Tax Administration

Tax Administration

Enabling Letters — The Sequel

MIKE TRUMAN reports on the ongoing war of words about enabling letters.

IN ONE OF his last 'Comment' pieces as consulting editor, John Newth looked at the Inland Revenue's so-called 'enabling letters' ('Enabled to Comply', Taxation, 29 July 2004 at page 447). In it, he quoted a response that a subscriber to AccountingWEB had suggested might be sent to the Inland Revenue.

The response said that Inspectors had a duty under sections 1 and 29 of the Taxes Management Act 1970 to satisfy themselves that the tax return was adequate, and to open an enquiry under section 9A if not so satisfied. The enabling letter received had no reference to section 9A, but that was not required by statute, and clearly the Inspector was dissatisfied with the return to 5 April 2003. On the assumption that the enabling letter was therefore the opening of an enquiry, and since there were no specific issues raised in the letter, the Commissioners were being asked to close the enquiry down under section 28A(4).

This was published by Taxation as advice from a subscriber on AccountingWEB and not as our own advice, although John Newth rightly said that it went to the heart of the debate about the whole controversy. We have, however, now received two letters from accountants who followed this course of action and have received replies. The replies are identical, which suggests that the wording has come from somewhere in the higher echelons of the Inland Revenue. The replies read as follows:

The letter concludes by saying that it is hoped the accountant will agree and that a copy has been sent to the relevant Clerk to the Commissioners. So, is the reply correct, and what should happen next?

The Inspector's duty

It is right that the Inspector's duty to satisfy him or herself that the tax return is complete and correct was removed with the introduction of self assessment. But that surely does not mean that Inspectors are free to pick on whomever they want to and ignore everyone else, no matter how egregious the errors in their tax returns?

The suggested response referred to both sections 29 and section 1 of the Taxes Management Act 1970; the reply refers only to section 29. Section 1 gives the care and management of direct taxes to the Board, who appoint Inspectors to act under their direction. Presumably they do so with the intention that the right amount of tax is assessed for collection. Whilst it might not be a breach of that duty for an Inspector to ignore an individual return thought to be a bit dodgy, it would surely be a dereliction of that duty if the senior management of the Inland Revenue were to set up a system that deliberately overlooked thousands of returns which they thought (on the grounds of a risk review) were likely to be incorrect? It would also be contrary to the instructions given to Inspectors in paragraph EM1051 of the Enquiry Manual: 'You should never make any statement, written or oral, which might be interpreted as granting an amnesty to a particular group or class of taxpayers.'

Is there an enquiry?

Regardless of whether the Inspectors have a duty to do so, have they in fact opened enquiries by sending out the enabling letters? As quoted above, the subsequent reply says that it was not their intention to open an enquiry and that the letter had not done so. This is, of course, vitally important for the Inland Revenue, since if an enquiry had been opened and now has to be closed down, it will not be possible to reopen it again.

The fact that the enabling letter does not refer to an enquiry under section 9A does not prevent it from being one. The Special Commissioners' decision in Murat v Ornoch (HMIT) [2004] STC (SCD) 115 says that:

According to the Inland Revenue's own Enquiry Manual (EM1050) there is no definition of what an enquiry is, so it carries its normal dictionary definition of 'seeking information, asking, questioning'. It might certainly be argued that the enabling letter is questioning. The key sentence says:

If it is an enquiry, which year is being enquired into? The paradox of the enabling letter is that it says in effect that your 2003 return is probably wrong, so we want to make sure that your 2004 return is correct. Why does it not specifically invite the taxpayer to reconsider the 2003 return in the light of the further advice provided?

Since the focus of the enabling letter is actually on the 2004 return, can it be argued that it is actually an enquiry into the 2004 return — even though it has not yet been submitted? The only requirement in terms of time for the opening of an enquiry under section 9A are that it is issued 'within the time allowed'. For a return submitted before the normal 31 January deadline, that is 'up to the end of the period of twelve months after the filing date'. There is no indication of when this period is meant to start, and no explicit prohibition on the enquiry being opened before the return is submitted.

Contrary evidence

So much for the case in favour of an enquiry being opened. How would the Inland Revenue try to justify its assertion that the enabling letter did not open an enquiry, whether into the 2003 or 2004 return?

The letters that I have seen include the following:

This is quite a strong argument that the letter is not an enquiry into the 2004 return, since the implication is that if the return is submitted with this aspect 'right', no enquiry will be made. How the Inland Revenue will know that the aspect is 'right' without an enquiry is not explained.

