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KEY POINTS
- Does a ‘one size fits all’ approach work for accounts?
- Does the Mirrlees Review still have relevance?
- Accounting standards and the unrepresented taxpayer.
- Arriving at a ‘true and fair’ view.
- Simplification and record-keeping.
The HMRC review of simplified accounting for small businesses – or at the moment, those small businesses chargeable to corporation tax – has progressed from seemingly pie in the sky to something that may have significant consequences, given the unexpected willingness of HMRC to look at simplification.
Furthermore, the EU Commission is now proposing to abolish financial reporting rules for micro-entities and, given current exchange rates, that can mean businesses with a turnover of £1 million.
This is important because the simplification agenda is now taking centre stage.
Clearly, if simplification happens to corporation tax then income tax rules for business will have to change as well.
But there is a clear and present danger that we may hit a ‘one size fits all’ solution, with the suggested target area being basically small/medium-sized enterprises (SMEs) with a turnover up to £1 million, or nearly all the businesses that there are.
From some of the more Olympian points of view (by which I mean the top of the accounting profession, where the big firm mentality is ingrained) all SMEs look the same. But they ain’t.
And ‘one size fits all’ is at the root of this problem. When the Taxes Acts required supporting accounts to be ‘true and fair’ the concept was flexible enough to cope at a time before self assessment when supporting accounts were actually required (strictly speaking, in order to determine an appeal).
Now, although there is no actual need for a set of accounts and the relevant figures can be entered straight into the tax return, what is now ITTOIA 2005, s 25 requires that ‘the profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustment required or authorised by law in calculating profits for income tax purposes’. The new Corporation Tax Act will include a similar requirement.
So – granted all the technical stuff about FRSSEs and the like – the accounting rules are the same for Tesco PLC as for Joe the Plumber, and they are basically designed to protect the shareholders, which matters for a PLC, but not for 99% of UK businesses.
The Mirrlees Review and after
The small business aspect of the Mirrlees Review, which the Institute for Fiscal Studies (IFS) saw as a discussion of root and branch reform for the UK taxation system, issued a paper in August and as far as workers in tax are concerned this created hardly a ripple.
Indeed, the whole review now looks as if it was set up for a world which no longer exists; somehow the notion of a 0% corporation tax rate doesn’t seem as appealing as it did – though it would end a lot of tax avoidance activity.
So perhaps we have to start again. Now it seems to me that we ought to be paying particular attention to the nano-businesses, by which I mean those with no employees (except for some personal service companies where that is an artefact of the structure) and a turnover below the VAT threshold or possibly a rather higher figure – say £100,000.
That will include some IT contractors and construction industry subcontractors, building industry craftsmen and a whole array of craft or service businesses exploiting personal skills from apiculture to yoga.
It includes so-called ‘lifestyle’ businesses, which as someone pointed out to me recently can involve a fairly mean and constricted lifestyle! The modern economy has a lot of niches where people may find themselves.
Why are they important to HMRC? Because a high proportion of self assessment tax returns come from this segment of the taxpaying population and because, historically, HMRC have devoted a great deal of time and energy to dealing with these taxpayers.
Simplifications
There have already been ‘simplifications’ – and I use the quotes because some would not accept that there is a real rather than a paper saving here.
Those with a turnover below £30,000 now find they do not have to detail expenses, and we can see why: if HMRC wants to examine the tax returns of this class of persons there is probably only one significant form of evasion and that is suppression of the takings.
No expense item is going to be large enough to make much difference, and an adjustment with a tax value of £1,000 would be very unusual.
It could, I think, be argued that a risk analysis of the expenses boxes on the tax return for the next tier – those turning over between £30,000 and the VAT threshold – will be next to useless.
It is not so very certain into which box a particular expense needs to go and once you find (as I often find myself) that ‘miscellaneous’ is the largest expense figure then really the tax return is not very informative.
Accounting standards
The law at the moment suggests that every business return should be compiled by reference to UK GAAP or international accounting standards; this for people who would not recognise GAAP if it came up to them in the corridor and bit them on the leg.
About half of this group submit their own tax returns rather than using an agent, and it is likely that most of the others use unqualified agents.
So yes, HMRC can have a field day making adjustments for stock and work in progress, for the odd £50 speeding fine, for shifting the business fraction for motor use from 75% to 60%, for goods taken for own use at cost rather than market value, and for buying stamps through the business and using them for your Christmas cards.
