Record Problems
JOHN T NEWTH FCA, FTII, FIIT, ATT investigates the minefield of small business accounts and records.
One of the phrases which the Inland Revenue uses in its literature, and of which it is very fond, is 'the correct amount of tax'.
The writer has no problem with this concept when it is applied to 'absolutes' such as pensions, dividends and interest received. These sources of income can be exactly defined, and verified from documentary evidence.
Record Problems
JOHN T NEWTH FCA, FTII, FIIT, ATT investigates the minefield of small business accounts and records.
One of the phrases which the Inland Revenue uses in its literature, and of which it is very fond, is 'the correct amount of tax'.
The writer has no problem with this concept when it is applied to 'absolutes' such as pensions, dividends and interest received. These sources of income can be exactly defined, and verified from documentary evidence.
When one turns to business accounts, a different story altogether exists. Anyone conversant with the preparation of accounts knows that this involves 'taking a view' on some transactions, as well as estimates and proportions. Accounting is not an exact science, and in this realm of business accounts the Inland Revenue needs to be reminded of this fact.
Obviously there are well publicised accounts of large public companies, where both the company and its 'Big Five' auditors have fallen short of required standards. However, for the most part, accountants and auditors of businesses of every size do their best to produce accurate accounts and submit them to the Revenue. Notwithstanding, even in the very best circumstances that phrase 'the correct amount of tax' cannot be applied to business tax accounts. As many practitioners know, tax itself is not an exact science.
The statutory requirements
In order to comply with the Taxes Acts, what are the obligations of the small business? In this instance one is dealing with sole traders and partnerships, not companies.
Firstly, in connection with self-assessment returns, under section 8(1)(b), Taxes Management Act 1970, a taxpayer is required to deliver with the return 'such accounts, statements and documents relating to information contained in the return' as may reasonably be so required. It should be noted that the legislation does not refer to a balance sheet and profit and loss account, or details of personal drawings. That aspect will be discussed later in this article.
One then proceeds to section 12B, Taxes Management Act 1970 to ascertain what the law says about prime records. Paragraph (1)(a) obligates the taxpayer to 'keep all such records as may be requisite for the purposes of enabling him to make and deliver a correct and complete return for the year or period'.
The legislation goes on to consider persons carrying on a trade, profession or business alone or in partnership. Section 12B(3)(a) details the records to be kept and preserved as:
(i) all amounts received and expended in the course of the trade, profession or business and the matters in respect of which the receipts and expenditure take place;
(ii) in the case of the trade involving dealing in goods, all sales and purchases of goods made in the course of the trade.
In connection with the obligation to preserve records, a reference is made to 'supporting documents' in section 12B(3)(b), and in paragraph (6)(b) these are defined as including 'accounts, books, deeds, contracts, vouchers and receipts'. It is interesting to note that these items must be 'preserved', but are not detailed in paragraph (3)(a)(i) and (ii) as records to be 'kept and preserved'.
Obviously, the affairs of limited companies, which are beyond the scope of this article, come within the Statements of Standard Accounting Practice, but these statements are not imposed on sole traders and partnerships.
Guilty until proved innocent
It is well known that under the 'file, pay and enquire' régime of self assessment, the main function of the Inland Revenue, as regards small businesses, is compliance and investigation.
However, against the background of statutory record-keeping and accounts requirements, the department adopts an aggressive but productive line.
Where a trader's accounts and records are, in the Revenue's view, deficient according to its criteria, (but fulfilling the law), then the department tends to make certain assumptions. Any unidentified credits are treated as additional income, and any unidentified debits are disallowed as non-business expenses. This treatment is extended to the private records, which may or may not have any relation whatsoever to the business trading. Private bank statements and building society records are demanded routinely when a self assessment enquiry takes place.
Assumptions made by the Inland Revenue then form the basis of 'additions to profit', which the Revenue may seek to extrapolate back by six or more years. Even if the trader has fulfilled the requirements of section 12B, Taxes Management Act 1970, the Inspector may 'draw his own conclusions' on the basis of the assumption that no-one in the United Kingdom is capable of telling the truth.
While the legislation makes no mention of this aspect, the Revenue has taken upon itself to request private records in a self-assessment enquiry. No successful defence has been raised yet to this demand, but it would be good if a credible case were taken to the Commissioners and courts, as was Farthings Steak House (SpC 91) in the realm of 'business economics'.
The writer is not a lawyer, but one would have thought that this area of enquiries and investigations comes squarely within the remit of human rights legislation.
The views of the Inland Revenue are set out in its Enquiry Handbook. Paragraphs EH 316, 317, 319, 320, 322, 398 and 401 are worth studying. Paragraph EH 319 concerns private bank and building society accounts, and it is the Revenue's view that they can reasonably be required under section 19A, Taxes Management Act 1970 for the purposes of checking the accuracy of a tax return.
Additional Revenue reasoning regarding this issue is set out in paragraphs EH 398 and EH 401. The current 'state of play' seems to be that investigation specialists have accepted the Revenue stance, and are not challenging requests made for 'private side' documents and information. Whether this is in accordance with statute law or in the best interests of taxpayers involved is open to debate.
An encouraging case
A recent article in Small Business Tax and Finance (March 2001 at page 132) drew attention to a case heard by the VAT tribunal in 1997 – Adrian Moon trading as Craft Master Construction (14855). The appellant was a jobbing builder who had one bank account which was used for both business and private transactions. Customs and Excise had assumed that unidentified credits in the bank account were business takings and had raised an assessment and interest imposition accordingly.
These unidentified credits did not correspond to invoices issued and evidence was submitted that loans had been made to Mr Moon by his mother and American Express. There was also a sizeable insurance claim and sales of various private items. The tribunal accepted that the duplicate invoices constituted a complete record of all his transactions subject to VAT. A number of principles emerged from the determination of the tribunal.
- In order to disprove the assessment, Mr Moon only had to satisfy the tribunal on the balance of probabilities that the unidentified receipts were non-business items.
- There is no statutory obligation on a taxable person to keep a separate bank account. Obviously, if separate business and private accounts are kept, it is easier to demonstrate the nature of the deposits, but this is not a legal requirement.
- The appellant was not required to produce written evidence that each and every one of the items, which went to make up the appealed assessment, were private receipts rather than business receipts.
- As it had been shown that many of the deposits questioned by Customs were non-taxable, 'a principle was created' that the other deposits were non-taxable.
- The tribunal observed that 'if there were suppressed business receipts, it hardly seems likely that the appellant would have paid them into his bank account'.
It was interesting to note that Mr Moon's accounts had been prepared by a firm of chartered accountants, but comprised an income and expenditure account, without a balance sheet and no inclusion of debtors.
Adrian Moon is a VAT tribunal case and not a direct tax case, and did not proceed to the High Court. Nevertheless, taxpayers and their advisers challenging estimated assessments raised by the Revenue on spurious grounds could do worse than take some of its principles on board.
If this is combined with the possibility of a positive impact from human rights legislation, the current unfair advantage that the Revenue holds in enquiry cases involving small businesses could be adjusted to reflect the facts of business life in the real world. At the present time, such businesses are a 'soft and easy target'. What is needed is the equivalent of another Farthings Steak House case, but fought on the principles highlighted in the Adrian Moon case.