I have also seen covering letters to agents that say the letter is not an enquiry, although (as is also true of the previous point) I do not know whether this has always been the practice or whether it is a response to the controversy. In any case, it is arguable that a covering letter to the agent cannot change the status of a statutory letter to the taxpayer. More importantly, perhaps, the letter also says that it does not increase the likelihood of an enquiry. Why not? If the Inland Revenue can afford to raise random enquiries when they have no suspicions of irregularities, they would surely be more inclined to investigate cases where they already do have such suspicions?

Pull the other one

All right, I suppose I'd better come clean. There isn't really a chance of any of the above arguments succeeding before the Commissioners. If the letter meant what it said, it would indeed be a gross dereliction of duty by the Inland Revenue not to raise enquiries, and one might assume that the enabling letters were enquiries because surely the Inland Revenue was not being so cavalier about tax lost? But in reality, of course, the letters do not mean what they say at all. Look again at the key sentence.

No you haven't. What you mean is that the computer system has identified that the level of expenditure entered into a particular box on the self-employment pages is unusual, and it has printed out an exception report. You have no idea whether this is an aspect of the return that needs attention or simply a different pattern of expenditure in this business. It is only correct to say that this 'may' need attention in the sense that anybody's return 'may' need attention.

It is interesting to compare this accusatory tone in the enabling letter with the instructions given to Inspectors who are actually opening enquiries (EM1121). They are told that they should: 'not presume or appear to presume that the taxpayer has committed an offence before you have evidence.'

Yet the enabling letter does precisely that. The best that can be said of the statistical exception report that the Inland Revenue have is that it is a tool for identifying cases where enquiries might be appropriate, it falls far short of evidence that there is an issue that 'may require attention'.

The reality

From the discussions on AccountingWEB and the cases that we have heard about, it is clear that certain types of client are being disproportionately singled out. The most common group mentioned is people who work in dentistry. On further investigation it normally turns out that they are locums, or hygienists that work for several different dental practices. As a result, they are claiming that they run their business from home and that their travel from home to the dental surgeries where they are working is business travel. Although it is possible that the case of Jackman v Powell [2004] STC 645 (see page 602) may throw doubt on the deductibility of these expenses in some cases, in most they would be accepted by a reasonable inspector. Several of the areas where advice is given to taxpayers in the enabling letters relate to use of home costs and business travel. Most dentists would clearly be based at their surgeries and therefore such costs should not arise, so the returns where they do would clearly be exceptions. The other reason for choosing dentists might simply be that there is a case involving a dentist and home to work travel, Sargent v Barnes [1978] STC 322, which makes it clear that the normal base of operations for a dentist with a surgery is the surgery itself.

What now?

So what should happen now? It seems to me that there are two sets of answers to this question, one for advisers and one for the Inland Revenue.

Advisers need to reassure their clients that these letters are not an indication that there is something wrong with the return, nor that the tanks of the Inland Revenue are about to be parked on the clients' lawns. They are simply the equivalent of whispering 'I know your guilty secret' into the ear of a random acquaintance in the hope of hearing something interesting.

Advisers then need to look at the self-employment pages and see what might have triggered the enabling letter, so that for 2004 an entry can be made in the white space, as the Inland Revenue suggests, explaining the reason for what might appear to be unusual figures. This exercise should be carried out for all clients, regardless of whether an enabling letter has been sent, in order to prevent the issue of one next year. At the same time, advisers need to be alive to the possibility that a discrepancy may not actually have an innocent explanation, and be ready to ask clients for answers that do indeed stack up.

The Inland Revenue should withdraw the current version of the enabling letter and have discussions with accountants about a properly worded one. As something to work on, I would suggest the following might form part of the revised letter.

'As part of our process of computerised risk review, we identify taxpayers where levels of expenditure in particular areas are unusual compared to others in the same business. On your 2003 return we identified that box [X], expenditure on [YYY] was unusually high. This may simply be because your business is different from others that we are comparing it with, or because you have entered an expense under a different heading from the one we would expect. If so, it would help us if you would explain the difference in Box 3.116 on page SE4 of your 2004 return.

However, it may be because you have misunderstood the rules for expenses in this area. I enclose some of the more frequently asked questions we receive which may help you to identify whether you have made any errors. We are not at present asking you to correct last year's return, but we hope that this will help you to get your 2004 return right first time.'

The reference to the additional information space is already in the existing enabling letter, which leads to the second thing which the Revenue needs to do. It needs to be sure it has systems in place which will check the information that has been entered in the white space before issuing enabling letters next year. Past experience of the use of the white space by the Revenue has not been good; if next year enabling letters go out when the reason for the exception report was entered in the white space, advisers will be justified in getting very cross indeed.

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Specialists in Senior Appointments. Contact us at www.integralsearch.co.uk

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