TaxAid is contacted by many people who are worried because they have not declared some or all of their income to HM Revenue and Customs. Quite often this is because they have not had the money to pay their tax and thought (wrongly) that it was best to 'keep quiet'.

This is unwise. If HM Revenue and Customs finds out that you have not declared income on which tax is due, you may be charged interest and penalties on top of any tax bill, and in more serious cases there is even a risk of prosecution and imprisonment.

The situation is very serious, but you will generally benefit from disclosing the position to HM Revenue and Customs without delay because:

• if you report the situation voluntarily, before HM Revenue and Customs suspects anything, you are most unlikely to be prosecuted
• if you disclose your income and cooperate fully with the investigation or enquiry that will follow, this should help to reduce any penalties payable.

It may also help to know that HM Revenue and Customs will often try to reach an agreement with you regarding your outstanding tax, that reflects your ability to pay.

While we would advise you to report your failure to HM Revenue and Customs as soon as possible, it is usually a good idea to seek advice from an accountant or tax adviser first. After reviewing the situation, they may be able tell you how much tax you have failed to pay, how seriously HM Revenue and Customs will view your situation, and how best to approach HM Revenue and Customs.

If you cannot afford to pay for this advice, TaxAid may be able to help you. For more information, see Our advice service. Otherwise, click on the following link: Finding an accountant or tax adviser.

Once you have received this advice, the matter should be reported to HM Revenue and Customs. This may be done by you or the adviser. It should normally be in writing, as it gives the chance to present your case in full, explaining any personal reasons why you failed to declare the income, and to include accounts or summaries which indicate the level of income involved.

This should help to ensure that HM Revenue and Customs responds to you appropriately.

Tip from TaxAid

HM Revenue and Customs has established a confidential helpline
(0845 608 6000) which you may contact to discuss your situation, without revealing your identity.

This may be a good way of initiating contact with HM Revenue and Customs .

Once you have clarification from the helpline as to how HM Revenue and Customs will view your situation, you may decide to give them your identity and they will pass your case to a tax office to continue negotiations with you.

At the tax office, your case should be passed to an inspector who is trained to deal with enquiries (or investigations). The inspector will write back to ask for more information and documents, and/or to suggest a meeting to discuss the case. The inspector will also want tax returns completed, if necessary, for all the years concerned.

From this point, your case will probably follow a similar course to an enquiry under self assessment. For more information on this, See the Frequently Asked Question 'Why are HM Revenue and Customs asking questions about my tax return?'

HM Revenue and Customs does prosecute people for failing to declare their income, but there are only a few prosecutions every year.

• You are unlikely to be prosecuted if you voluntarily disclose your failure to HM Revenue and Customs before they have any suspicion of wrongdoing.
• You are unlikely to be prosecuted if you are guilty only of failing to declare your income. HM Revenue and Customs concentrates on cases where there has been further wrongdoing, for example the creation of fraudulent documents or the deposit of profits in foreign bank accounts.
• You are unlikely to be prosecuted if the tax evaded is small. Most prosecutions involve unpaid tax of over £50,000.

However, if you are prosecuted you could well face a prison sentence. So if there is any suggestion from HM Revenue and Customs that it might take criminal proceedings, you should seek legal advice immediately.

In almost every case HM Revenue and Customs will be seeking a financial settlement, which will be the end of the matter (although you may expect the tax office to take a closer interest in your tax affairs in future years).

A financial settlement is an agreement between you and the tax office that you will pay HM Revenue and Customs a certain amount to cover the unpaid tax plus interest and some penalties.

By law, the penalties may be equal to the amount of unpaid tax, although in practice they will be reduced:

• by up to 20% (30% in exceptional cases) to reflect the extent to which you have disclosed information about your income (especially if this is voluntarily)
• by up to a further 40% to reflect the extent to which you have cooperated in the enquiry, and
• by up to a further 40% to reflect the gravity of the case.

Note: The penalty regime is due to change in April 2009.

e.g. Graham has worked as a minicab driver since 2000 but did not declare his income. In February 2005 he became worried that the authorities would find out about him and so wrote to disclose the position to HM Revenue and Customs, enclosing accounts for all years. He cooperated in the enquiry. The inspector said he would be prepared to reduce the penalty by 20% for disclosure, 35% for cooperation and 20% for gravity, giving a total reduction of 75%. So he would want a penalty equal to 25% of the tax unpaid.

In practice HM Revenue and Customs will normally provide a calculation of the tax and interest due, and indicate the level of penalty that it would expect. You would then be 'invited' to make an offer to agree to pay the total sum. There is not usually any point in offering less than the amount indicated by HM Revenue and Customs.

Once the amount of the payment has been agreed, HM Revenue and Customs will draft a letter for you to sign, in which you offer to pay this figure, by a specified date(s), in full settlement of all matters.

The inspector may also want you to sign a letter stating that you have made a complete disclosure of all your income and gains. This should be taken very seriously. If it turns out later that you have not told the whole truth, you could face prosecution.

In the course of his enquiries the inspector will ask about your current assets and liabilities, and income and expenses. If you could not afford to pay all the tax, interest and penalties immediately, HM Revenue and Customs may accept an offer to pay it over a period of time, for example:

• within six months, if you are planning to sell your home to raise the necessary funds, or
• by monthly instalments, if you could pay it from your earnings over no more than a year or two.

If you have no valuable assets, and your income is not very high, the inspector may settle the case on a reduced number of years. Penalties may also be reduced. Once the enquiry is concluded, the case is passed to Debt Management and Banking to pursue payment of tax and interest in the same way as any other unpaid bill (see other categories under Can't pay your tax).

HM Revenue and Customs can normally go back 6 years - strictly the time limit is 5 years from the 31 January following the relevant tax year. If there has been fraud or neglect, the rules are different. Under current rules, HM Revenue and Customs can go back 20 years in these cases, from the 31 January following the relevant tax year. The rules before 1994 were different - in some cases allowing HM Revenue and Customs to go back further.