HMRC Audit – Guidance Notes

HMRC will, from time to time, undertake audits in respect of those funds making gross payments of interest distributions. The purpose of these audits is to determine whether interest distributions have been properly made without deduction of tax. The inspections will be undertaken by auditors from HMRC SPSS Audit Unit.

References below to actions taken by or rights and responsibilities of an AIF are to the trustees in the case of an authorised unit trust.

The auditors’ objectives will be to ensure that:

  • where an interest distribution has been made for a distribution period the AIF concerned satisfied the 'qualifying investments test' (see CTM48270) throughout the distribution period in question
  • interest distributions have been made without deduction of tax in every case where fund managers/trustees of AIF have held relevant and valid declarations, the reputable intermediary test is satisfied, or there is automatic entitlement to payment without deduction (see CTM48600 onwards)
  • where an interest distribution has been paid without deduction in reliance on the reputable intermediary test that the AIF had reasonable grounds for believing the test was satisfied in respect of the unit holder (see CTM48620);
  • interest distributions have not been made without deduction of tax in any cases, apart from those indicated above, where the AIF has not held appropriate valid declarations on the distribution dates concerned
  • where the AIF has received, or otherwise become aware of, information that a declaration was not valid at the time it was made, or that it had subsequently ceased to be valid, it has not - at any time on or after the date it became aware of that information - made interest distributions without deduction of tax in respect of the unit holdings to which the declaration relates
  • in cases where an AIF has received, or otherwise become aware of, information that suggests a declaration was not valid at the time it was made, or that it had subsequently ceased to be valid:
    • it has not made interest distributions without deduction of tax in respect of the unit holdings to which the declaration relates at any time on or after the date that it became aware of that information, except where
    • it had satisfied itself that the declaration was, in fact, valid on the distribution date or dates in question
  • there are adequate arrangements for the flow of information between the relevant parties where that information confirms or suggests a change in residence status of a unit holder that could affect the validity of a declaration or ability to satisfy the reputable intermediary test.

When carrying out their inspection, the auditors might visit both the trustees/authorised corporate director and the management companies of the AIF concerned. Where administrative functions such as the registration of unit holders, the holding and processing of declarations, or the processing of distributions are delegated to a third party, that party might also be visited during the course of the audit.

The AIF remains fully responsible for ensuring that the scheme is operated correctly in compliance with the legislation in circumstances where its day-to-day management has been delegated to other parties.

Requirement to make information available

When required to do so, the AIF must make available for inspection all books, documents and other records which are in its possession or under their control as the auditors may reasonably require. These items should comprise everything that the auditors might need to enable them to determine whether interest distributions have been properly made without deduction of tax. This may require the manager, or authorised corporate director to provide information on behalf of the fund.

There are penalties for failing to make records available for inspection.

The types of records that might be called for include:

  • declarations themselves (declarations may be stored on microfiche or by image processing; funds who wish to hold declarations in this way should write to the address below for authorisation before destroying any written declarations)
  • records of unit holders who have made declarations
  • correspondence files of unit holders receiving interest distributions without deduction of tax
  • any other information held that might have a bearing on ability of a unit holder to receive interest distributions without deduction of tax, whether by reason of residence or automatic entitlement
  • records that demonstrate ability to pay an interest distribution, distribution records and accounts and any other records of payments of interest distributions made without deduction of tax.

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Maintaining records

For HMRC audit purposes, the AIF is expected to retain records for at least two years after the units in question have been disposed of, or transferred, by the unit holder.

Code of Practice

HMRC has a Code of Practice entitled 'Inspection of Schemes operated by Financial Intermediaries' which explains how inspections are carried out. In particular, it sets out the financial intermediaries’ rights, and provides an undertaking that they will be treated fairly and courteously. It also explains that HMRC will provide help where appropriate.

Copies of the Code of Practice are available from our website.

The telephone number for enquiries about the auditing of the scheme for paying interest distributions without deduction of tax is 0151 472 6166. The fax number is 0151 472 6124.

Selection for audit

The Code of Practice explains that most audits are routine, and that their timing and frequency will generally depend on the HMRC estimate of the amount of tax at risk. The frequency with which a particular manager of AIFs is audited will usually be determined by the number of AIFs making interest distributions for which it acts, the extent to which interest distributions are made without deduction of tax, and the results of any previous audits. Other factors such as a merger of funds might also affect the timing of an audit.

Notification of audit

HMRC will give at least 28 days notice of an intended audit. Where the fund is large or the nature of business is complex a longer period of notice may be given. The auditors will discuss practical arrangements for the audit with the the AIF, or the manager if this is preferred, in advance of the inspection. In particular, they will want to establish which persons and places are to be visited, and to make arrangements for inspecting the records they wish to examine.

Selecting a sample

Where large numbers are involved the auditors may select a sample of unit holders from a list of those who have received interest distributions without deduction of tax instead of reviewing the whole population. The sample will be selected using established statistical methods, and is intended to:

  • enable HMRC to determine whether interest distributions have correctly been made without deduction of tax, and
  • provide a basis for agreement of the amount of any underpayment of tax (if applicable).

The size of the sample will be determined by the number of declarations held and the auditors’ estimate of the likely error rate. Generally, it will be taken from a list of all unit holders receiving interest distributions without deduction of tax, and may be selected randomly, or on an equal interval basis.

Auditors will always explain the sampling method they intend to use, and will seek agreement to it before actually selecting the sample.

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Additional cases to be audited

Auditors may also want to compare the set of those unit holders who have made declarations with the set of those to whom interest payments have been made without deduction of tax. Any case where a member of the second set is not also a member of the first may be reviewed by the auditors.

