HMRC Nudge Letters: Offshore Assets, CRS, and AEOI in Tackling Tax Evasion

HMRC (Her Majesty’s Revenue and Customs) has implemented a strategy of sending "nudge letters" to UK taxpayers who may have offshore assets or income. These letters serve as a reminder or a warning to ensure taxpayers have declared all relevant foreign income and gains. They are primarily part of HMRC's broader effort to crack down on tax evasion, often utilising international agreements and mechanisms like the Common Reporting Standard (CRS) and Automatic Exchange of Information (AEOI).

For example, a lot of people are under the impression that because they have paid income tax on their foreign property income in the country where the asset is situated, nothing further needs to be reported in the UK. Unfortunately, that is usually due to a misunderstanding of the double tax treaty agreement as in most instances you also need to declare that income in the UK, albeit with the ability to deduct from your UK tax bill the tax already paid abroad.

Those letters allow for a much wider net to be cast as the letters are sent even when there is poor evidence of tax underpayment.

1. Common Reporting Standard (CRS)

The CRS, developed by the Organisation for Economic Co-operation and Development (OECD), is an international framework aimed at combating tax evasion and improving tax transparency. Over 100 jurisdictions have signed up to the CRS. Under this framework:

• Financial institutions, such as banks, custodians, and investment entities in participating countries, are required to collect and report financial account information to their domestic tax authorities.
• This information includes the account holder's name, address, taxpayer identification number (TIN), account balance, and any financial income such as interest, dividends, or proceeds from sales of financial assets.
• The domestic tax authorities then share this information with the taxpayer’s country of residence, under Automatic Exchange of Information (AEOI) agreements.

This is key for HMRC, as they receive financial data on UK tax residents with accounts or assets held abroad. If HMRC suspects that a taxpayer has not fully declared foreign income or gains, they may issue a nudge letter encouraging voluntary compliance before initiating any further investigation.

2. Automatic Exchange of Information (AEOI)

The AEOI is the mechanism through which data is shared between countries. Under the CRS, financial institutions report account details to their national tax authority, which then exchanges this information automatically with other signatory countries.

For the UK, HMRC is the agency responsible for receiving data from foreign tax authorities and ensuring UK residents report income from foreign sources. The AEOI has dramatically expanded HMRC’s capacity to detect undisclosed offshore assets. It works in tandem with FATCA (Foreign Account Tax Compliance Act), a U.S.-led system, but the CRS has a wider reach since it includes many non-U.S. countries.

Key entities involved in AEOI and CRS:

• OECD: Developed the CRS as an international standard.
• HMRC: UK tax authority responsible for implementing the CRS and receiving data under AEOI.
• Financial Institutions: These include banks, investment companies, and other financial entities that report financial data on foreign account holders to their respective tax authorities.
• Foreign Tax Authorities: HMRC exchanges information with these bodies under the AEOI.

3. Nudge Letters

When HMRC receives information through the CRS and AEOI, they may send a nudge letter to a taxpayer. The nudge letter typically serves as a soft warning, giving taxpayers an opportunity to review their financial affairs and make any necessary disclosures before HMRC takes more direct enforcement action.

The tone of these letters varies:

• Educational letters: These remind the recipient of their legal obligations to declare overseas income and assets.
• Warning letters: These suggest that HMRC has information about undisclosed foreign income or assets and may take further action if the taxpayer does not respond appropriately.

These letters usually urge the recipient to consider making a voluntary disclosure to rectify any past omissions. If you are convinced that you have made no mistake in the past you can let HMRC know that you believe that your affairs are in order and they will close the case if you are correct. But they can open a formal investigation instead. Also, you should keep in mind that the wording on the reply coupon makes it a criminal offence to misrepresent your tax situation. That's why it's a better idea to either talk to HMRC over the phone or reply to them on plain paper instead.

4. Worldwide Disclosure Facility (WDF)

If a taxpayer realises they have underreported or failed to declare offshore income or gains, HMRC offers a voluntary disclosure route through the Worldwide Disclosure Facility (WDF). Launched in 2016, the WDF allows individuals to disclose offshore tax liabilities.

• This facility is used to declare unpaid tax on offshore income, assets, or activities, such as investment income, property rental income, or the sale of foreign assets.
• The WDF offers a streamlined way for taxpayers to correct their affairs, often leading to reduced penalties compared to waiting for HMRC to begin a formal investigation.

To make a disclosure, taxpayers must:

1. Register for the WDF by notifying HMRC that they wish to make a disclosure.
2. Provide details of all previously undeclared income, gains, or assets.
3. Pay the tax due, including interest and penalties.

Penalties for non-compliance can be significant, often ranging from 100% to 200% of the tax owed, particularly in cases where there is deliberate non-disclosure.

5. What Happens If You Ignore a Nudge Letter?

While the nudge letter itself is not an investigation notice, it is a clear signal that HMRC is scrutinising the taxpayer’s financial affairs. Ignoring such a letter can lead to:

• Formal investigation and tax audits.
• Larger penalties if undeclared income or assets are found later.
• Criminal prosecution in extreme cases, particularly where tax evasion is suspected to be deliberate.

Conclusion

The HMRC nudge letters related to offshore assets are part of a sophisticated, globally coordinated effort to combat tax evasion. By using the CRS and AEOI, HMRC can access financial information from over 100 jurisdictions and is able to identify individuals who may not be fully compliant with their tax obligations.

The Worldwide Disclosure Facility (WDF) offers a path for taxpayers to correct any oversights, potentially reducing penalties. However, failure to respond to a nudge letter or disclose foreign income can lead to severe financial and legal consequences.

For those who have offshore accounts and/or assets, it is critical to ensure that all income and gains are properly declared to HMRC to avoid future complications.