The question of avoiding what every taxpayer fears – a long and time consuming enquiry from HMRC – is one that should be at the forefront of any good accountant’s mind. Inherent to this is that we must understand how HMRC target enquiries. Many of the methods HMRC use in their detection of tax returns which should be enquired about further are not within the public domain, for reasons which should be fairly obvious, but an experienced accountant will be aware at least in general of the methods used by HMRC in detecting a tax return for investigation.
The first threshold which any return to HMRC will be expected to pass are computer modelling tests. Within the profession any business or sole trader operates in, HMRC have a range of values of measurements such as Gross profit, Capital Allowances or Net Profit which they expect the business to fall within. More specific trades with a history of high levels of tax evasion will be especially subject to other measurements. For example, HMRC will take a close look at the ratio between a Taxi Driver’s revenue and the motor running expenses they claim within the year as anyone declaring their full income would expect to see a very close relationship between the two figures.
With an understanding of what HMRC expect to see within any given profession, we can better judge the likelihood of HMRC issuing an enquiry if figures are far outside the expected range and can make additional pre-emptive disclosures or take other steps to ensure that no enquiry is brought about.
The other thing HMRC will of course look for is relative consistency – a set of accounts with wild fluctuations in the figures are more likely to raise an eyebrow than a set of accounts showing fairly consistent trade and margins.
Even with a full understanding of how HMRC set up enquiries, no taxpayer can be assured of their records not being audited. As with all things, there is an element of sheer random selection in whether HMRC choose to investigate a taxpayer’s records. As checking every businesses submission every year is clearly impossible, HMRC take a sample of records which are flagged and investigate a number of these tax returns each year, approximately 5% of the total returns submitted.
So how can you ensure you won’t suffer at the hands of an HMRC investigation? The best solution is of course to keep good records of your business activities. The job of any good adviser should involve, to a certain extent, pestering clients who fail to live up to this task. We understand as well as any of our clients that keeping track of every little receipt is tedious and can seem somewhat pointless, after all, we have to do the same. However, in the long run tax advisers who are willing to accept consistently poor records without giving clients advice on how to improve their record keeping are doing their client no favours. For any trader who stays in business long enough, tax inspections of one sort or another are inevitable, be it VAT inspections or enquiries into claims. When the day comes for this, a good accountant should be able to justify every single item they have claimed on behalf of a business.
The final point to bear in mind is of course that HMRC regularly get it wrong. When a tax enquiry arises many practitioners or small businesses who do not receive good quality advice are often inclined to be far too passive in accepting HMRC’s ruling on matters. The reality of the situation is that HMRC are regularly defeated when cases go to tribunal, their inspectors have a clear agenda in favour of uncovering evidence that a taxpayer’s case has problems within it – after all, they will have to justify time spent on an investigation to their manager and the longer an inspection drags on the harder it can become to explain to a manager why it remains ongoing.
By being willing to contest HMRC’s opinions on tax law and counter-offer rulings made by inspectors, a good tax adviser can achieve much better outcomes for their clients than one more inclined to accept HMRC’s ruling as objective. The reality of the situation is that HMRC’s inspectors are no more qualified than a good accountant and their rulings on complex areas of tax law can be contested provided that the accountant has a good understanding of tax law and tax tribunal rulings. Proactive ensure that each client has cover on the costs should a tax investigation arise (though not on any additional tax due). This should give our clients one upside should they be unlucky enough to be selected!