Overstepping The Line

MARK MORTON warns readers of the questionable tactics being used by the Revenue in close company full enquiries.

THE FOLLOWING IS the text of a letter issued by the Inland Revenue on 25 October 2001. In my experience, this letter is representative of the approach taken by the Inland Revenue in many corporate enquiry cases. What concerns the writer is that the majority of the requests in this letter are not appropriate.

'Dear Sirs

'Thank you for the company's accounts, computations and corporation tax return for year ended 31 December 2000.

'I have today given notice under paragraph 24(1) of Schedule 18 to the Finance Act 1998 to your client company of my intention to enquire into the company's return for year ended 31 December 2000. I attach a copy of the notice.

Can you please arrange for the following information to be made available for year ended 31 December 2000:

'Company Records

'I would like sight of all the company's records to include:

• All the books and ledgers (whether manual or computerised), sales invoices, purchase and expenditure invoices, etc. These records should fully support the figures in the company's trial balance.

• Statements/passbooks supported where appropriate by cheque stubs and paying-in books for all company bank/building society or other investment accounts.

• Statements detailing each individual transaction on each of the company's credit cards.

'Working Papers

'Can you please let me have sight of your accountancy working papers. This will enable me to see how the company's records have been reflected in the accounts produced. My experience is that this will save considerable time when reviewing the records. The papers should include details of all journals covering adjustments between the company's trial balance and the final accounts, schedules of debtors, creditors, stock, fixed assets and directors' loan account.

'Directors

'The company has three directors as at 31 December 2000, with A having overall control. As this is a close company, there is a close link between the financial affairs of the directors and those of the company. Will you please supply for each director:

(1) A statement detailing all private bank/building society or other investment accounts held whether in their names, joint names or over which they had control, whether held in the United Kingdom or abroad.

(2) For each of the accounts in subparagraph 1 above, can I please see statements/passbooks supported where appropriate by cheque stubs and paying-in books.

(3) Can I please have statements detailing all transactions on all credit cards held (whether general credit cards or specific cards such as store cards), whether held in the directors' own names or joint names.

'Review of Employers and Contractors Records

'My colleague wrote to the company earlier this month concerning a proposed visit to the company on Thursday 13 December to look at the employer's and contractor's records. It is intended that this review is encompassed within the enquiries outlined above and will be dealt with at the same time.

'Progress

'I would suggest the best way forward is a meeting at the company's premises to discuss the operations of the company and the directors' personal financial affairs and then to look at the records for the company and the directors. In view of the size of the company, it is likely that the review will take longer than two days and I therefore suggest 11, 12 and 13 December for my proposed visit. Will you please telephone to confirm these arrangements are convenient.

'Yours faithfully'

Points arising

Several points arise from this letter. Firstly, this is an example of what the Revenue calls 'whole case working'. This may involve more than one Inspector helping with the records examination, coupled with a pay-as-you-earn audit and a review of the director's personal affairs. This approach is sensible and will, in the future, avoid piecemeal enquiries regarding the same client. Secondly, there are many issues that arise from the information requests in the letter and these are dealt with in turn below:

Company records

There is no great issue with the three requests under this heading. The information belongs to the company and will aid the Inspector in a review of the company's affairs.

Working papers

Increasingly, Inspectors will attempt to gain access to working papers. Some Inspectors are not as brave as others and will ask for access to link papers. The first question that arises at this stage is: what exactly are link papers? The Revenue's reasoning is that link papers are not part of the working papers and can therefore be requested. The Revenue defines link papers as:

'Those papers which show how the figures in the return are derived from the figures in the prime records, are held by the agent, but are available to the taxpayer.' (Tax Bulletin Special Edition 2 August 1997.)

 

When this definition is considered, it becomes clear that link papers are no more than items from the working papers, most commonly trial balances and journal entries. A request for such information is inappropriate in the majority of cases and is covered by Statement of Practice 5/90. Although this Statement of Practice is eleven years old, the Inland Revenue has confirmed that it is still appropriate. What this Statement of Practice illustrates is that requests for link/working papers should not occur on a regular basis.

