable care);
- 70% for deliberate but not concealed error; and
- 100% for deliberate and concealed errors.
HMRC provides us with these examples which help to give us an indication of the likely penalty position.
Example: ABC Ltd, a large company.
Lack of inadequate basic systems and procedures, as there were no procedures to identify the entertaining element of advertising costs, and therefore no way of cross-checking how much is disallowable. Result: a failure to take reasonable care and could be shown to be deliberate.
Example: DEF Ltd
An earlier employer compliance review advised that reimbursement of private phone bills should be dealt with through the payroll and subject to PAYE and NICs. A recent review found that this advice had been ignored. Result: a failure to take reasonable care because it has ignored the advice given by HMRC.
What should you do now?
You should ensure in so far as possible that you maintain your compliance record and build an open and honest relationship with HMRC. Reviewing your own records regularly and disclosing any areas of non- compliance will result in lower penalties and fewer interventions from HMRC. It may pay to undertake some process mapping in order to assess your risk areas, or even consider input into a tax risk map.
At the end of the day HMRC want to be concentrating on those organisations where they think they will collect the highest level of tax loss and which carry the greater risk.
For those who are low risk …keep it up! It is worth its weight in gold as you can get on and run your organisation with less active involvement form HMRC and that can’t be bad.
Case study
A 'double glazing' company was selected for a PAYE review. Aside from a smaller number of minor errors discovered, by far the most important issue raised related to the employment ‘status’ (employed or self- employed?) of the double glazing fitters.
The first mistake which the company made was to enter into a detailed question and answer session with HMRC prior to taking professional advice and meeting with the officers without their accountant.
The officers proceeded to run through their 55 set questions, pausing to cover in further detail the areas that best suited the case that the fitters were employees rather than self-employed (which was how they had been historically treated). A one-sided note of the discussions was produced by HMRC and not challenged. HMRC also sent the company their computations of the tax and national insurance 'due' covering a six year period, for failure to operate PAYE on the payments made to the fitters. This amounted to £125,000. Although several years ago we were involved in one where the liability was over £1m.
Our firm (Crowe Clark Whitehill LLP) was appointed at this point and reviewed the position with the directors. HMRC was told that there were just as many factors in support of the case for self-employment as employment. HMRC was then challenged on three fronts, namely, the lack of 'mutuality of obligations', the absence of the any control or supervision of the fitters by the directors and the right of the fitter to provide a substitute. After two or three exchanges of correspondence, HMRC conceded the point and agreed a final tax bill of less than £10,000.
There are many decided tax cases which provide very useful legal precedents where the tax position is 'grey' rather than 'black or white', as tends to be the case in most status disputes. A well drawn contract for services (as opposed to a contract of service which would point toward an employment) will also help achieve a successful defence. Each situation must, however, be considered on its own merits and individual facts.
Note that further information on this issue and other employment tax issue will be covered in the forthcoming Pay and Benefits Legislation conference, being held at Crowe Clark Whitehill’s offices in association with Purely Payroll, on 9th June 2011. Details can be viewed on the downloadable PDF here
[1] See ‘Late for an important date’ in The People Bulletin, 10 February 2010
[2] See also Deborah Parks-Green’s article ‘Surprise visit’ in The People Bulletin, 31 July 2009.