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TaxZone Newthwire 52: The Accountant's Tax Affairs

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1st Jan 2005
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TaxZone Newthwire
Issue 52 - 26 May 2004 - The Accountant's Tax Affairs
Available on subscription at:
https://www.accountingweb.co.uk/premium_content/newthwire


Editorial note
John Newth
Most practising accountants are overworked and workaholics. When they have dealt with their clients' affairs there is one further job to be done - their own accounts and tax returns. Because this job is likely to be left until last, the accountant, particularly if he is a sole practitioner or in a smaller practice, is likely to be vulnerable in a number of ways. I shall seek to explore some of these in this wire.

Regards,
John T Newth
mailto:[email protected]

Disclaimer
==========
No responsibility for loss occasioned to any person acting or
refraining from action as a result of any information in this
wire is accepted by the author or AccountingWEB. In all cases,
appropriate professional advice should be sought before making
a decision.

Regulation
==========
First of all one must mention regulation. This has increased
dramatically over recent years, and for a small accountancy firm
is a real deterrent to entrepreneurial activity.

If the accountant is a member of a professional institute, he or
she will be bound by the code of ethics of that body, and may
have to obtain and pay for a practising certificate. The members'
handbook of the particular body is likely to be quite extensive.
Failure to observe basic rules will result in disciplinary
proceedings by the investigation body of the particular institute
or association.

One universal obligation is to take out professional indemnity
insurance against possible financial claims by disgruntled
clients.

There are also strict regulations imposed by the FSA if the
accountant engages in advice regarding pensions, insurance and
investments. These are beyond the scope of this wire. Similar
regulations apply to those who specialise in liquidations and
receivership, charities work and/or management consultancy.

Other disincentives to practice include employment law, health
and safety regulations and the Data Protection Act.

However, having mentioned all these issues, I want to focus on
the accounts and taxation affairs of the practising accountant.

Money laundering
================
I only want to touch on the subject of money laundering, as I
have already had my say in Newthwire No 38, and the 'nuts and
bolts' of this subject are dealt with on the site very ably by
David Winch.

Nevertheless this subject has had an immense effect on the
profession. All new clients must be 'vetted' and asked for
embarrassing identification. The accountant or a member of his
staff must be appointed Money Laundering Reporting officer, and
every client transaction involving funds comes under potential
suspicion.

This situation is exacerbated when the accountant has some part
in a client's financial transaction, either in the form of advice
or actual financial participation. The use of a clients' bank
account, already subject to strict regulation, has the potential
to lead the accountant into trouble. Enough said, but this aspect
will remain a very important one until the draconian laws and
regulations are changed. The salutary tale of former solicitor
Jonathan Duff, who was imprisoned for six months under the money
laundering law and regulations, is sufficient warning for us all
to comply at present or cease practice.

Accounts
========
Larger firms of accountants are likely to have an administration
partner who, inter alia, will be responsible for the books and
accounts of the firm. Smaller firms are likely to rely on a
bookkeeper for routine transactions, while a partner or sole
practitioner prepares the final figures. In some cases the
practitioner himself will do all the work.

One hardly needs to remind practising accountants of the need to
keep proper books of account and to comply with section 12B,
Taxes Management Act 1970, but the possibility exists, however
faint, of a full random audit under the self-assessment
provisions, meaning that the books and accounts will be actually
examined by the Inland Revenue. The tax fine for not keeping
proper books of account is a mitigable amount up to 3,000 pounds.

PAYE matters
============
In a small firm the payment of salaries and the administration of
PAYE is likely to be dealt with either by the practitioner
himself, or someone outside the firm. It could be the wife or
partner of the practitioner. It should be remembered that any
firm may receive notice of a PAYE Audit, purely on a random
basis. Any errors or defaults found could be reported to the
Schedule D inspector and lead to a general self-assessment
enquiry.

Accountancy firms of all sizes may use either agency staff or
subcontractors in connection with technical work. Where
subcontractors are treated as self-employed, it is essential that
the contract and facts stand up to Revenue scrutiny. If not, any
PAYE Audit or Schedule E Compliance Visit could lead to an attack
by the local status inspector.

