When HM Revenue and Customs (HMRC) suspect serious tax evasion, they will normally launch a full-scale tax investigation into the person they suspect.

They use many tools in such investigations and one of the more common ones is to compare the cost of a person’s apparent lifestyle with their available income over a period. If the former exceeds the latter and the difference cannot be explained (i.e. by inheritance or spending savings), HMRC is likely to conclude that the gap arises from taxable undisclosed income and to raise tax assessments to recover the tax on the ‘undeclared income’.

A recent case showed that there are limits to HMRC’s abilities to make such assessments. It involved a taxpayer whose company attracted the attention of HMRC when there were some VAT irregularities to do with imports of VATable goods. HMRC then became interested in the company director himself and launched an investigation which led them to conclude that there was a £250,000 shortfall between his income and the amount needed to maintain his lifestyle, and that this must be due to failure to declare taxable earnings.

Their next step was to raise Income Tax assessments to cover the shortfall. However, HMRC were completely unable to offer evidence as to what the source of those ‘earnings’ might be and went so far as to say that they were unaware of any other likely sources of income.

As HMRC could not say what the source of the income was or might be, the First-tier Tribunal could not accept the validity of the assessments.

If you are facing problems with HMRC or any government department, it is important to remember that they are not always right.