How to avoid a tax enquiry
Dealing with a tax enquiry can be a time consuming and expensive exercise. HMRC have stated that they have recruited additional resources to deal with the increased number of enquiries they plan to raise. For trustees and executors it is important to minimise the likelihood of an enquiry being raised, and this article will consider how lawyers and accountants can work together to achieve this.
One obvious way of managing the cost, where a professional prepares the tax return, is to take out tax investigation fee insurance. For a relatively modest fee the cost of dealing with an enquiry is effectively managed.
The next step is to consider the likelihood of HMRC raising an enquiry. Some enquiries are randomly selected and therefore any tax return could, in theory, be selected for an enquiry. However, some tax return entries are more likely to be enquired into than others, and it is sensible to consider how best to disclose these. The lawyer and the accountant can work together on this.
Any capital gain disclosure involving a valuation has a chance of being enquired into, whether it involves land or shares. A suitable valuation should be obtained by an expert who can not only provide an accurate valuation, but who is prepared to defend it should HMRC enquire into it. A well prepared valuation will not only back up the tax return disclosure but demonstrates that the trustees took expert advice.
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Where the capital gains tax entries include a claim to a tax relief such as Entrepreneurs Relief, Principal Private Residence Relief, Capital losses set against income or EIS capital gains tax deferral, there could be significant tax at stake and an increased chance of an enquiry. It is worth ensuring that the claim is accurate and that the relevant paperwork is in place to substantiate it. For example the relevant EIS certificates should be submitted to HMRC to support any claim to defer capital gains. Where a capital loss is being set against income the company should be reviewed to ensure that it either qualified under the EIS rules, or it is a qualifying trading company.
It is not necessary to prepare trust accounts for every trust. However, for the more complex trusts, such as those with mixed funds, possibly having different tax treatments, accounts are recommended. Where the tax treatment depends on the nature of a distribution, i.e. whether it is income or capital, trust accounts are useful. A set of accounts is in every trust’s best interests from time to time to demonstrate how the trust assets are faring and whether any action needs to be taken.
Review tax status
The trust’s status should be reviewed each year to ensure that there have been no changes leading to tax implications. For example, have the beneficiaries satisfied any age contingency and so have become absolutely entitled to the trust income or capital? Are there any inheritance tax charges pending because of either a distribution of capital or a ten year charge? Has the residency of the trustees changed so that the trust is not UK resident? For an estate, has a deed of variation been made and have the income tax and capital gains tax issues been considered? Has the estate been wound up? Failure to identify these issues can lead to an HMRC enquiry.
Some trust expenses are tax deductible and can be set against trust trading or rental income, under generally accepted accountancy practice. Others will form the trust management expenses (TMEs), such as legal and accountancy costs, investment management and bank charges. It is important to meet these from the correct income or capital fund as it will affect the beneficiaries’ entitlement. Some expenses such as legal costs and trustees’ remuneration can be apportioned between income and capital. For an interest in possession trust the TMEs do not reduce the income tax liability but simply reduce the net income entitlement of the beneficiary. For discretionary trusts, TMEs are only deductible under general trust law. For settlor interested trusts the settlor is taxed on the trust income and TMEs are ignored.
Consideration of these and other issues by the lawyer and the accountant can reduce the likelihood of an HMRC enquiry, thereby saving the trustees or executors worry and expense.
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