A Simplified Guide
When you use personal bank accounts for business transactions, HMRC has special rules about who must prove what during investigations. **The key principle is simple: you must prove your innocence, not HMRC prove your guilt.**
What HMRC Assumes About Your Bank Account
### For Regular Mixed Accounts
HMRC doesn’t automatically assume every unexplained deposit is business income. Initially, they treat mysterious money as **“drawings”** – personal money you’ve taken from your business.
But this changes if your lifestyle doesn’t match your declared income.
When HMRC Changes Their Mind
If you’re declaring £20,000 profit but living like someone who earns £40,000, HMRC will **assume the extra money comes from hidden business income**. At this point, every unexplained deposit becomes suspected undeclared earnings.
For Self-Employed People Using Personal Accounts
HMRC applies stricter rules here. They examine your personal account specifically looking for **“unidentified lodgements which may be undisclosed business profits.”**
**The presumption flips**: unexplained money coming in = business income unless you prove otherwise.
The Legal Framework: Why You Must Prove Innocence
### The Basic Rule
Under the Taxes Management Act 1970, **taxpayers must prove HMRC’s assessments are wrong**. HMRC only needs to raise an assessment – you must prove it’s incorrect.
This means:
– You can’t just say HMRC’s assumptions are questionable
– You must **positively prove** your explanation is right
– The burden stays with you throughout any appeal
– Even if HMRC suspects fraud, you still must prove innocence
HMRC’s Power to Make Inferences
Courts recognise that only you know the true facts about your money. This gives HMRC broad authority to **infer** where unexplained income comes from, provided their assumptions aren’t “wild or extravagant.”
### The Technology Behind It
HMRC’s Connect system processes over 55 billion pieces of data from 130+ sources. It compares your declared income against:
– Your spending patterns
– Property purchases
– Lifestyle indicators
– Information from banks, estate agents, online platforms
The Investigation Process
**Phase 1**: Gentle “nudge letters” asking for explanations
**Phase 2**: Formal enquiries demanding bank records
**Phase 3**: Assessments, penalties, and tribunal cases
Financial Institution Notices: The Game Changer
Since 2021, HMRC can get your bank records directly from your bank **without asking you or getting court approval**. They just need internal authorisation that the information is “reasonably required.”
What Evidence HMRC Accepts
To prove money is personal (not business income), you need **“convincing evidence”**:
Good Evidence
– **Contemporary documentation**: Records made at the time, not created later
– **Third-party verification**: Statements from family members, solicitors
– **Official documents**: Inheritance papers, gift letters, loan agreements
– **Bank transfer records**: Showing where money actually came from
– **Written agreements**: Formal documentation of family financial arrangements
What Doesn’t Work
– Your word alone
– Explanations created after HMRC starts asking questions
– “I think it was…” or “It must have been…”
– Plausible stories without supporting evidence
Real Cases: Success and Failure
### Successful Defences
**Ali v HMRC (2012)**: NHS pharmacist proved unexplained deposits were “family monies” with proper documentation and family member statements.
**Romark Jewellers v HMRC (2012)**: Company proved deposits came from director’s mother with comprehensive evidence and third-party confirmation.
### Failed Defences
**Anthony Calcutt v HMRC (2022)**: Self-employed landlord “did not produce any credible evidence” and faced assessments plus 60% penalties for deliberate behaviour.
The Practical Reality
### Time Limits
– **Standard assessments**: 4 years from end of tax year
– **Careless errors**: 6 years
– **Deliberate understatement**: 20 years
– **Information gathering**: No time limit – HMRC can demand old records anytime
### What This Means for You
HMRC’s position has become much stronger through:
– Better technology for spotting discrepancies
– Direct access to bank records without court approval
– Legal precedents supporting their inference-making powers
Your protection comes from:
– **Meticulous record-keeping** from day one
– **Professional representation** when problems arise
– **Proper documentation** of all family financial arrangements
The Bottom Line
### HMRC’s Approach Varies by Context
– **Initially**: Unexplained deposits treated as personal drawings
– **After lifestyle analysis**: Shifts to assuming hidden business income
– **For business accounts**: Stricter presumptions from the start
### What You Must Do
You need evidence to explain your **entire financial position**, not just individual transactions. HMRC looks at the big picture – if your lifestyle exceeds your declared income, they’ll assume business income is hidden somewhere.
### Key Takeaways
You must prove innocence** – HMRC doesn’t need to prove guilt
**Document everything** at the time it happens, not later
1. **Separate accounts** provide better protection than mixed accounts
1. **Professional help** often essential once HMRC starts investigating
1. **Family arrangements** need formal documentation to avoid tax problems
The system is challenging but navigable with proper planning and documentation. The key is understanding that traditional expectations of privacy and “innocent until proven guilty” don’t apply to tax investigations.
Your Tax Guide 