In a smaller practice, the spouse or partner of the
practitioner(s) may be involved in the practice to one extent or
another. If treated as an employee, it is important that PAYE is
operated correctly. Payment should actually be made, and the
salary agreed be commensurate with the responsibilities
undertaken and number of hours worked. Unusually, the wife or
partner could be self-employed (i.e. if providing computer
services), in which case the usual contract and self-employment
criteria should be considered.

Accounts items
==============
I shall now turn to items in the accounts and tax returns that
may be controversial, or invite the attention of the Inland
Revenue.

Work in progress
================
Traditionally, work in progress for a smaller firm of accountants
has always been valued on the basis of the cost of employee time
and overheads, including administration. Partner's and
principals' time has always been excluded. Obviously, the basis
of calculation at the accounts year end should stand up to
scrutiny.

There has been a recent controversy about an amendment to
Financial Reporting Standard 5 (FRS 5). Some commentators believe
that, in the future, work in progress will have to be valued at
full market value, inclusive of partners' and principals' time.
Others do not believe that FRS 5 has any application to
unincorporated businesses. The debate continues, but it does seem
that the Inland Revenue favour the view of Robert Maas, who
considers that nothing has changed.

Corporate hospitality
=====================
Many accountancy firms now use corporate hospitability as a
valuable marketing tool. It is important that such items are
recorded correctly in the accounts, and only claims for tax
purposes valid under law are made.

Motor vehicles
==============
Partners and perhaps staff will use motor vehicles in connection
with the work of the practice. In the case of staff, the practice
must make a decision as to whether the firm will supply a motor
vehicle, in which case the employee will suffer a benefit in kind
imposition. Alternatively, if the employee owns the vehicle,
reimbursement can be made at the agreed tax rates on a mileage
basis.

In the case of the principal or partners, different criteria will
apply. They may own their own vehicles personally, and charge the
practice based on mileage records. What they have preached to
clients about keeping a mileage record will apply to them.

In other instances the practice will own the motor vehicle, and
the total expenses will be debited in the accounts, with an 'add
back' in the tax computation. The percentage add back must be
based on evidence of business and non-business mileage, and will
be recorded in the Standard Accounts Information section of the
tax return, as well as the tax computation. This is an example of
the Revenue giving tacit agreement to 'duality of purpose'.

Use of home
===========
Another dual purpose claim may involve use of the home for
business purposes by the practitioner. Unusually, he or she may
be based at home. In other instances, some of the work of the
practice will be performed there, perhaps to preserve privacy and
the need to eliminate office distractions.

A claim may then be included in the accounts for use of home,
based on the usual criteria. Despite recent Revenue statements, I
still submit that it is possible to make a reasonable claim and
retain CGT exemption.

Technical issues
================
The concept of adherence to accountancy principles has become
much more widespread and is recognised by Revenue inspectors.
Some transactions will be judged on this criterion. For instance
in the case of the well-known solicitors, Herbert Smith, a claim
was made for a deduction for a provision against future rents in
connection with a property that the firm was vacating. The firm
won their case in connection with this deduction in the High
Court (see Herbert Smith (a firm) v Honour [1999] STC 173).

Susceptibility to investigation
===============================
We now turn to the question of the susceptibility of the
accountant to Revenue Enquiry and investigation. It is ironic
that, despite the fact that accountants spend much of their time
preventing clients from being investigated or helping them when
they undergo an enquiry, an accountant is equally susceptible to
investigation. The following are some of the triggers for
investigation.

Type of client
==============
If an unusual number of clients of the practice are investigated
by the Revenue, the attention of the Revenue may turn to the
accountant himself. In extreme cases, it may transpire that the
accountant has committed a tax default personally in connection
with client matters.

The Revenue then has the power to impose a tax penalty of up to
3,000 pounds under section 99, Taxes Management Act 1970. Almost
certainly this will be followed by a section 20 notice to examine
all client files.

It should be noted that section 99 is not limited to the
principal or partners of the firm concerned. It could apply
equally to a tax manager, a junior tax clerk or someone in the
accounts department of the firm concerned.

In less serious cases, the Revenue may consider an alternative to
imposing a section 99 penalty. They may 'do a deal' to the effect
that no further action will be taken if, either the accountant
ceases in practice immediately, or he makes immediate plans to
sell the practice. This is entirely up to the Revenue inspector
involved.

In serious cases the Revenue may even consider prosecution of the
accountant, and it should be noted that a section 99 penalty may
only be imposed by SCO following reference to the Revenue's
Standards Office.

