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image of people eating with chopsticks | accountingweb | The Wok Inn Restaurant VAT and CT underpaid due to sales suppression
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Suppressed sales on the menu at Chinese restaurant

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The owners of a restaurant underpaid VAT and CT by suppressing sales but inspectors from HMRC didn’t get fed up with gathering evidence.

16th Apr 2024
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Cheon Fat Ltd, the owner of a Chinese restaurant, bit off more than it could chew when it took HMRC to the first tier tribunal (FTT) to appeal an assessment to VAT as well as corporation tax (CT) under s 455 Corporation Tax Act 2010 (CTA 2010). 

Seasoned HMRC officers secretly dined at The Wok Inn, operated by the taxpayer, on six separate occasions between 24 April and 28 May 2016. HMRC conducted another covert visit a year later, on 26 July 2017, when undercover officers ordered both lunch and dinner (very thorough). 

HMRC interspersed these secret visits with unannounced inspections. During those inspections, HMRC checked the restaurant’s records against its own record of what its officers had ordered. As this process continued, HMRC eventually reached the view that the restaurant had been systematically under-reporting its sales figures. 

Fine dining

HMRC extrapolated the pattern of under-reporting and applied it to all the taxpayer’s VAT periods from December 2012 to December 2016 and CT accounting periods ending March 2013 to March 2016. It assessed the taxpayer to £247,427.75 of CT and £136,709 of VAT. HMRC also issued the taxpayer with penalty notices of £102,700.33 for CT and £53,715.08 for VAT. 

The taxpayer appealed to the FTT and argued that HMRC had overestimated the extent to which its turnover and profit had been under-reported. The taxpayer also argued that its behaviour had not been deliberate and that the reduction HMRC had applied to the penalty to reflect the taxpayer’s cooperation should be increased. 

Making a meal of it

The FTT first considered problems with HMRC’s evidence. HMRC had submitted in evidence a spreadsheet summarising its analysis of business records it had taken from the taxpayer but had not submitted the originals or copies of those records. The taxpayer argued that HMRC had never returned the records and that this prevented it from challenging HMRC’s analysis. It invited the FTT to draw an adverse inference against HMRC for failing to disclose the records as part of the hearing. 

The FTT declined. It found that HMRC had not intentionally withheld the records; it simply didn’t have them. The FTT found on the balance of probabilities that HMRC must have returned the original records because, according to an (unsigned) note of the visit during which the taxpayer shared the records, HMRC had promised that it would. Furthermore, the taxpayer had not complained until the hearing that the records had not been returned. The FTT also found that HMRC had either lost or destroyed any copies of the records it had made. 

Skipping meals

The FTT then analysed the evidence. It found a “disturbing pattern” of meal tickets being left out of the taxpayer’s records and considerable under-reporting of cash sales. The FTT agreed with HMRC that this was deliberate. HMRC was therefore entitled to raise assessments for a period exceeding four years and the taxpayer was liable to penalties of up to 70% of the amounts assessed.

However, the FTT thought that HMRC’s methodology for calculating the extent of the under-reporting was half-baked. HMRC had used data from the taxpayer’s merchant acquirer in estimating the extent of the under-reporting but had not disclosed that data to the FTT with the result that the FTT could not verify it. Furthermore, the FTT found clear errors in HMRC’s initial calculations. The FTT therefore concluded that HMRC’s estimate of the unreported card sales, as well as its overall methodology for calculating the assessment, had to be disregarded. 

Wok of shame

Nevertheless, the FTT found that HMRC had undercooked its estimate of the taxpayer’s unreported cash sales. The taxpayer’s director had been grilled during cross-examination and had admitted that cash sales in fact represented 30% to 40% of all the taxpayer’s sales, much higher than the 9% it originally declared. The FTT therefore increased the estimate of the unreported cash sales (and the VAT due on them) for the purposes of the assessment.

Even though it had substituted its own, higher estimate of unreported cash sales, the overall effect of the FTT disregarding unreported card sales was to reduce the amount of VAT assessed to £76,626. The FTT held that the CT assessments would need to be adjusted on the same basis but left that task to HMRC. The FTT rejected the taxpayer’s argument that s 455 CTA 2010 could not apply because HMRC had not proved that the unreported takings had been extracted by the director.

Service not included

Ultimately, any success the taxpayer had in reducing the assessments proved to be a flash in the pan. The FTT found that an appropriate reduction of the maximum 70% penalty percentage for cooperation had already been given. While the taxpayer had not obstructed HMRC’s investigation and had provided some assistance, it had also not admitted to any under-reporting until the hearing itself. The FTT therefore held that any further reduction for cooperation was unwarranted.

Replies (12)

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By FactChecker
16th Apr 2024 18:56

"the FTT thought that HMRC’s methodology for calculating the extent of the under-reporting was half-baked"
"HMRC had submitted in evidence a spreadsheet (summary ..) but had not submitted the originals or copies of those records"
"FTT also found that HMRC had either lost or destroyed any copies of the records it had made"

IANAL but if that doesn't demonstrate a fine balance between incompetence and the laziness to not bother following accepted procedures, then I don't know what does.

