Why the inheritance tax police might pay you a visit

Every year HM Revenue and Customs sets its investigators on the trail of thousands of families it suspects of underpaying inheritance tax.

Last year, over 4,345 estates were investigated, according to official data revealed in a freedom of information request.

Being chased by the taxman can be highly stressful no matter the reason, but especially after a bereavement.

Here, Telegraph Money explains when HMRC may decide to exercise its investigative powers – and what to do if your loved one’s estate falls under the microscope.

What is an inheritance tax investigation?

HMRC will open an investigation where it believes an incorrect tax return has been submitted.

It is the job of the executor to calculate the value of the estate as well as determining whether inheritance tax is payable and submitting the relevant inheritance tax forms to HMRC.

If they fail to pay the tax within six months of the death, then interest is charged on the late payment. This is 2.5 percentage points above the Bank Rate so it has soared in recent years, from 3pc in 2022 to 7.75pc today.

On top of this, executors also face penalties for submitting inaccurate information – of up to 100pc of the tax due.

The average inquiry will drag on for 558 days, during which time the executors are blocked from distributing the estate to the beneficiaries.

The burden of proof will be on the executor to prove they followed the rules, and an inquiry will generally start with HMRC asking for written evidence. But this could then escalate to a house visit from the tax office. 

Nimesh Shah, of accountancy firm Blick Rothenberg, said: “If HMRC do not believe the executor, they may then ask for a face-to-face meeting at the property of the deceased so they can see that the rules have been followed and the deceased did not retain an asset, for example a painting or a car, after gifting it.”

Although HMRC will generally arrange the visit, Mr Shah said its investigators had sometimes “gone looking through windows and peering over fences” without warning, to gauge whether a taxpayer had reported the estate correctly. 

In 2021-22, HMRC clawed back £326m through inheritance tax investigations – a year-on-year increase of 28pc.

Sean McCann, of financial advice firm NFU Mutual, which obtained the figures, said the soaring tax take is the result of frozen tax thresholds.

He said: “More inheritance tax is being recovered from HMRC investigations due to the rising value of assets and the potential sums at stake, which justify HMRC spending more time looking at individual cases.

“The £325,000 nil-rate band and the £175,000 residence nil-rate band are frozen until 2028, which means more families will be caught in the inheritance tax net with ever increasing bills for those affected.”

Couples leaving property to their children can pass on up to £1m free from inheritance tax before they must pay 40pc on the excess.  

HMRC employs over 450 staff to administer inheritance tax. This includes staff working on administrative tasks as well as the officers carrying out investigations.

Dominic Arnold, of wealth manager Evelyn Partners, said: “As with all tax returns, HMRC undertakes a targeted number of inheritance tax investigations each year. This can vary from cases where HMRC believes an innocent mistake might have been made, to those where they suspect deliberate evasion including non-declaration.

“Estates which are higher value, complex or high profile are more likely to be subject to investigation and HMRC has a vast amount of intelligence data at its disposal to assist in selecting inheritance tax investigations.”

When will HMRC investigate?

Between April and August last year, HMRC raked in over £105m of inheritance tax through compliance checks, according to a freedom of information request submitted by Evelyn Partners.

The number one reason it chose to investigate was due to concerns around the valuations of assets in an estate, the request showed.

This could be because an executor has failed to declare the existence of a bank account or because the property was incorrectly valued.

But HMRC may also launch an investigation in order to check that a family is correct in claiming certain exemptions and reliefs.

Strict rules dictate how much of their own wealth a person can give away before inheritance tax is due.

Gifts are no longer considered part of a person’s estate once seven years have passed. So someone could give their child their home to bring their estate under the inheritance tax threshold, and no tax would be due on the transfer, so long as they survived the gift by seven years.

However, if the parent continued to live in the property rent-free, they could end up with a huge tax bill.

Mr Arnold said: “Where assets have been gifted pre-death (for example a main residence from a parent to children) HMRC will often check whether the donor had reserved a benefit (in this case perhaps rent free occupation of the property) which would result in the asset remaining part of the death estate for inheritance tax purposes.”

Joe Cobb, of law firm JMW, said: “In our experience we have noted that lifetime gifts are a particular area of focus, which is why HMRC will be keen to look at bank statements when conducting an investigation – although policing accurately lifetime gifts of heirlooms such as family jewellery, art, antiques and so on can be extremely challenging, which is why HMRC has historically relied on the family’s own reporting.”

During an investigation, executors will be expected to hand over relevant income tax returns, bank statements and Land Registry documentation so the team can determine whether an estate has been correctly reported.

To avoid the chance of HMRC investigating your affairs after your death, keep accurate records of gifts and ensure your executor has a clear understanding of your financial affairs.

Why do the investigations take so long?  

While some investigations can be closed quickly, in many cases they could drag on for months or even years.

“If the estate is large and complex, HMRC may investigate multiple aspects and request large amounts of information to review, resulting in further queries,” Mr Arnold said. “Disputes may also arise during the course of an investigation which may take time to resolve.”

In a recent case, a dispute opened up because HMRC challenged the domicile status of the deceased, Anantrai Maneklal Shah, who died in 2016. HMRC did not conclude its investigation until July 2020 and the Tax Tribunal did not release its judgement on the case until June 2023, seven years after Mr Shah died.

An HMRC spokesman said: “Only 3.7pc of deaths resulted in an inheritance tax liability in 2020-21. The vast majority of liable estates pay the right amount without an investigation being opened.

“We take a risk-based approach to investigations and on the rare occasion where it is appropriate to do so, may make site visits.”