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'Reasonable and relevant'

18 October 2000
Issue: 3779 / Categories:
During an Enquiry, an Inspector has requested a copy of my client's mortgage application form, and has now issued a Section 19A notice demanding the document. My client has said that he did exaggerate his business profits on the form to get the mortgage.
During an Enquiry, an Inspector has requested a copy of my client's mortgage application form, and has now issued a Section 19A notice demanding the document. My client has said that he did exaggerate his business profits on the form to get the mortgage.
Is it worth appealing against the Section 19A notice? If not, then would an Inspector be able to increase self-assessed profits on the basis of a mortgage application form, particularly if my client is happy to admit to the Revenue that he exaggerated his profits for the mortgage? Is there any known legal standing/cases that can help on this point?
(Query T15,695) Cleft Stick.

'Cleft Stick' could appeal against the production of the section 19A notice although this would merely mean:

(a) If the document could not be produced, the Inspector would issue a third party notice on the bank or building society.
(b) If the document was available, the Inspector justifying his reasons for requesting the same, namely another source when the information could be obtained and the appeal failing.

It is not uncommon for these forms to be requested although whether the lender actually makes his decision on the form bearing in mind most insist on an accountant's report in respect of self-employed earnings. 'Cleft Stick' would be better advised to obtain the form, if it is still available, and discuss it with the client, thus providing an explanation of any discrepancy to the Inspector when submitting it. For example (a) did the client consider his income to be gross earnings or even turnover? (b) Was the income he declared an estimate of what he expected to make rather than what he was making? Explain the drop. (c) If all else fails, he should explain that he completed the form without recourse to professional advice, knowing that it was an invitation to treat to the lender and not as a formal return of income.
If 'Cleft Stick' has a copy of any return he made to the lender or can obtain any such third party return in line with the income on the return, that should also be considered for submission at the same time.
Obviously the Inspector is out to prove a higher income and is casting around for any evidence that would support this. By appearing to help but at the same time discounting that evidence with a valid reason, control of the investigation remains with the client and his adviser, and thereby hopefully a better settlement could be obtained. – PJS.

When a mortgage is sought, the lender requires an application form, completed by the borrower, together with proof of income. For employees, this would be a recent form P45 or P60 and a recent pay advice. For the self employed, it would be copies of accounts for (typically) the last three years and, usually, certification of some kind from the accountant who prepared them. Indeed the agent is often invited to project, or opine on, future performance – a request to treat most cautiously. Whether the mortgage is granted or not, both the application and certification forms become the lender's property and are not within the borrower's power for the purpose of section 19A, Taxes Management Act 1970 notices. So the Inspector is wasting his time asking for that which is neither in the client's possession nor within his power to procure. In fact, if the mortgage application was refused, the forms may well no longer exist, having been destroyed by the potential lender. If this query is really about an application (or even a certification) document, the parties are either ill informed or not thinking very clearly.
The Inspector cannot assess on the basis of the application, because the income data disclosed is likely, as in this case, to include a degree of optimisation, if only by minor rounding up. The accounts are the only reliable basis. In fact, I have seen some lenders to the self employed consider turnover rather than profit, in cases where transactions in materials are not a factor.
The net gain in wealth certified by the accountant is almost bound to exceed the profit shown by the accounts, as he must include contributions to the family finances from:

Payments to the partner for bookkeeping, secretarial services, telephone minding and errand running.
Where the home telephone cost is recharged to the trade, net of private calls, the standing charge element so covered spares the trader the like expense from taxed income.
Where there is a home office, an area portion of council tax, water, etc., insurance, maintenance, and light and heat will be recharged to the trade.
If the home includes a garage, a like recharge of property overhead on it is likely to be recovered.
Where the trade uses what is also the family car, there will be a similar recovery of the trade portion of road fund tax, insurance and maintenance that would otherwise be borne from taxed income.