There are extremely serious professional consequences to the
imposition of a section 99 penalty. First, clients may sue for
professional negligence and the PII insurers must be notified at
an early stage. If the accountant (or clients) are covered under
a professional fee protection policy (see below), this will be
another area where negotiation must take place. In theory, cover
could be withdrawn in all cases because of the facts.

The imposition of a section 99 penalty will also come to the ears
of the professional institute involved. In consequence the
accountant will face disciplinary proceedings under the rules of
the body, and could:

# Lose his or her practising certificate.

# Be suspended from practice for a period; and

# Suffer a fine from the institute.

# Be excluded as a member of the institute.

Random audit
============
Accountants are just as likely to undergo a 'random' self-
assessment enquiry as anyone else. I know two well-known people
in the tax world who have suffered enquiries already. The
suspicion exists that their standing and public views may have
had some bearing on the Revenue's decision to investigate, but
that is pure conjecture.

However, every accountant must accept that an enquiry could take
place. This could be purely an 'aspect' enquiry, or full
investigation, either random or due to some item in accounts or
returns that has come to the attention of the tax inspector.

Delay
=====
Most accountants in professional practice are under time
pressure, particularly at key times of the year involving self-
assessment, the Budget, and Tax Credit claims.

This is of particular relevance to sole practitioners and smaller
accountancy firms, and situations may develop that produce delays
in submitting the practitioner(s) own accounts and tax returns to
the Inland Revenue. The impact of personal ill health could also
affect the accounts and tax returns of a sole practitioner, even
though he or she may have arranged 'peer group' assistance for
such an eventuality.

Failure to file accounts and tax returns on time will produce a
fixed penalty fine, but could also be a trigger for an enquiry
into the accountant's affairs.

Tax planning
============
The use of sophisticated tax avoidance and tax planning schemes
on behalf of clients that go to the very edge of the law will
bring an accountant to the attention of the Inland Revenue. One
is not referring to tax evasion in this context, but legal tax
avoidance.

Unfortunately, in the perception of the general public, Inland
Revenue and government, tax evasion and tax avoidance now appear
to be indistinguishable, and this perception has spread to the
courts of law. The niceties of tax law and practice will be alien
to lawyers and judges in the criminal courts, who will deal with
any perceived negligence or fraud on the basis of criminal law
criteria. This subject is referred to in Newthwire No. 48 on
Fraud, Prosecution and Searches.

As illustrated in that wire, regular use of legal avoidance
schemes could make the accountant personally liable to enquiry
and investigation. In some instances such schemes may be
challenged by Special Compliance Office and the actual
involvement of the accountant may come under scrutiny.

In extreme cases, the involvement of the accountant in a scheme
could lead to criminal prosecution by the Revenue, and
practitioners need to be extremely careful of their involvement
in schemes at the edge of the law. This was illustrated
dramatically in the case of R v Cunningham, Charlton, Wheeler and
Kitchen [1996] STC 1418, where three accountants and a barrister
were involved in a tax planning scheme that 'went wrong'.
Following criminal prosecution all, including a chartered
accountant and the barrister, received custodial sentences.

This particular case has caused considerable controversy in
professional circles, but is a clear warning to the accountancy
profession. The performance of defending criminal counsel in the
court may be as important as tax law and facts. Ken Dodd
demonstrated this aptly when defending himself some years ago,
and has continued to bait the Revenue about this in his one-man
shows.

Matters have now moved even further forward as the provisions of
the 2004 Budget include a requirement for taxpayers and their
agents to notify proposed 'tax avoidance' schemes to the Inland
Revenue, and, in effect, gain clearance before matters proceed.
It is far from clear how these requirements will actually work in
practice, but they are an illustration of the current Inland
Revenue and political climate.

VAT defaults
============
There is now official co-operation between Customs and Excise and
the Inland Revenue, and this will increase further as the
Departments merge. Any defaults picked up by Customs
investigators during a routine visit will be notified to the
Inland Revenue, who will then mount their own enquiry. The
converse also applies.

Technical issues
================
Technical arguments over the basis of entries in the accounts and
returns of an accountant will lead to an 'aspect' enquiry. Indeed
it is the only way that the Revenue now has of challenging
accounts and returns.

