Tax Enquiry

Mark McLaughlin

Introduction

Many taxpayers do not have an accountant to deal with their tax affairs. There may be a number of reasons for this. For example, professional fees can be expensive. In addition, the taxpayer may feel that he can competently prepare a self-assessment tax return and (if applicable) accounts as a self-employed individual. In an ideal world, it should be possible for every taxpayer to understand their own tax affairs, and to be able to prepare their tax returns without professional help. Unfortunately, tax and accounting rules are often complicated, and innocent mistakes can be costly. The following query concerns the accounts of a self-employed individual, who has prepared their own tax return for a number of years.

Query from TaxationWeb visitor ('j000000002')

I've been preparing my limited company accounts and doing the self assessment myself for 9 years now and the taxman has opened an enquiry for the year ending 31/12/05.

He has noticed from invoices I sent him that an invoice from January 2006 was actually for sales in 2005. He has told me that accounts should be prepared on an accrued basis and not a cash basis and that he would like to add the sale to 2005 sales.

I'm afraid I've been accounting for everything on a cash basis. Sorting this out properly is going to take forever and probably cost me a lot more than the extra tax, interest and penalties I will need to pay.

What do I do now?

i) Can I ask for him to accept accounts prepared on a cash basis?
ii) Should I wait to see if he pursues this further for other invoices I have sent him?
iii) Should I work out an accurate figure for 2005 and 2006 and tell him about it?
iv) Should I work out an accurate figure for all years or just going back a certain number?
v) Should I make some sort of estimate for all years or estimate for just a certain number?

or

v) Should I write to him and tell hime that I've been accounting this way since the company started and ask him what he wants me to do about it?

Any advice gratefully received.

Editor’s Comments

Having made the initial error in the accounts and tax return, the way in which the subsequent enquiry is handled can have a significant impact on the approach that HM Revenue & Customs take, and on the level of any penalties charged for the error. There are at least two possible approaches. One is to allow HMRC to take the lead in the enquiry, and to co-operate in providing the information and explanations requested. Another is to enagage a professional with extensive experience in HMRC enquiry cases, to deal with the enquiry and negotiate with HMRC if necessary. Depending on the size of the business and the amount of tax at stake, the second option will often be the most sensible and cost-effective, and would certainly be worth considering in the case of j000000002.

Prevention is generally better than cure. Employing the services of an accountant or tax professional from the outset may seem expensive, particularly for a newly self-employed individual. However, if this prevents problems such as those highlighted in this query, it will surely be money well spent.      

Forum responses included those reproduced below.

'robbob' commented:

I would workout what impact the ajustments would have on 2005,2006 and 2007 accounts.

You could ring him up and apologise, say you will in future do accounts correctly.Say to him any understated 2005 sales will be overstated in 2006 so any adjustment to one year will even out the next year.
 
However make clear you will add additional sales as appropriate in current year.

Then ask what adjustments he is proposing.

And see if this is fair.

Remember the same applies for expenses as it does for sales, so if you get credit from suppliers or the like there may be additional expenses to offsett.

'j000000002' replied:

Thanks robbob,

I will do that.

Simon Sweetman commented:

The real question is whether that is all there is. If there are other problems I would suggest that you need to go to someone who understands enquiry work. If this is all then you ought to be able to reach a reasonable solution.

'j000000002' replied:

The thought that there is more to it did cross my mind. The extra tax the revenue could get from this wouldn't seem to be worth their effort.

The only other issue brought up was about a health insurance policy I've had for the last 2 years which I've found out should have been declared as a benefit on my personal tax return and not been deducted as an expense to the company. Again this will not result in a substantial tax payment.

Would they be able to use either the health insurance issue or the accounting basis issue to go back and ask for tax from other things they've missed in earlier years though?

The thing I'm thinking of is an expense accounted for in the 2004 accounts which I was not 100% sure would be allowed, so I pointed it out in my letter accompanying the accounts. Will either of the above problems allow them to ask for tax on this if it turns out not to be allowable?

'robbob' added:

As they have found errors they can look back at previous years if they wish too, that is not to say that they will.

It's probably easier just paying the health insurance privately in future (unless you already do a P11D).

Note the company can take out key man insurance to the benefit of the business which would probably be allowable expense.

It's best to contact the tax man asap holding your hand up to your errors that he knows about and ask for a settlment figure. Again making clear all problems will be rectified.

Make sure you treat the benefits correctly in the current year so they do not do another inspection straight away.
Have you considered using an accountant in future? A decent accountant may be able to provide you with some decent tax saving ideas.

'j000000002' replied:

Thanks for the pointers. I will probably employ an accountant as accounting on the accrued basis will take me a lot longer than on a cash basis.

I've just this second finished reading a thread here on discovery which explains some of the issues I'm concerned about http://www.taxationweb.co.uk/forum/discuss.php?id=17508

Unless I'm mistaken wamtax seems to be saying that negligence in an open tax year doesn't allow them to reassess on a completely different matter in an earlier closed tax year.

That was what I was worried about. Of course if they really discover something in an earlier tax year that they couldn't have been expected to know about then that is something they can assess on.

Mind you, I was reading about discovery in the revenue's manuals yesterday http://www.hmrc.gov.uk/manuals/emmanual/EM3306.htm and I was quite shocked to see the definition of "discover" being recommended to the tax inspectors.

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Article Added Saturday, 08 March 2008

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