'Accountants' working papers will not be called for on a routine basis. The Inland Revenue will normally do so in connection with enquiries into a client's tax affairs only where they have been unable to satisfy themselves otherwise that the client's accounts or returns are complete and correct.'

The process in enquiry cases should be that the company records are examined and, once this has been done, questions arising from the examination should be addressed. It may be that at this stage access to working papers is appropriate for particular entries in the accounts; for example, the calculation of work-in-progress is not easily reconciled by a mere examination of the company records. In such a case, sitting with the Inspector across a table and illustrating how the figure has been calculated will be appropriate, but this is in respect of particular items in the accounts, not wholesale access.

Directors

The Inland Revenue starting point with the review of directors' affairs is that, for close companies, the affairs of the directors and the company are intrinsically linked. However, this reasoning is faulty when considered in light of the self-assessment legislation. What the Inland Revenue is doing in this case is requesting third party information from the company; that is, information that is not the company's to give. If the Inland Revenue wishes to request such information, a section 9A notice should be issued to the directors personally. Of course, different time limits apply. In this particular case, the Inland Revenue is requesting information in respect of the directors from two different tax years, 1999-00 and 2000-01.

The first three-month period of the company accounts from 1 January 2000 to 5 April 2000 is covered by the earlier self-assessment year and a section 9A enquiry needs to be opened by the Inland Revenue by 31 January 2002, which is fast approaching.

Secondly, even if a section 9A enquiry is started in respect of the directors personally, the information requests are inappropriate. Once again, the process in enquiry cases is that the business accounts should be examined and, if the accounts are incorrect and extraction can be shown, then it is appropriate to attempt to quantify the amount extracted. There are a variety of means of doing this, including means tests, capital statements and business economic models. The first two methods would require a review of personal and private expenditure.

However, in the majority of cases, the Inland Revenue will not be able to prove that the records are materially incorrect and, consequently, stage two, the quantification process, will not be appropriate. The Inland Revenue centrally has acknowledged this many times. In the Inland Revenue Enquiry Handbook at paragraph EH319, this is confirmed. Furthermore, in meetings between the Tax Faculty of the Institute of Chartered Accountants in England and Wales and the Inland Revenue over recent years, referred to in the ICAEW's Tax Technical Releases 23/98 and 3/00, the Inland Revenue has been asked directly whether private bank statements should be requested as a matter of routine. The Inland Revenue's response is as follows:

'The Revenue replied that officers should not ask for private records as a matter of course.'

However, as many practitioners will be aware, the Inland Revenue does ask for them.

With regard to credit cards, it is a moot point whether credit card statements need actually be retained by taxpayers and, unless the case is serious, this request is inappropriate.

Finally, the most alarming request is for a statement of assets for each director. This appears to be a request for a Certificate of Disclosure. Such certificates are part of the settlement procedure, not the initial information requests. The Inland Revenue views incorrect certificates extremely seriously and will consider prosecution in such cases.

A certificate should only be requested at the end of an enquiry, where material errors have been discovered. In the writer's view, this is not only a breach of internal Revenue guidance, but it may have dire consequences for the client. It should be resisted strongly.

Progress

The Inspector is trying to force this case and apply pressure to the accountant and directors involved. Several issues arise from this final paragraph. Firstly, a request for a meeting; the process of a full enquiry case should be that the records are examined and, when this has been done, a consideration of what issues remain to be addressed. If the records examination does not lead to any outstanding issues, there is no need for a meeting. If a meeting is seen as the best way forward, whilst not obligatory, an agenda would be appropriate. This allows a large degree of control over the course of the enquiry to be obtained by the accountants.

Secondly, the request for the records examination to take place at the company premises; in a similar way to the PAYE audit, there is no general right of access to clients' premises. The reason why the Inland Revenue adopts this approach is an attempt to have a 'snoop' around the business premises without the accountant present. This should be resisted. Records examination could take place at the Inland Revenue's offices or, as an alternative, at the accountant's premises. The accountant can be present and available to answer any questions arising from the records examination in his own office and hopefully this will save a great deal of time.

