Why this report has been written
This report has been written as a warning! There have been a number of worrying developments over recent years and when combined with established Revenue practices means that investigations can no longer be ignored.
Important – your systems need to be very good.
Revenue inspectors use a practice called “breaking the records” – in plain English the taxman scrutinises your bookkeeping to find mistakes! If any are found, even if they are relatively minor, the taxman can simply say that they are not satisfied with the accounts.
We are then embroiled in a formalised investigation process until the tax man is satisfied – this can be a lengthy and expensive experience. Often you may be encouraged by the Revenue to negotiate a settlement when none may actually be due, just to get the investigation closed. To protect yourself you need to have strong and robust financial systems.
We believe the most effective way to achieve this is to purchase and use good bookkeeping or accounting software. We are issuing this warning because we have a duty of care to advise clients and offer help where we believe there is a risk. Today the tax office is more likely than ever to investigate your returns and accounts, and under the Self Assessment rules fines can be imposed for just failing to keep good records.
This report is primarily designed for small businesses which use manual or spreadsheets to do their bookkeeping. However, businesses that have a computer system can also be vulnerable to attack if the software is not used correctly. The problem with manual and spreadsheet systems is they have no built in controls and checks, which the taxman expects as a minimum.
This means small errors and mistakes can easily be made and even if there are no mistake the lack of controls means the taxman can always undermine the information. If you are using a computer system but not using it correctly it could be that the built in controls and double checks are not being used correctly.
As you will see, this report identifies the key issues relating to tax investigations and uses jargon free language to explain them. By reading this report it will give you the inside track on how tax investigations work. You won’t become an expert but you will understand why you need to take action now to ensure your bookkeeping is robust enough to withstand a Revenue audit. As a minimum you should seek independent advice to find out how weak or strong your financial systems are, and if needed you should improve your record keeping and possibly take out an insurance to cover the professional fees of defending an investigation.
The good news is that improving your accounting records will not only make your defence of a Revenue challenge that much easier, you will also gain a number of “knock on” benefits. These include:
Better management information – would you like to know who owes your money? Would it help if you knew how much profit you made last month?
Improved levels of control – would it be good to know what’s in your bank before looking at the bank statement? Would it be helpful to see your VAT bill building up?
Quicker cash collections from your customers – if you know who owes you money you can chase them quicker.
Less time spent doing the books – you could potentially save thousands of pounds of your time
Fewer questions from us – at the end of the year we’d like to have only a few questions for you to deal with
Better levels of service from us - we will be able to produce mortgage references quicker
Easier access to additional professional services such as tax forecasting and advice on your business and financial planning.
Why do Investigations start?
Investigations can be started on a random basis – your name can just pop out of the hat! There are however some factors which could increase the risk of you being selected. Make sure you don’t draw attention to yourself by:
Obvious mistakes in your return
Sending your tax return in late
Paying your tax late
Sending two tax returns in at the same time
Fluctuating profit margins and other accounting ratios
Mistake with employer regulations
Large benefits in kind to employees, particularly directors
Loans to directors and/or participators
Overseas issues
Large balance sheet adjustments
Cash trade
Business in a sector being targeted by the Inland Revenue
Disparity between money taken from the business and private living expenditure for owners/directors
Complex technical issues
Qualified accountants report
Although the risk of selection cannot be eradicated completely, it can be reduced by taking the following actions:
Ensure that Returns are submitted and payments made on time.
Check submissions carefully to avoid obvious errors
Consider the factors that are likely to attract Revenue attention; review them to identify potential problems in advance. Provide additional explanation or information where it might assist the Revenue officer's understanding of what has happened, particularly if the results appear unusual.
The inside track about Tax Investigations
It’s true: Tax Investigations are a nightmare, no matter what the Taxman says. Quote from HM Revenue and Customs publication – “when we start an enquiry it does not mean that we think you have done anything wrong. We check some tax returns to make sure they are right or if we need further information to understand the figures.
We also and only select tax returns for enquiry to ensure the system is operating fairly” Source IR160 This sounds pretty friendly, almost like a service. But make no mistake about it, the reality is very different! Investigations are by their nature confrontational and very stressful. The technical name for an investigation is an enquiry and if you are investigated you need to know if you have a “full” or an “aspect” enquiry.
An aspect enquiry focuses on a number of specific aspects regarding your accounts or tax return. A full enquiry looks at potentially all of your return and accounts, in depth! Hopefully you will now see why investigations start, the way investigations are structured and what you can do to protect yourself.
We would also like to draw your attention to the following points:
Warning 1 - You have no choiceYou can not prevent a tax investigation. If you are selected you MUST comply with the inspector’s proper requests for information.
Warning 2 – You are guilty until proven innocentUnlike the application of common law, tax regulations treat you as guilty until you prove yourself innocent. Remember, under the current tax system (known as Self-Assessment) you assess yourself and have a legal responsibility to make sure your tax affairs are correct. As you will discover later, even a minor mistake on in your bookkeeping will be seized upon as “proof” that there is a problem.
Warning 3 – the taxman can go back six yearsIf there is a problem with one year and the taxman can show that it is “likely” to occur in previous years they can raise a bill going back six years and add interest with penalties. The interest is based on bank rate but penalties are left to the discretion of the inspection and can be up to double the discovered tax arrears. So a £1,000 mistake can result in a tax bill for one year of £400. Multiply that by six you get £2,400. Now add on a penalty and interest and you could have a final settlement of £4,800. Take note that all the taxman needs to do is show that there are reasonable grounds for believing errors would have occurred in past years based on the results of their investigation in the current year. They do not have to find actual errors in past years!
