Keeping Dracula from the door

Keith Preece from Qdos Consulting looks at issues and behaviour which attract the attention of Revenue inspectors and could lead to investigations.

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A recent survey has discovered that the taxman is the most feared "bloodsucker". Shock! Horror! Those of us who work in tax, and those of us who have been the victims of tax enquiries, will not be surprised by this news. Freelancers work under the constant threat of being investigated by the Taxman, who has an expanse of legislative teeth at his disposal. Small companies live under the threat of IR35 and the Settlements legislation, but they are not alone. Unincorporated businesses, be they sole traders or partnerships, as well as companies, may fall victim to an enquiry into a Self Assessment Tax Return.

The Inland Revenue conducts both "full" and "aspect" enquiries into the tax returns of companies, partnerships and sole traders. These enquiries are worked by fully-fledged H.M. Inspectors of Taxes, who are trained in investigation techniques and are granted extensive powers under the Taxes Acts. These enquiries can be time-consuming, stressful, and costly in terms of professional fees, even if the victim is entirely innocent. Failure to co-operate can lead to disaster. Being honest will not protect you. The Revenue says that their enquiries are simply a checking device that has no preconception of guilt. So must we accept that a visit from the Tax investigator is inevitable, or are there protective strategies that can be adopted to ward off the 'Evil One'?

The answer is yes. Many Revenue enquiries are provoked by errors in returns, and many enquiries happen because of financial events or trends in business results that may be avoided or easily explained.

Errors

Here are some typical mistakes that will provoke enquiries from the Taxman:-

• Company accounts showing dividends paid of £40,000, but the director/shareholders declaring dividend receipts of only £30,000. The moral of this is: check that your personal returns are correct, even if they have been prepared by an accountant.
  
• A director's personal return showing salary received of £12,000, but the PAYE return shows he has been paid only £11,000. How silly is that? It does happen, and can be prevented by a simple process of checking that the returns agree.
  
• A sole trader misses an interest-bearing account from his tax return. It has been taxed at source, and the trader is only taxable at basic rate, so what is the problem? Later he introduces to his business savings from that account. The Inspector asks about the source of the capital introduced and is told that the source is an account that has not been declared. This will provoke a full enquiry, and the Inspector will want proof of the origin of every penny invested in that account.

Trends

There are common business trends or events that will often provoke unwanted enquiries from the Revenue, and it is wise to explain their cause to the Revenue at the time the Return is submitted, with a view to putting the Inspector's mind at rest.

• Significant year-to-year declines in turnover.
  
• Declines in the rates of gross or net profits.
  
• Estimated or round-sum expenses.
  
• Significant increases in expenses.
  
• Large subcontractor payments.
  
• Bad debts.
  
• Declining drawings.
  
• Capital introduced.
  
• High levels of debtors or creditors.
  
• Large or "private" loans.
  
• Any unusual balance sheet entry, such as "deferred income".

Business Records

If the worst comes to the worst and you are investigated, it will be a great help to you and your professional adviser if your business records are complete, correct and clear. The Inland Revenue publishes booklets on this subject, and any reputable accountant or tax consultant should be able to advise you. Good business records will protect you against the negative effects of tax enquiries.

Businesses that are paid in cash, or may be suspected of receiving cash, are especially vulnerable. Have you ever wondered why virgins wander around churchyards late at night, wearing only their nightclothes and a gormless expression? Well the Inspector wonders why people in cash trades fail to keep proper business records. He does not complain too much however, because they are his life-blood. It is essential that such traders keep a record of every single transaction, and that any marked trends in business performance are monitored and explained. For instance, a high level of wastage of stock or materials will affect profitability, so it needs to be recorded.

Keith Preece