The true cost of compliance

Recently the newspapers have been reporting the case of a West Country businessman who was left with a £770 bill for professional fees, following an Inland Revenue enquiry that had revealed an underpayment of just 8 pence. This is not news. Complying with the tax regime has always been a heavy burden, in terms of physical effort and mental anguish, as well as accountancy costs, irrespective of whether you have done anything wrong.

Local tax offices are given annual "take up" targets, which oblige them to begin a set number of full and aspect enquiries each year. Of course, begin does not mean complete. They will have to take on a similar number of cases in the following year, irrespective of how many old cases remain unfinished. Few full enquiries are completed within 12 months. Many drag on for years.

Full enquiry

A full enquiry is exactly that. The Inspector will investigate your business affairs, which means wanting to know precise details of how the business operates, your profit margins, discounts and wastage, debtors and creditors, bank accounts, stock on hand, cash in hand, and all of your overheads. The Inspector will want to see your till rolls. Did no-one say you had to keep them? Oh dear! You will have to produce all of your business records for examination, including all invoices and receipts, sales ledger, purchase ledger, bank statements, cash book, petty cash book, details of private motoring, and a record of your personal drawings, the whole lot. Failure to keep proper records could lead to a fine of up to £3000. The investigation could also extend into all aspects of your personal Tax Return and your private affairs.

In addition to examining your business records, the Inspector will often ask to see all of your private bank accounts and undertake a full "private side review". The Inspector might want to conduct a cash-flow test, a business economics exercise and a means test. He might ask you for a certified statement of personal assets and liabilities. Then there will be the face-to-face interview. After all of this, if the Inspector feels that something is not quite right, and you cannot prove that everything is right, you may face the prospect of funding a settlement. If something is deemed to be wrong, the Inspector will normally want to review six tax years, and the additional tax bill will be supplemented by interest and penalties. The maximum penalty is 100% of the additional tax.

Aspect enquiry

An aspect enquiry will often begin as a seemingly harmless question about the private use of a business asset or the source of a business loan. It is not unusual for an accountant to reply confidently to such a question, assuming that the enquiry will be quickly concluded, only to be met with a peremptory demand for all of the business records. Thus an aspect enquiry has been seamlessly transformed into a full enquiry.

Did you hear the story of the tax investigation into the farmer that had dragged on for four years, but despite having found not one error or irregularity, the Inspector refused to close it down? The Inspector's reluctance to let go of the case was based upon the fact that when he had paid a surreptitious visit to the farm, he had seen two dogs running about in the yard, but at the interview the farmer had said he owned only one dog. I suppose the Inspector's reasoning was that if the farmer had lied about the number of dogs he owned, he might have lied about all sorts of things. Curiously the Inspector had not bothered to challenge the farmer on this point; he just sat in his office harbouring dark suspicions. One wonders why so conscientious an investigator had not asked to interview the dogs concerned.

The costs of paying your accountant to defend you against a long-running tax enquiry can run into thousands of pounds. But what about the cost to the public purse? As taxpayers we are all funding the Revenue's compliance programme. Should we really have to foot the bill for prolonged investigations that result in no additional tax? I suppose the answer to this question depends on whether the Revenue has a good reason for taking up the enquiry in the first place. But as things stand the tax authorities do not have to give reasons. They can run up substantial costs for their "victims" and the general public without any explanation whatever.

In March 2004 the Chancellor announced a new compliance package for the Inland Revenue, including an investment in "extra specialist staff" and "new systems...to improve performance". Let us hope it is money well spent.

Keith Preece

Senior Tax Consultant

Qdos Consulting Ltd