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Minimising the risk of enquiry. By Kevin Igoe

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11th Apr 2006
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There has been much talk since the budget of HMRC's stated intention to reduce the number of enquiries. But there is no indication that HMRC intends to reduce the targets for collecting extra tax. Indeed, HMRC is still expected to collect more overall. Kevin Igoe of PFP examines areas which most commonly increase the risk of investigation, and how the risks can be mitigated.

It is one of life's ironies that on one hand the stated intention of HMRC is to ensure only the correct amount of tax is paid and on the other have a target that is designed to prove that over three quarters of those selected are not paying their due. HMRC has published targets to collect tax in 78% of full enquiries. However, it is currently achieving 80%.

Almost all accountants and their clients would wish to avoid an enquiry. Some enquiries are unavoidable. For example, a return featuring a capital disposal of shares in a close company can be expected to be subject to an aspect enquiry. There is little that can be done other than to warn the client before the return is submitted that such an enquiry is likely. Yet significant numbers of enquiries are caused each year by academic and avoidable errors. It should be remembered that when HMRC receives a return the figures are entered on the computer and risk assessed. Relatively few of the returns are read with a view to launching an enquiry. But, by bringing HMRC's attention to a return, the risk of an enquiry is increased.

There are a number of items which will result in a review. This does not guarantee an enquiry but it certainly increases the risk significantly. HMRC do not give a reason for launching an enquiry, but through experience we have seen a number of common features emerge.

Late Returns
The submission of late returns can bring HMRC's attention to a client. The later the submission, the higher the risk. In the event the return is over 12 months late a mandatory review will occur.

Don't forget that the submission of late returns extends the enquiry window. This is a fact that those clients who are tardy in supplying information should be reminded of.

Late Payment of Tax
If tax is outstanding, the collector has been known to send reports to the accounts inspector following visits to the taxpayer's house or business. They have commented on such things as the quality of the cars parked outside.

Omissions
Bear in mind the Revenue receive information from a number of sources, such as banks and the National Lottery. Banks give details not only of interest received but also PEPs, TESSAs, ISAs, etc (for non taxable sources they are looking to check where the capital has come from). A careless omission from a tax return of taxable interest can attract interest from the Revenue and we see a number of enquiries being launched as a result of this information held.

As a general guide the opening letter may feature a paragraph asking for confirmation that all sources of income have been declared. If you see this type of paragraph it can be assumed HMRC thinks they have something already. It may not be correct information but experience dictates it usually is. If investment income is mentioned this can be bank interest. If a more general question is posed this may refer to income from property.

Use of the Additional Information Box
There is some debate about whether completion of this box increases or decreases the risk of an enquiry. Some have commented that local HMRC's don't even read the box. However, this is not such a 'black and white' matter. In our experience it depends upon what the box actually says.

We have seen a return completed where the accountant has clearly been concerned with the client's record keeping to the extent they wished to comment on the return. It was stated that the return contained figures provided by Mr X. The accountants were unable to check any of these in the complete absence of records. The return was unsurprisingly selected for enquiry. It may be debateable whether such a disclosure was necessary but clearly this did increase the risk of an enquiry. As a general rule, if the disclosure highlights almost certain weaknesses in the return an enquiry can be expected. However, what of more general comments? We have seen a number of comments explaining variances in the GPR. For example, a local convenience store may have a supermarket open next door.

The writer does not believe such general comments increase the risk but may help, albeit in some small way, to avoid an enquiry. Even if not intending to make any disclosure it is often good practice to have sensible explanations ready just in case.

Dealing with Aspect Enquiries
It is possible for an enquiry to move from aspect to full i.e. for HMRC to move from a request for information concerning one or two entries on the return to a full scale all books and records review. However, they cannot do this without reason.

There can be a temptation to treat aspect enquiries as something less than important. We have seen a number of aspect enquiries being extended to full enquiries just because full responses have not been given or even no response has been received within the given timeframe. As a general rule, if it is not going to be possible to reply to the initial enquiry let the Inspector know both over the telephone and in writing.

Estimates/provisional figures
If there is an indication that figures have had to be estimated or are provisional, this could again be of interest to HMRC. It may suggest to them that accounts have not been finalised because there are problems with the records, or perhaps the taxpayer does not take his tax affairs as seriously as he should.

If the return is marked provisional and no indication is given to HMRC of final figures ' or indeed that the figures originally submitted can be considered final ' HMRC will look to issue an enquiry notice before the enquiry window closes.

Round sum estimates do, of course, bring added scrutiny.

Sometimes this cannot be avoided but it is worth stressing to clients that they need to provide information in good time and keep adequate records.

Errors/Mistakes
This really speaks for itself. If mistakes have already been acknowledged HMRC will certainly take a close look at the accounts etc.

Incidentally, be aware of the position when submitting amended returns. Once the original enquiry window closes, HMRC can only raise an enquiry into the amended aspect of the return.

