Cooking The Books...!

CHRIS JOWITT and MIKE DOWN explain why the Revenue is licking its lips over a major project into the catering industry.

THE REVENUE IS giving the catering industry a grilling. A project has developed from routine enquiries which is turning into one of the largest of its kind ever undertaken by the Revenue. This has caused such speculation and rumour, much of it incorrect, that the Revenue considered issuing a press release.

The scheme

The Revenue has discovered that it is common in the industry for commission payments to be made to chefs by suppliers. Early enquiries have led them to believe that this is happening throughout the industry, especially in London and the larger provincial cities.

A typical scenario is that the head chef in a large establishment will ask the main suppliers for a payment. In return, the chef will ensure that the particular supplier's goods, usually foodstuffs, remain on the menu. If payment is refused, there will be a change of supplier to one who is more amenable to the arrangement. For some years, the suppliers have been over a barrel.

The types of establishment involved are mainly hotels and large restaurants, although we have seen evidence of payments made to chefs in London clubs and even to a chef in a merchant bank's staff restaurant. It appears that the establishment owners have either not been aware of this practice, or have turned a Nelsonian blind eye. Recent publicity within the industry is beginning to alert them.

The amounts of the payments can be quite large, often an agreed percentage of the total goods supplied. While it seems that a usual amount will be in the region of three to five per cent, we have heard figures as high as 15 per cent. The payments are usually in cash, in the traditional anonymous brown envelope. There have been instances where payments have been sent by registered post (the Revenue will have a field day with those) and even by cheque, subsequently paid into an overseas account.

Nature of investigation

Special Compliance Office, Manchester is running the project. We understand that several senior investigators have been seconded and are working almost full time on the investigations. They are making enquiries into the returns of the wholesalers under Code of Practice 9, Hansard. They are, however, looking for a high profile case suitable for criminal prosecution. Their hope is that publicity generated within the industry by a successful prosecution will encourage others to co-operate.

The Revenue view is that the payments fall within section 577A, Taxes Act 1988 (expenditure involving crime) and should be disallowed in the supplier's computation. It is worth noting that this section applies only to payments made on or after 11 June 1993.

The payments are usually included either in the trading account, under purchases, or in the profit and loss account under some other head. Alternatively, in the time-honoured fashion, they are not reflected anywhere in the accounts, with a like amount omitted from sales. The amounts can be large. We are seeing cases where over a period of years the sums are in excess of £1 million and have heard of cases where the amounts are in the £3 to £4 million bracket.

Spill the beans

Special Compliance Office is putting a lot of pressure onto the wholesalers to name the individuals to whom payments have been made. In its view, if the wholesaler is unwilling or unable to name individuals, the disclosure is incomplete and there is a lack of co-operation. Both these factors affect any penalties chargeable at the settlement stage of the enquiry. Although most wholesale suppliers are likely to be companies, they could be partnerships or large sole traders.

Where admissions are made in corporate tax cases, Special Compliance Office is asking for the usual Hansard style reports, covering both the company and the individual directors. The Revenue will not be shifted from its long-held view that where a payment has been made to a third party and has not been correctly dealt with in the accounts, the directors will have taken at least an equivalent amount of money for themselves. Often, the only way to convince the Revenue otherwise is to produce private side reports for the individual directors. This will either prove the point, or, if the directors have succumbed to temptation, will give an indication of how much has been extracted over and above the amounts paid to third parties.

How is the Revenue going to tackle the chefs? It is clear that in most cases the amounts involved are below the limit for registration by Special Compliance Office and, if so, enquiries will not be made under Code of Practice 9. We understand that an Inspector has been seconded to Special Compliance Office to deal with these cases, which will be worked under the rules relating to self assessment. There will be a challenge under section 9A, Taxes Management Act 1970. In this way, Special Compliance Office will maintain overall control of the project, but will only work the largest individual cases.

Taxing the payments

How will the Revenue seek to tax the payments in the hands of the individual chefs? In the cases we have seen so far, it has accepted that the receipt is taxable under Schedule D, either Case II or Case VI.

In one of our cases, a chef had taken up a new post and, to his surprise, the supplier made payments to him under an agreement reached with his predecessor. We considered an argument that, as the payments had never been discussed or solicited, they were nothing more than a gift and not taxable in the hands of our client. For various reasons we did not pursue the argument and looked at alternative approaches. The Revenue's response to this line would no doubt be very interesting.

As it stands, the taxation of receipts on the one hand and the disallowance of expenses on the other is a real double whammy, a clear case of the Revenue having its cake and eating it.

Schedule E complications

There may be an argument that the receipts are taxable under Schedule E. Many head chefs will be employees rather than self-employed proprietors and the payment is arguably being made to them by reason of the employment and therefore taxable under Schedule E. If this were the case, then it could be argued that section 577A did not apply and the payer would receive a deduction if it could be shown that the payment was made wholly and exclusively for the purposes of the trade. So far, so good, but what of the rules relating to pay-as-you-earn and National Insurance contributions?

Under Regulation 2 of the Income Tax (Employments) Regulations 1993, the payer, in this case the supplier, would be deemed to be the 'employer' (any person paying emoluments) required to operate pay-as-you-earn on the payments. Even more disastrous, however, under the provisions of section 7, Social Security Contributions and Benefits Act 1992, the actual employer, in this case the hotel or restaurant, normally an unsuspecting and unknowing party, would find itself responsible for Class1 National Insurance, both employers and employees.

The Schedule E argument is unlikely to be advantageous to the chefs and will be difficult for the Revenue to sustain, as the payments are surely not made by reason of the chef acting as or being an employee. There is no real parallel with pay-as-you-earn cases on third party payments such as Booth v Mirror Group Newspapers plc [1992] STC 615. The court supported a pay-as-you-earn deduction by the third party, but the payment was made with the full knowledge of the future employer to induce the recipient to carry out the duties of an office for the benefit of both the payer and the real employer.

Maturing over time

To appreciate the sheer size of the project, the Revenue intends to look at the returns of over 300 suppliers nationwide as resources permit. It already has the names of more than 100 chefs who have been named as recipients of payments, declared or not. The project is likely to last for the next couple of years. For any business or individual likely to be involved, it could be worthwhile to consider a voluntary disclosure, which will enable the adviser to argue for a reduction of penalties.

As this tasty project gains momentum, so the Revenue gleans more knowledge of the individuals and businesses involved. We recently attended a meeting to represent a wholesale supplier. The Inspector had given the client a real roasting. The stage had been reached where the client was, very reluctantly, giving the Revenue details of payments made. He had no difficulty with the names of the establishments, but on a few occasions only knew the forename of the chef. Every time this happened, the Inspector was able to supply the surname! Numerous chefs are undoubtedly about to feel the heat, and as a result some of their employers may well want to get them out of the kitchen.

Chris Jowitt and Mike Down are directors of tax investigations at Baker Tilly. Chris can be contacted in Bradford on 01274 750250, Mike in Guildford on 01483 307000. The views expressed in this article are their own and do not necessarily reflect those of Baker Tilly.

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