In recent years, HMRC has tried to bridge the ‘tax gap’ – the difference between the total theoretical tax liabilities and the actual amount collected. Estimated at £35.8 billion, or 4.8% of total theoretical tax liabilities in the 2021 to 2022 tax year, this gap is not entirely due to fraud or tax evasion. Mistakes and misunderstandings of tax law also play a significant role.

HMRC has employed various strategies to address this issue, including targeted campaigns and ‘nudge’ letters. In this blog post, we’ll explore these letters, why you might receive one, and what steps you should take if you find one in your mailbox.

The Evolution of HMRC’s Approach

In 2007, HMRC launched a series of campaigns to encourage taxpayers to voluntarily come forward and bring their tax affairs up to date. These campaigns targeted specific taxpayer groups or taxable activity types and offered advantageous terms for those who disclosed previously undeclared income.

Fast-forward to the present day, and the only remaining campaign focuses on the non-declaration of income from let property. However, this doesn’t mean that HMRC has given up on its mission of closing the tax gap. Instead, the organisation has shifted its approach, leveraging advanced data collection and analysis techniques to identify potential discrepancies in individual tax affairs.

The Rise of ‘Nudge’ Letters

One key tool in HMRC’s arsenal is the ‘nudge’ letter. These letters are sent out en masse as part of targeted campaigns and relate to specific areas of tax, such as overseas income or the disposal of property. The intention is to prompt taxpayers to review their tax returns and check whether they need to notify HMRC of any further gains, income, or profits that have yet to be disclosed.

It’s important to note that these letters do not explicitly state what is missing from the return. Instead, they are designed to ‘nudge’ the taxpayer to investigate the issue and take any necessary action. The recipient is responsible for reviewing their tax affairs and correcting errors or omissions.

The Power of Data

HMRC’s sophisticated Connect computer system generates the’ nudge’ letters, which analyse vast amounts of data from various sources to identify potential anomalies in individual tax affairs. This data-driven approach enables HMRC to segment its ‘customers’ into groups and take targeted action to tackle avoidance, evasion, and criminal activity.

By leveraging the power of data, HMRC can identify potential issues more accurately and efficiently than ever before. This means that if you receive a ‘nudge’ letter, it’s likely that HMRC has identified a specific area of concern in your tax affairs that warrants further investigation.

Responding to a ‘Nudge’ Letter

If you receive a ‘nudge’ letter from HMRC, it is essential to take it seriously and act promptly. The letter will accompany a Certificate of Tax Position, and you will have 30 days to respond. Failure to do so may result in HMRC taking further action, such as raising a discovery assessment, which could lead to penalties.

When responding to a ‘nudge’ letter, you have two main options:

1. If your tax return is correct, you should confirm this with HMRC by email, providing a calculation of the relief available and details of the consideration received on incorporation (if applicable).
2. If you identify an error in your tax return, you should contact HMRC via the specific email address provided in the letter to discuss the next steps.

It’s worth noting that HMRC has agreed to accept a letter response as an alternative to completing the declaration if you prefer.

A Recent Example: Incorporation Relief

One of the most recent sets of ‘nudge’ letters has been issued to individuals who incorporated their property business in 2017/18 and applied for incorporation relief on the transfer for capital gains tax (CGT) purposes. These letters target taxpayers who declared disposal of their property interests but paid no CGT due to the application of incorporation relief.

HMRC believes that excessive incorporation relief may have been applied in some cases and advises recipients to check their position. If an error is identified, the taxpayer is invited to contact HMRC via a specific email address. Where the tax return is correct, taxpayers are advised to confirm this with HMRC by email, providing a calculation of the relief available and details of the consideration received on incorporation.

HMRC uses “nudge” letters to tackle the tax gap. By leveraging data and targeted campaigns, HMRC identifies potential discrepancies in individual tax affairs more accurately and efficiently. If you receive a “nudge” letter, take it seriously, review your tax affairs, seek professional tax advice if necessary, and engage with HMRC to resolve any issues quickly. Respond promptly to HMRC to avoid penalties, interest, and unnecessary stress. Remember, it’s always better to be proactive than reactive when it comes to tax.