Business status
===============
Many accountancy practices now trade as limited liability
partnerships (LLPs). In other instances all or part of the non-
auditing function may be carried out by a limited company. Issues
such as IR35 and section 660A, Taxes Act 1988 could be in point.
At the very least the use of these business media or the change
to them will add to tax complications, and accordingly to the
vulnerability of the practice to enquiry and investigation.

Means test
==========
One trusts that accountants are trading profitably, but this is
not always the case. The classic investigation criteria of means
and profitability could apply in some cases.

Is the accountant trading profitably, and if not why not? Are
drawings from the practice sufficient to fund the lifestyle of
the individual(s)? How do profits compare with other accountants
within the same geographical area? Unexplained variations in
profitability and means are an open invitation to enquiry. It is
therefore very important for the accountant to pre-empt such an
occurrence by the use of the white space' in the self-assessment
tax return and/or explanation to the Revenue by letter.

Tax defaults
============
The commission of routine tax defaults in connection with the
self-assessment legislation can be another obvious trigger.
Failure to file the self-assessment return and accounts on time
is one. Failure to pay tax on time is another. Although both of
these defaults lead only to fixed-rate penalties, the Revenue may
use them to institute a full SA enquiry.

Disclosure and discovery
========================
The principles of making a clear and fill disclosure has been
preached to us by our institutes and others, and no doubt we have
passed the message on to our clients. However, the message
applies to each accountant as well. It is essential that full
disclosure of necessary items is made in the white space of the
tax return and/or accompanying letter. Failure to do this leaves
the door wide open for the Inland Revenue to institute a full
enquiry, which will not be limited to the usual self-assessment
enquiry time-limits where the inspector has made a 'discovery'.

Representation before the Revenue
=================================
If the worst comes to the worst and an investigation or enquiry
takes place into the accountant's affairs, the accountant has to
make a decision as to whether he will represent himself or
arrange representation by a third party.

Some accountants will feel that they do not want another
professional person to be involved in their affairs. If the sole
practitioner, or a partner in a small practice is competent to
handle an investigation, then the matter can be dealt with in-
house.

The other point of view includes the following points:

# Enquiries and investigations are time-consuming and costly, and
the accountant will be diverted from practice work and more
remunerative fee-earning potential if the enquiry is dealt with
personally.

# It may well be that the investigation is being dealt with by an
inspector known to the accountant. Engaging a third party
investigations specialist will 'take the heat out of the
situation'. The accountant may wish to retain the current
friendly relationship with the local inspector. On the other
hand, the proceedings in Mr & Mrs Scott trading as Farthings
Steak House SpC 91 (although a client case) demonstrate that the
intervention of a tax investigations specialist and a solicitor
versed in criminal matters can have a salutary effect on a
thoroughly awkward inspector.

# Unless the accountant is an investigations specialist, it may
well be more time and cost effective to engage an expert to carry
out the work.

Fee insurance
=============
This brings us to the issue of professional fee protection
insurance. This product is much more established now, and there
are several reputable insurance providers in the market.
Nevertheless only a small number of firms have taken this product
up for their clients.

Whether or not the practitioner has recommended the product
positively to his clients, he or she needs to consider whether or
not to take out personal cover. The writer has taken out cover
personally on two of the main grounds mentioned above - 'taking
the heat out of the situation' and delegating the work of an
enquiry, should it occur, to a well qualified and experienced
third party.

Final point
===========
If the worst comes to the worst and the accountant undergoes an
SA enquiry which he or she feels has been handled inefficiently,
then a complaint should be considered. This does not include
technical issues, which are appealable to the Commissioners and
the courts.

Complaints about the conduct of the investigating inspector(s)
should be made first to the inspector in charge of the District
Office. Failing satisfaction, the accountant may then complain to
the Area Manager. If he or she is still not satisfied a complaint
can then be made to the Adjudicator and/or the Parliamentary
Commissioner (Ombudsman). A complaint to the Adjudicator can
later proceed to the Ombudsman, but not vice versa. Complaints to
the Ombudsman must be routed through the accountant's Member of
Parliament.

If maladministration can be proved, the Revenue may be
recommended to pay compensation to the accountant.

Ask a question
==============
Readers with a current case should post their query in Any
Answers.

JOHN T NEWTH
https://www.accountingweb.co.uk/premium_content/newthwire

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