Warning 4 - The taxman has more timeThe Self-Assessment system has freed up time for the tax office to do more investigations. In 2008 many more tax returns will be submitted online so there will increasing savings in processing time. This again will free up time for investigations.
Warning 5 - The Tax Inspector is well trained If you are selected for an investigation you will be expected to attend a meeting as part of the process. Although you are not legally obliged to attend, if you do not the Revenue may assume that you are trying to hide something. If subsequently it is discovered that there is extra tax to pay, this could increase the level of penalties charged. Also, if you do not attend a meeting the Revenue may find grounds for calling a meeting of the Commissioners. At this meeting you or your representative may have to answer questions under cross examination which can be hugely stressful and costly. The problem with attending a meeting is that the inspector is trained in interview techniques. Leading questions can result in you opening yourself to an attack even where there is no problem.
Warning 6 - The Tax Office has huge resources and powersRemember the Tax Office has wide ranging powers and almost unlimited resources. The Revenue can afford to invest time testing and analysing your records and asking lots of questions. The taxman will use the resources to their advantage in an attempt to grind people into submission - and to accept extra tax bills just to get the investigation closed down. The VAT Office even developed their own software called SPACE used to interrogate spreadsheets and find mistakes. This is now available for tax investigations.
Warning 7 - Inspectors are on a bonusHM Revenue and Customs pay bonuses on tax collected from investigations and there are internal targets for gathering additional revenue. Amazingly a settlement (extra tax) is expected in 76% of investigations. This means three in four people will be paying additional tax and extra accountancy fees to defend the Revenue’s claims. The average Investigation lasts 18-months; results in a tax settlement of £3,000 and costs £3,000 in professional fees.
Warning 8 - Information gathering and sharingThe Tax Office and VAT Office have been combined and because they are now under one roof they can share information. The Internet is a great tool for research and electronic data is more widely available.
Warning 9 – Business Economics ModelsOne strategy used by the Taxman to try to gather in more tax revenue is to argue that the business profits are understated based on business economics models. The taxman compares your business to information they have about your industry or sector. The main attack is often based on gross profit margin comparisons. If your books are accurate and based on sound accounting principals you will have a better chance of defending against unrealistic comparisons based on a business economics model. Conversely if your books are inaccurate you will find it difficult to defend your case.
Warning 10 – Interventions There is a "new game" in town, HMRC Interventions! The Revenue are trialling a new approach with their customers (taxpayers), the stated objectives being:
a review of current record keeping, to make sure they meet HMRC standards.
a short risk review.
self audit of tax returns, i.e. phone calls or letters requiring taxpayers to consider changes to their returns.
correction challenges - where the Revenue have good quality information, from banks etc, they will simply change your return and ask you why the information returned was incorrect.
Initial contact may be by letter or a telephone call. At the moment this is a trial so the Revenue have no powers to compel you - they can only do so with your agreement and co-operation. However, some people think that not co-operating can raise the interest of the Revenue! Like the standard investigation, without proper professional support, and without good underlying accounting records, this approach can quickly lead to a full blown investigation.
Warning 11 – Higher targetsThe tax office wants to collect an extra 25% tax from investigations in 2007. With government finances under pressure maybe more resources will be put into this activity. 4 What you can do to protect yourself?You can’t prevent a tax investigation starting but you can reduce your chances of being selected. For instance:
We believe that due to our reputation with the tax office you are less likely to be investigated.
Whilst completing your accounts we automatically carry out risk management checks to highlight areas of concern. If necessary we will discuss these with you.
We can recommend additional disclosure notes on tax returns to pre-empt questions.
We will manage your tax affairs and help you ensure your accounts and tax return is sent in on time.
We can help by providing free bookkeeping software and support to make sure your records are accurate. We can provide this for no charge as it saves time at the year end.
We can give you mid year or quarterly tax forecasts so you can budget for tax bills and make sure you are able to pay your tax on time.
We know the detailed rules and procedures of investigations and can help you if you are investigated.
What are you going to do?
You have three choices:
1.Do nothing and take the risk
2.Make good use of bookkeeping or accounting software
3.Take out some insurance and cover some of the risk
We believe that if you do nothing, unless you are very lucky you will eventually fall foul of the investigation process, and your lack of good evidence in the form of accurate accounting records will prejudice your case. Bearing in mind what can go wrong and how easy it is to avoid the problem we obviously don’t think doing nothing is a good idea. This is why many firms like us have a new policy - if you decide to do nothing and you are selected for an investigation we will ask you for an up-front deposit of £1,000 to represent you. This is not want we want to do but we have no choice because of the changes. Instead, we think the best choice for you is a combination of insurance and assurance supported by us.
Insurance – professional fee insurance will cover our fees representing you. This means we can argue on your behalf for as long as the taxman wants.
Assurance – producing good quality bookkeeping by using software will mean we can argue and defend you aggressively.
Keep in mind we are able to provide you with a specialist insurance and we have the capability to give you free bookkeeping software and support. We can also offer advice on selecting and purchasing more complicated accounting software and if you want we can even do your bookkeeping for you.
Copyright Notices No part of this publication may be reproduced or transmitted in any material, including photocopying or storing it by any medium by electronic means and whether or not transiently or incidentally to some other use of this publication, without the written permission of the copyright owner. The reader is authorised to use any of the information in this publication for his or her own use only. Legal Notices While all attempts have been made to verify information provided in this publication, neither the author nor the publisher assumes any responsibility for errors, omissions, or contrary interpretation of the subject matter given in this publication. The reader must accept full responsibility for determining the legality of any and all ideas adopted and enacted in his or her particular business, whether or not those ideas are suggested, either directly or indirectly in this product. Do not attempt to implement any strategy outlined or implied by this publication without first talking to your accountant.
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