Stock/WIP
It is generally accepted that accounts are prepared on an accruals basis. HMRC will look for evidence of such.

They will look for evidence of stock held or the WIP at the year end. If they think that no adjustments have been made they may start an enquiry.

The defence of 'we have always done it like this' is not going to be of use.
In the days of 78% targets, to offer a guaranteed result at the outset may be too tempting for HMRC.

It is surprising how many enquiries feature arguments over the use of the 'cash basis'.

Private Use Adjustments
HMRC like to see expenses disallowed in returns and tax computations. It is therefore important to show these separately. Although it may be tempting to 'net off' the disallowable items (such a private motor expenses) HMRC may be inclined to feel that there has not been any set off.

Incorrect Statement of Assets/Certificates of Disclosure
If a previous enquiry has taken place, HMRC may well have asked for Statement of Assets to be completed. This is a declaration of all assets held. If adjustments to the declared profit have been found necessary a Certificate of Disclosure may be requested. This is a declaration that everything has now been declared correctly and fully.

If any information subsequently comes to light that suggests either of these have been incorrectly completed, HMRC can be expected to take a very dim view.

The above points are not intended to be an exhaustive list of enquiry triggers but merely highlighting a number of areas in which it can be possible to avoid an enquiry.

Risk Management ' A Summary

Area of Risk What can be done?
Late Returns Agents should have a well managed tax return completion programme. Clients should be contacted as soon as possible after the year end and asked to submit the required information. The appropriate follow up procedures should be in place. They should be informed that submission after a given date will not guarantee the return will be submitted on time and explained the increased risk of an enquiry and the extension of the enquiry window.
Late Payment of Tax Clients should of course be told when and how much tax is payable. If it cannot be paid on time the Collector should be contacted and suitable arrangements agreed.
Omissions An annual comparison should be carried out with the previous years return to ensure all sources of income have been included. Clients need to be reminded it is ultimately their responsibility and of the increased risk of enquiry of even simple omissions.
Use of Additional Information Box Agents should decide whether an entry is necessary. If so the risk of enquiry should be explained to the client.
Dealing with Aspect Enquiries Prioritise these enquiries. Highlight possible enquiries prior to the submission of the return to have answers ready where possible. Ensure required information is submitted on time. If more time is needed let HMRC know before the deadline is reached. Explain to client the implications of not giving complete and satisfactory answers.
Estimates/Provisional Figures Ensure client is aware of the increased risk of enquiry and the extension of the enquiry window. Where provisional figures are submitted set out a timetable for submitting final figures or confirming to HMRC the original figures may be considered final.
Errors/Mistakes Notified It should be stressed to clients the importance of ensuring everything is correct. If errors subsequently arise they should be notified in the appropriate way and the client informed of the increased risk of enquiry.
Stock/WIP Accounts to be prepared on the appropriate basis. Adjustments to be made for stock/WIP.
Private Use Adjustments Do not net off disallowable expenses against overall expenses but show separately. Ensure private consumption is shown.
Statements of Assets/Certificates of Disclosure If asked to complete such a form ensure it is appropriate to do so. If so, client must be advised, in writing, of the implications of the form being incorrect or incomplete.

Kevin Igoe has been claims manager at Professional Fee Protection for ten years and has been involved with nearly 7,000 investigations and disputes. He has previous experience with an international accountancy firm and also the Inland Revenue. The above represents his opinions and is intended as a guide only.

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By lorraine.hickson.bennettb
12th Apr 2006 13:07

Inland Revenue Enquiry
We have a soletrader client under enquiry. All the business records such as the business bank statements, sales invoices, etc have been provided to the Inspector. Shown on the bank statements are a number of transfers of money into to his wife's private bank account. The money is for housekeeping. The Inspector has requested sight of the wife's bank statements with a view to identifying all deposits made in that year - she has not recieved an enquiry notice.

I have reviewed the Inland Revenue manuals and there is no guidance to such a request. Has anyone come across this before and do we have to provide this information?

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By kotcisthedon
12th Apr 2006 14:21

Just say NO
There is no reason to give anything relating solely to the wife. The payments being made are not being claimed as tax deductible, and therefore it should be argued that they do not form part of the tax return, which in general is the criterion for requesting books and records. Will the inspector also ask for the statements of all the suppliers your client has?

Insist that the Inspector issues a separate enquiry notice on the wife's return if he wants to see ANY information that is personal to her.

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By anver
16th Mar 2007 19:32

unidentified bankings into a personal bank account
I came a cross a case afew years ago where Revenue wanted to charge as additional income some unidentified bankings that had been made into a self-employed's personal bank account.

However Commissioners held that the Inspector could not assume that these bankings were income and therefore rejected the argument.

Has anyone else come accross this case as I cannot remember the name or details?

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