Rebecca Benneyworth considers the evidence gathered during HMRC’s pilot record checks in 2006-7 and considers what its new approach will mean for advisers and their clients in 2011.
During the development of HMRC’s new powers, and when the tax authority was ready to start bringing forward legislation, it set out the its objectives for compliance checks on taxpayers including businesses.
“It is envisaged that an officer of HMRC might begin a compliance check in respect of any of the relevant taxes for one or more of a number of purposes. These include checking that:
- a tax return, amendment to a return or claim is correct
- statutory record keeping requirements are being met
- tax has not been underpaid or over-claimed
- any issues concerning possible tax avoidance are considered.”
The second of these objectives is now generating some publicity and HMRC is expected to target smaller businesses to check the quality of their records during 2011. Although the stated intention of the record keeping checks is to ensure that smaller firms are keeping adequate records, there are potentially more serious issues at stake than a “slapped wrist” for poor records.
The issue for businesses is a complex one, but the key points to bring out in regard to poor records keeping are:
- If the records are shown to be poor then the officer has in effect shown that the figures on the tax return cannot be relied upon and the officer could then look make assessments for under declared profits.
- Basic integrity of records is clearly identified in the guidance as an element of “taking reasonable care”. So a taxpayer with very poor records faces not only a discovery assessment – for a period of 6 years due to the failure to take reasonable care (the period would otherwise be 4 years) but also potentially penalties of up to 30% of the tax to which he is assessed based on that failure. The opportunity to make an unprompted disclosure is lost, because the integrity of the records is only disputed when a compliance check is under way
- However limited the business owners’ abilities it is up to them (by law) to keep sufficient records so that any tax return prepared from them is correct and complete.
There is not presently any evidence that HMRC is planning a “big stick” approach to smaller businesses, but the consultation process that concluded on 28 February made it clear that there will be a focus SME record keeping in 2011.
There is also some history for HMRC of looking at business records (in the relatively recent past) and being dismayed with what was observed!
The 2006 Budget included details of HMRC’s plans to use new approaches to compliance. Business and the accountancy profession were consulted to see how this might work. Although this all occurred five years ago, the work done then will have a bearing on what happens in 2011.
Almost as soon as the consultation closed, HMRC announced a trial of the new methods that started on 10 July 2006. The accountancy profession’s view was that the trial was set under way far too quickly, and many advisers had doubts about participating in the trial.
HMRC’s 2006 approach included a review of business records as they were kept (rather than after the end of the tax year as would be more normal). Under the real time record review current business records and record-keeping procedures were examined to make sure they met the standards that HMRC considered appropriate to record the results and make returns accurately. The checks focussed on cash transactions and covered both direct and indirect taxes.
Evaluating the results
Although the 2006 pilot scheme was much criticised, a number of key lessons were highlighted in the evaluation report (467kb PDF) produced in April 2007. These are likely to shape compliance developments over the next few years, and indeed are likely to form the basis of the entire structure of compliance effort in the medium term.
The document’s executive summary stated that while more streamlined compliance processes were welcomed by both taxpayers and advisers, more collaborative work was needed to produce a workable system. This led to a joint working party which has produced some very useful work.
In the shadow of this overall conclusion there is a risk that some of the more specific issues arising have not had sufficient attention from the profession. The pilot scheme review included the following comment, which highlighted the specific issue of record keeping: “Some taxpayers are not able to declare the correct amount of tax because their business records are not adequate. If this is left unaddressed it could subsequently lead to more significant errors.”
HMRC identified the poor records they observed in the trial as a key risk to the integrity of the tax system. It would be naïve to expect that this conclusion would not form a major part of the compliance drive in the future.
Detailed analysis – record keeping
It is likely that the format of the real time records review work will be repeated when HMRC starts focussing on record keeping in 2011. Here is how the work was described in 2006: “Real Time Records Review checks business records before the relevant tax return is submitted. It provides an opportunity for HMRC to discuss record keeping with the taxpayer and examine the completeness and adequacy of records in order to form a view on the taxpayer’s ability to make accurate tax declarations. Any errors found during the examination are corrected and the taxpayer given guidance to help prevent future errors occurring. “
The visiting officer would consider the specific risks identified for the Real Time Record Review and:
- ask questions to establish what systems were in place to ensure the taxpayer could complete their returns accurately
- examine a selection of records to confirm that the systems and controls operate in the manner described by the taxpayer
- reach a conclusion about whether the systems in place gave reasonable assurance that the returns will be accurate and complete; and
- discuss those conclusions with the taxpayer.
Following the visit, where no errors were identified which required an assessment, based on their opinion of the adequacy of the records, the officer recorded their view on the adequacy of the records as either:
- The Real Time Records Review demonstrates that, from the records reviewed and information given, the taxpayer is keeping adequate books and records to give reasonable assurance that returns will be accurate and complete.
- The Real Time Records Review demonstrates that, from the records reviewed and information given, the records kept may not be wholly adequate to ensure that returns will be accurate and complete.
- There is strong evidence that books and records retained are inadequate and would be incapable of ensuring that returns will be accurate and complete; or
- Books and records are not maintained.
This entire approach is very similar to the old fashioned “systems audit” of the 1970s and 80s – and indeed is intending to achieve similar outcomes by ensuring records are adequate to produce reliable figures for the tax return.
When carrying out the review in 2006, HMRC found the refusal rate very high – only a third of those businesses approached agreed to take part.
The results of the tests were also quite poor, with 36% of businesses having inadequate records to prepare a tax return from. HMRC concluded this was predictable and fitted its assumption that those who thought their records were good were more likely to agree to the voluntary intervention well founded. In short, HMRC saw the “best of the bunch” and their records were quite poor – so the rest must be worse on the whole.
The test review concluded: “Even though the pilot was voluntary, the level of record keeping among those willing participants demonstrated a sizeable potential problem around the adequacy of records kept. It is reasonable to assume that the position would be no better, and could be worse for those who are unwilling to engage with HMRC voluntarily. Earlier identification of such problems could limit errors and problems in the future.”
So the lessons are there, and it should now be no surprise to advisers that HMRC is focussing on records in the small business sector.
However, our own work in rectifying the problems with records is being excluded here as if the records are examined “live” this cannot take account of what we do. The message for us all is to ensure that our clients’ systems are designed to create the best possible evidence for the accounts and return, even if there are inaccuracies which we resolve later.
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Rebecca trained in London with Kidsons and, on qualifying, spent some time as Chief Accountant of a manufacturing company. She now has her own small practice in Gloucestershire that comprises of owner managed businesses and small companies.
She also lectures extensively for a range of professional bodies, accountancy firms,...