Despite my suspicion that the appellants were to put it mildly 'trying their luck', the FTT seems to have entrusted HMRC with the same 'above reproach' status that criminal courts used to do back in the '50s when faced with contrary Police evidence.
Not the way to encourage the 'raising of standards' on which HMRC are so keen!

Thanks (15)
the sea otter
By memyself-eye
16th Apr 2024 20:30

So HMRC undertook SIX separate visits plus one more a year later to ONE Chinese restaurant to ascertain there was fraud?
Blimey, all the takeaways, chip shops, pop ups, curry houses, pizza-rears (yes I know that's poor grammar), spud U likes (do they still trade?) and itinerant street traders in the country must henceforth be terrified of a visit by His Majesty's storm troopers...
They say that war is the poorest waste of capital resource's.
I beg to differ.

Thanks (6)
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By taxdigital
17th Apr 2024 08:06

I had to deal with an exactly similar case a few years ago except that:

a) the assessment was much higher
b) HMRC made 8 test purchases over a period of 7 months on different days (e.g Friday evening, Monday afternoon etc), all paid for in cash,
c) two unannounced visits were made after the restaurant closed at about 11 pm! and
d) the FTT asked the client to deposit the VAT assessed with HMRC first, forcing us to move a hardship application.

We sorted it out through the ADR process, which I think is a better route as no one except the client would ever know what exactly the cash takings are! HMRC extrapolations can sometimes produce hilarious outcomes when looked at the average revenue potential per seat, and other metrics used in restaurant business.

Thanks (3)
Replying to taxdigital:
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By djn
17th Apr 2024 13:46

We also had two where they had carried out unannounced visits and also came with a warrant after hours.
We refused entry.
There were a few mistakes with their workings which helped us.
Plus on one they made the rookie mistake of weighing the chips back at the office after they had been cooked.
We calculated that frozen chips lost maybe 50% of their weight being cooked. That was a massive mistake and probably saved the clients bacon as they were after something luke £80k in vat alone.
We never knew officially if the client was fiddling but surprisingly they sold up quite quickly after that.

Thanks (2)
Replying to taxdigital:
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By stevenckay
17th Apr 2024 19:50

I had a similar case some years ago whereby HMRC had their Christmas meal at my client's Indian restaurant and paid a substantial amount by cash. Needless to say it didn't show up on their records when they did an unannounced spot check. They also made a number of one-off purchases and spent several weeks sitting outside counting customers leaving with take-away containers.

The case went on for some two years and only fell apart when, at the VAT Tribunal, HMRC came out with their hidden trump card and noted that there appeared to be no chicken purchased on any of the invoices. I quietly asked the client where they bought their chicken from and he replied that "the chicken man" was paid cash every time he delivered and they didn't get a receipt.

Case over very quickly after that!

Thanks (3)
Replying to stevenckay:
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By Paul Crowley
09th May 2024 20:53

Client had no cash records?
VAT was due on the sales but not recoverable on the purchases.
What am I missing?

Thanks (0)
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By JustAnotherUser
17th Apr 2024 08:39

On 24 April 2016 HMRC undertook an initial covert visit to the premises....
Judgment date: 29 February 2024

what kind of medieval system are we running when it takes 8 years, £177,101.05 and the associated £80,580.97 values and manual visits to a restaurant to catch these people??

with the local data, big data and AI capabilities a simple query should be able to spot the likely culprits ...
...and where did all the extra money go? any follow up for undeclared earning, money laundering?

Thanks (5)
Replying to JustAnotherUser:
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By johnjenkins
17th Apr 2024 11:34

"That's life".

Thanks (2)
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By moneymanager
17th Apr 2024 11:55

I only came for the comments but really I would like HMRC to investigate the Post Office and the Horizon scandal, they ARE criminals.

Thanks (8)
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By johnfrancis
17th Apr 2024 12:01

Google maps currently describes The Wok Inn as "temporarily closed". After so many years and all that effort, how much of the money is HMRC likely to recover?

Thanks (4)
Replying to johnfrancis:
Lone Wolf
By Lone_Wolf
17th Apr 2024 14:34

Call me cynical, but what's the chances that "The Wok Inn" has closed, but the same building now houses another Chinese restaurant under a different name.

I doubt the company operating the takeaway even owned the property so it'll just be a case of lease it to the next Ltd company in the chain, with another fall guy as director.

We almost took on a client like this a few years back. The son had just lost at the FTT for similar - underdeclared sales, and was looking for advise on how to proceed.

I've eaten at the place a few times and it's been going for years. Father owns the building and a bunch of other property. It transpired it was never him trading though. A list of brothers and cousins had all taken their turn running the trade, and it had gotten to the sons turn. They all either never paid their VAT and disappeared abroad, or in the sons case, got caught massively undeclaring takings. Unlucky for the son, he wants to remain in the UK, so was hoping for an "out". We ran a mile.

Really nice curries though.

Thanks (3)
Replying to johnfrancis:
the sea otter
By memyself-eye
17th Apr 2024 17:56

Recover?
Nothing.
HMRC bankrupted two pub tenant clients of mine some years ago for a quarter of a million each.
HMRC recovered.... nothing/nada/zilch/nowt - actually did the two a service as they were able to move on with their lives after a year as bankrupts
The lesson?
Never buy a pub tenancy.

Thanks (3)