A competent agent will always compute the above values, and augment the certified income accordingly. This can easily add hundreds, if not thousands, to the loan base income, depending on how much is paid to the partner. – Barham.

Extracts from further replies received:

It is most unlikely that a mortgagee would rely upon some unsupported or unsubstantiated statement of income before granting a loan. 'Cleft Stick' will undoubtedly have taken steps to ensure the exaggeration is no more than is said.
Although section 19A may be a formal notice, it does not have the more far-reaching power of its big brother – section 20 (although some Inspectors would think and treat otherwise). As the query heading infers, the information must be reasonable and relevant to the return. The return is relevant and certainly a reference to the mortgage application, but this does not equate the other way around. In all cases a request under section 19A must be limited to documents connected with the return. Unless such information can be shown to be reasonably relevant to an entry in the return, it cannot be requested under section 19A. This is borne out in the Revenue's own guidelines (SAT 2, as a starter). – Jim.

There is no doubt that a mortgage application is within 'possession or power' – you can just write to the building society and ask for a copy.
The 'reasonably require' phrase in section 19A(2), Taxes Management Act 1970 is slightly more interesting. No entry on the mortgage application correlates with any entry on the return either directly or indirectly. Whilst the application contains a profit figure at variance with that on the return, that simply demonstrates that your client lied to get a mortgage.
I would certainly appeal against the notice on the grounds that this is not a document that the Inspector can reasonably require. I suspect that at any subsequent hearing, the Inspector will argue along the lines that returned profits would be insufficient to convince the mortgage provider to release funds. Your argument should be that this is irrelevant since whatever your client may have said, the mortgage provider has no effect on his tax return. – A.D.

Strictly, I suspect that the Inspector is exceeding his powers in seeking to obtain a copy of the form under section 19A. After all, section 19A is about getting information which casts light on the true size of the taxable profits - exaggerated statements made to a third party are no evidence at all. Will we next have Inspectors assessing capital gains tax on the basis of boasting at the golf club bar about the huge gains made on a share tip?
Of course, having lied to the prospective lender will not put the client in a good light with the Inspector or commissioners – the Inspector will be keen to assert at the very least that a man who will lie to a lender will lie to the Revenue. But the best thing will be to brazen it out: yes the client exaggerated his profit: yes this was reprehensible: but no he is not the only person ever to have done it and no it does not prove anything one way or another about the accounts. Accept the fact but attack the unwarranted conclusions that the Inspector may seek to draw from the fact. This has been successful in several cases here.
'Cleft Stick' will be very unlucky if he encounters commissioners as unreasonable as those once reported to me, who allegedly took such a dim view of the offence of mortgage fraud that they confirmed the assessment in the numbers shown on the form plus 10 per cent to show their displeasure. That decision, if it were true, would clearly be reviewable as abuse of process. – Lewis.

Editorial note. All those of us who have been in small practice must have come across this scenario at some stage. A mortgage application for a self-employed person consists of three main 'planks': (a) existing prepared accounts; and (b) an estimate of profits since the last prepared accounts; and (c) partner's and investment income.
If it is (b) that has been exaggerated, forecasting by a 'lay person', though foolish, can hardly be called fraud. If (a) has been exaggerated, that is another matter altogether, and calls into question the ethical problems that the adviser will face, as mentioned by several readers.
'Barham's' point about the ownership of the mortgage form (if no copy has been retained) is also interesting. His resumé of 'add backs' in order to enhance family income is also entirely valid, and the writer has used this approach himself.
Conversely, self assessment has produced a completely new set of rules. 'Incomplete records' are effectively outlawed, and any business person is required to keep proper books of account and be subject to section 12B, Taxes Management Act 1970.
Ultimately the adviser has to assess the basic honesty and accountability of the client, and whether she and the client are prepared to take a stand on a point of principle – with all the costs that this may involve – or 'do a deal' with the Inspector.
Each of the nine replies received to this query had merit, and those not selected for publication on this occasion should not be discouraged.
(Note by John Newth.)

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