Finally, the proposed meeting to cover the affairs of the directors personally should be considered. As illustrated above, this is not something that should be done at the outset, but at a later date if appropriate.

As a point of interest, when these points were made to the relevant Inspector, he issued the following text as justification for his requests.

'Full Enquiries Into Close Companies

'This note is supplemental to the formal notice of enquiry and Code of Practice 14 attached. It details from our experience of enquiry work, how we see matters progressing during the proposed visit to the company.

'A full enquiry involves a detailed and critical review of the company's return, examination of the company's records and usually, as the company is closely controlled by the directors, a review of the directors' personal financial affairs. It is intended that as much of the initial work as possible is carried out during the visit to the company. This should minimise costs to you and enable the enquiry to proceed quickly. It does mean that the visit is likely to last more than one day and could be up to three days dependent upon the size of the company. We aim to avoid disrupting the running of the business during our visit; we may, however, ask for a tour of the premises.

'At the start of the visit, we would like to meet with the directors, normally with the auditor/accountant present, before moving on to examine the records. After the meeting it is not necessary for the directors and the auditor/accountant to be present. We would, however, like the person responsible for maintaining the company's records, usually the company's bookkeeper or internal accountant, to be available for at least part of the time. This usually enables many points to be resolved during the course of the records examination without the need for further correspondence.

'The meeting at the start of the visit will normally last one to two hours and will include discussion:

• With the directors to establish how the company's business operates and how the company's records are maintained.

• With the accountant on accountancy/audit matters.

• With the directors concerning their own personal financial affairs.

'Records examination

'The records examination for the remainder of the visit will include:

• Full examination of the company's records. Review of all books and ledgers (including full nominal ledger), whether manual or computerised, following transactions through to the trial balance. Review of all prime records of income and expenditure. Review of bank statements, cheque stubs and paying-in books for all company bank/building society accounts. Review of credit card statements for all company credit cards. Review of wages records. Review of other business records (this varies with the nature of the business, but may include order books, delivery notes, job diaries and the like).

• Review of the accountants' papers showing how the company's records have been reflected in the accounts. This will include all journal adjustments made to the company's trial balance and schedules for such items as debtors, creditors, stock, fixed assets and directors' loan accounts.

• Examination of the directors' financial records. Review of bank statements/pass books supported by cheque stubs and paying-in books for all of the directors' personal accounts. Sight of statements for all directors' personal credit cards.

'Follow-up

'After the visit:

• We will send a copy of our notes of the initial meeting and ask for agreement from the directors to the contents.

• We will either write to you about any issues arising from the visit or request a follow-up meeting. This will depend on the number, nature and complexity of the issues involved. Generally we find that meetings progress cases more quickly than lengthy correspondence.

• We will ask for further paperwork to support explanations of issues raised and of any significant transactions. Where we consider it necessary, we will seek verification of transactions from third parties.

'Progress

'We will seek to progress matters as speedily as possible but this will be dependent on obtaining the information necessary to complete our work.

'If at any time during the enquiries the directors feel there are matters that need to be disclosed to the Inspector, then they should contact the Inspector (either direct or through their adviser) immediately.

'This leaflet is intended to be helpful guidance based on local experience and practice. It in no way varies the contents of the Department's Codes of Practice and any dispute will be determined only by reference to those Codes.'

This is, as far as the writer is aware, not an Inland Revenue publication but a locally generated wishlist. It is completely out of order to issue this with Code of Practice 14. As can be seen, the majority of the requests in the letter and the wishlist are inappropriate at the outset. This is a typical example of a 'try on' by the Inspector concerned. There are many things that the Inland Revenue can do in order to review the affairs of clients. However, Inland Revenue procedures establish a set order for the process. To point out these errors is not being awkward for the sake of it, it is restricting time and costs for the client.

 

Mark Morton provides lecturing and consultancy work for Mercia Group Ltd. He can be contacted on 0116 2581200; email: mark.morton@mercia-group.co.uk.