All good knockabout stuff, but not paying for itself in terms of the time of relatively expensive tax inspectors.
In his article Think big!, John Cullinane proposed a flat rate to cover direct tax on profits and PAYE. A problem with some of the more radical suggestions like this, or allowing standard percentages for expenditure, is that they do not take account of the vast range of utterly different businesses which are nonetheless subsumed under the same trade group, and as a result they do not seem capable of being fair.
While full compliance with accounting standards seems unreasonable, I suspect that we all still want things to be, in some sense, true and fair.
After several hundred years, the concept of profit seems to have stuck. It is also relevant that if someone feels their treatment is unfair they are likely to look for a way of getting something back and may well then slide into non-compliance.
The notion that accounts supporting a tax return should give a ‘true and fair’ view is one that most people would support.
It is, however, unlikely that they would then expect to turn to the way this is defined for GAAP.
Perhaps the principle should be that over the life of a small business it should pay the right amount of tax – with the point here being that the adjustments for debtors/creditors/work in progress may add little to the tax take.
Even if you take a 31 March year end, then the due date for tax is ten months after your accounting period ended and any bills for the year that are still not paid then are unlikely to be thereafter.
Achieving a truer picture
What causes the trouble is that what is true and fair by accounting standards may not be true and fair for tax. To give a true picture of the state of the business you may need to show various items as expenses that would not be allowed for tax.
If – and it is not unknown – you have included your drawings as an expense of the business, then the true cash position of the business needs to take that into account, but an account prepared for tax purposes would not need to do so. TA 1988, s 74 (and its predecessors) was in its way a bridge between the two. The need is to decide which adjustments really make a difference.
Timing adjustments do not: very small businesses are unlikely to have fluctuations from year to year in most levels, and if in hard times the list of creditors grows then it seems reasonable to tax what is received rather than what may be received one day. We do need to accept a cash basis.
Personal expenditure does need to be adjusted for, and as long as the law requires that entertaining and extra-legal expenditure is disallowed and there is a need to make adjustments for (in some sense) the depreciation of fixed assets, then accounting profit will not equal tax profit.
Here HMRC still does not always help. I hardly like to mention the consequences of FA 2008, s 37 and Sch 15, which committed the error of casting in stone the ill-thought-out decision in Sharkey v Wernher 36 TC 275 and, in theory at least, requires an adjustment whenever goods are taken from stock (except of course for a few cases).
This is a perfect example of legislation which is entirely illogical and will cause trouble but raise very little tax. It is also a perfect example of legislation that would need to be repealed in a simpler world.
But, apart from that, how much simplicity do we have already?
Record-keeping requirements
It may not be necessary to amend the record keeping legislation. That requires a taxpayer to ‘keep all such records as may be requisite for the purpose of enabling him to make and deliver a correct and complete return for the year or period’, and in the case of a trade ‘the records required to be kept and preserved… shall include records of the following, namely:
(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; and
(ii) in the case of a trade involving dealing in goods, all sales and purchases of goods made in the course of the trade’.
Bear in mind that ‘the duty … to preserve records may be discharged by the preservation of the information contained in them; and where information is so preserved a copy of any document forming part of the records shall be admissible in evidence in any proceedings before the Commissioners to the same extent as the records themselves’.
However there is also a duty to keep all supporting documents, which include ‘accounts, books, deeds, contracts, vouchers and receipts’.
For a simple one-person business, though, this may come down to copies of invoices issued and evidence of expenditure: you don’t have to keep accounts, books and contracts if they don’t exist.
Even if these records are just kept in a plastic bag, they are evidence which has to be displaced.
There is no need for a balance sheet or for double-entry records. If this is accepted by HMRC – and I have certainly heard Dave Hartnett say as much – then perhaps there is not a lot of simplification needed.
The cultural leap
And that of course may be the answer, if everyone accepts what is reasonable.
Anecdotal evidence speaks of inspectors in the past maintaining that anything short of a complete and balanced set of double entry records was inadequate.
There is some evidence now that HMRC is beginning to make the cultural leap from ‘all small businesses are on the fiddle’ to ‘most of them aren’t and those that are should not be a major priority if we are looking to close the tax gap’.
Obviously investigative powers will remain, but the buzzword now is ‘help’. The rolling-out of the Agent Account Manager programme and the new material being produced to help small business suggests that we might be at a crossroads if we can all overcome our prejudices.
Simon Sweetman is a self-employed tax consultant and can be contacted by telephone on 01394 274857 or by email.