Specific issues

Interest distributions should be made without deduction of tax where validly completed declaration forms are held by the AIF concerned on the distribution dates in question, and there is no information which indicates that the relevant requirement was not met at the time the declaration was made.

Where auditors discover cases of interest distributions made without deduction of tax on the basis of declaration forms that are incorrectly completed, or on the strength of declarations that have been made in the wrong form, tax must be deducted from future distributions until a fresh valid declaration has been made to the trustees of the AIF concerned. Such cases will be treated as errors within the audit results.

Examples of other cases that will be treated as errors within the audit results include:

  • interest distributions being made without deduction of tax in a case where there is not a valid declaration made by the unit holder in question and neither the automatic entitlement or reputable intermediary test are satisfied
  • an interest distribution being made without deduction of tax on a distribution date occurring on or after the date on which the AIF concerned received, or otherwise became aware of, information suggesting that the declaration had ceased to be valid (or had never been valid), except where:
    • the trustees had satisfied itself that the declaration is, in fact, valid, and have recorded their reasons for doing so; or
    • the circumstances described in paragraph 6.8 apply and the AIF has accounted to HMRC for the tax due in the relevant quarterly return
  • an interest distribution not being made without deduction of tax where the AIF concerned held a valid declaration on the distribution date in question, except where the AIF has made a supplementary payment to 'gross-up' the distribution.

Cases in which interest distributions have been made without deduction of tax where the relevant declaration has been lost or mislaid will generally be treated as cases where no declaration had been made. An exception will be made, however, in circumstances where the trustees of the AIF can provide good evidence that a valid declaration that has been lost was, in fact, held by them at the time of the first payment of an interest distribution without deduction of tax to the unit holder in question.

In all cases where it is found that a declaration has been lost or mislaid, tax must be deducted from distributions made after the discovery until the trustees have obtained a fresh valid declaration.

Reporting the results

At the conclusion of the audit, the auditors will discuss their findings at a summary meeting with the parties concerned. They will formally report their findings to the trustees within the following 28 days.

Where, on the basis of the audit results, the auditors are satisfied that interest distributions have correctly been made without deduction of tax, the trustees will be advised that no further action is needed.

Recovery of tax

Where it is discovered from the sample of cases audited that interest distributions have been incorrectly made without deduction of tax and the auditors can reasonably conclude that the errors identified in those cases are likely to be present in the remainder of the population of unit holders they will seek to determine the amount of tax due in respect of the population as a whole.

Exceptionally, the AIF may be able to satisfy the auditors that where a sample has been made the number of cases in which errors have been identified is so small as to be unrepresentative of the population as a whole. Where this is the case the AIF concerned will be asked to:

  • pay the tax due in respect of the error cases identified; and
  • put things right for the future.

Normally, where a sample has been used, the amount of tax underpaid can be agreed between the AIF concerned and HMRC by extrapolating the agreed audit results from the sample across the whole population. If agreement cannot be reached on this basis, however, the AIF may be required to undertake further work to quantify the actual amount of any underpaid tax. That could involve reviewing:

  • all the other cases where interest distributions have been paid without deduction of tax; or
  • a further sample of sufficient size to reassure themselves that the audit results obtained from the original sample are reliable enough to be extrapolated across the rest of the population of unit holders who have received distributions without deduction of tax.

If the AIF decides to review all the other cases where interest distributions have been paid without deduction of tax, it will need to reach prior agreement with the auditors on the way in which the review is to be carried out. Where it decides instead to review a sample, it will need to reach prior agreement with the auditors on the size and structure of the sample and the basis on which it is to be selected. In either case, the auditors will wish to check the results of the review.

Where, exceptionally, agreement cannot be reached between the AIF and the auditors on the amount of underpaid tax, HMRC may raise an assessment to recover what they consider to be the amount due. The AIF has a right of appeal against assessments.

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Information on HMRC Audit can be obtained from:-

HMRC, Audit Unit (APSS Information Returns)
St John's House
Merton Road, Bootle
Merseyside
L69 9BB
Telephone: 0151 472 6129

Default interest

Section 87 of the Taxes Management Act (TMA) 1970 provides that underpaid tax attracts interest in respect of the period which commenced when it was due and ending on the date when it is paid.

Penalties

Where tax has been underpaid, penalties may be charged for each incorrect CT61(Z) return made and for any incorrect annual information return submitted under section 18 TMA 1970 provisions. Penalties may also be charged where valid declarations have been received and not acted upon, or the trustees fail to provide information or documentation required under a notice.

Audit protection

It is possible that HMRC might seek to undertake a further review in respect of a time interval that has previously been audited. But this will happen only in exceptional circumstances. In line with general practice, as described in Statement of Practice SP8/91, HMRC will not, as a result of such a further review, seek recovery of tax in respect of any period ending on or before the latest distribution date occurring in the time interval covered by the previous audit unless:

  • the settlement (if any) was based on misleading or incorrect information provided by the AIF concerned; or
  • the settlement (if any) was based on computational errors which the trustees could not reasonably have believed to have been correct or intended; or
  • errors arose before the end of the period covered by the previous audit which were not readily susceptible to audit checks made during that audit.

The protection afforded by the Statement of Practice does not extend to interest distributions made after the end of the time interval covered by the previous audit.

Other issues

There may be some particular issues that arise out of an audit which are of special concern to the AIF in question. HMRC will be pleased to give advice or explain their approach on any issue as it arises.

Any trustees, managers or administrators of AIF undertaking major systems or procedural changes may seek advice from HMRC, Audit Unit (Information Returns) at any time.

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