Enquiries by HM Revenue & Customs (HMRC) into tax returns will often involve a review of all monies received, with a view to establishing whether taxpayers have declared all taxable income and gains. Unless those amounts can be satisfactorily identified, HMRC will probably infer that the receipts are additional taxable income. For example, the accounts of self-employed individuals will generally be open to scrutiny during a tax return enquiry, particularly in respect of cash-based businesses. HMRC will often request private bank statements, and (where this information is provided) seek explanations of unidentified lodgements into the account.
It is generally easier for HMRC to contend that unexplained lodgements represent additional income of a person engaged in a business compared with (for example) an individual whose only source of earned income is from an employment. However, this does not seem to deter HMRC from adopting a similar approach with employees.
No other source
In Ali v Revenue & Customs  UKFTT 289 (TC), HMRC made discovery assessments and amended the tax returns of a surgical pharmacist employed by the NHS. HMRC alleged that the taxpayer's income had been under-declared for the years in question. The taxpayer appealed.
Interestingly, HMRC did not suggest the source(s) of the income which it considered to be under-declared. Nevertheless, the tribunal pointed out that the burden of proof was on the taxpayer to persuade the tribunal that she had been overcharged by the discovery assessments and amendments to her self-assessment tax returns. With regard to the burden of proof, TMA 1970, s 50(6) states:
"If, on an appeal notified to the tribunal, the tribunal decides—
(a) that, the appellant is overcharged by a self-assessment;
(b) that, any amounts contained in a partnership statement are excessive; or
(c) that the appellant is overcharged by an assessment other than a self-assessment,
the assessment or amounts shall be reduced accordingly, but otherwise the assessment or statement shall stand good."
Burden of proof
For each of the tax years in question, the tribunal considered the amounts treated by HMRC as undeclared taxable income. HMRC pointed to a number of significant deposits in the taxpayer's bank account which were not derived from her employment, and were taken to be undeclared taxable income. The tribunal reviewed the evidence and concluded on a balance of probabilities that the taxpayer's bank accounts were used as a conduit for family monies. This satisfactorily explained some of the deposits and withdrawals, and evidence was provided that some deposits arose for other reasons, such as the taxpayer's personal circumstances.
HMRC submitted that the question in the appeal was whether to accept the explanations given by the taxpayer as to the nature of the bank deposits. The tribunal accepted HMRC's submissions that the issue in the appeal was whether the taxpayer's explanations as to the nature of the various bank deposits were acceptable, and that if uncertainty remained she had not discharged the burden of proof upon her. However, having considered the taxpayer's evidence, and the explanations of the entries on her bank statements, the tribunal was satisfied on a balance of probabilities that the bank lodgements for each year did not represent undeclared taxable income. The taxpayer's appeal was allowed.
HMRC relied on four tax cases in support of its arguments that the bank deposits in question represented undeclared taxable income (Woodrow v Whalley  42 TC 249, Jonas v Bamford  STC 519, Johnson v Scott  STC 476 and Duffy v HMRC  STC (SCD) 377). It is interesting to note that those cases all involved business owners, where the sources of additional taxable income included a business. Particularly in the case of self-employed individuals, it will generally be feasible that the business is the source of any undeclared income. However, In Miss Ali's case, there was no business interest but a full-time employment with the NHS. It is difficult to understand (for me at least) how HMRC could bring such a case without identifying a potential taxable source for the amounts assessed.
Balance of probabilities
Nevertheless, it appears that all taxpayers, not just those who are business owners, are at risk of challenge from HMRC if monies are received which cannot be readily identified. The burden of proof before the tribunal is on the taxpayer. It is therefore important that all taxpayers retain documentary evidence and/or can satisfactorily explain any extraordinary amounts received (e.g. gifts or legacies from family members), in case of an HMRC enquiry. Whilst it seems that HMRC will generally wish to be satisfied beyond doubt, the standard of proof applied by the tribunal is on a balance of probabilities.
Finally, it is worth noting that in another recent case, this time involving a business, a company successfully appealed against assessments by HMRC in respect of undeclared income, as the company owner's evidence discharged the burden of proof and the tribunal were satisfied on a balance of probabilities that the original source of the amounts assessed was the director shareholder's mother (Romark Jewellers Ltd v Revenue & Customs  UKFTT 432 (TC)).
Mark McLaughlin CTA (Fellow) ATT TEP