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I have a client who joined us approximately six months ago. As well as working as a surgeon, he also prepares medical reports for insurance companies. He has never appointed an accountant to help fill in his tax returns or prepare his accounts.
Six months ago the Revenue enquired into his 1999-2000 tax return and provisionally opened an enquiry into his 1996-97 tax return. This is where I came into the picture. My client has been fully co-operative and furnished the Inspector with all his books and records for the 1999-2000 tax year.
I have a client who joined us approximately six months ago. As well as working as a surgeon, he also prepares medical reports for insurance companies. He has never appointed an accountant to help fill in his tax returns or prepare his accounts.
Six months ago the Revenue enquired into his 1999-2000 tax return and provisionally opened an enquiry into his 1996-97 tax return. This is where I came into the picture. My client has been fully co-operative and furnished the Inspector with all his books and records for the 1999-2000 tax year.
The Inspector calculated that several arithmetical errors had occurred when casting the income columns which covered approximately twenty pages, but also agreed that certain expenses had not been claimed and would be allowed. Again we were happy up to this stage, agreeing mostly with her calculations.
The problem was with her final letter after covering all aspects of the investigation. She has used the tax year in question as a guide to calculating the level of error, for example 30 per cent, and applied this percentage to the previous ten years of trading, presuming that my client would have more than likely made the same casting errors for the last ten years.
I would appreciate any comments and possible counter-arguments to the Inspector going back ten years and assuming this 30 per cent level of error in each of the ten years.
(Query T15,933) – RAK.
The Inspector is only able to go back ten years if the taxpayer has been guilty of fraudulent or negligent conduct. The onus is on the Inspector to show this.
There is the question of materiality and it is assumed that the figures are substantial, although none are quoted. Without fraudulent or negligent conduct, the normal time limit of five years ten months applies to individuals. This should be the maximum period for which 'RAK' should accept adjustments in respect of addition errors.
It is possible for errors to arise on an individual's tax return which are made in all innocence and not knowingly. An addition mistake is not an error that is made deliberately. Without intent I do not think it is possible for the Inland Revenue to demonstrate there has been negligence or fraud. A genuine mistake is not negligence, although it may be careless.
The nature of the addition mistakes is distinct from adjustments which might arise in respect of the omission of income or the understatement of past expenses claims; this is because addition mistakes will not produce the same effect every year. An addition mistake may overstate income by 30 per cent but, if the net result of several years' investigations was to discover that errors annually resulted in a 30 per cent add back to takings, this would strongly suggest that the errors are deliberate. There is no suggestion of this. It is quite possible income has previously been overstated. Would the Inspector accept retrospective tax refunds for the past ten years? I think not.
It seems odd that the past years' records of income have not been produced and the additions checked. If there were only 20 pages a year, this is hardly a substantial exercise. It would seem the records are not available. This will not help the client, but nevertheless he should be able to quantify his total income for each year with a fair degree of accuracy by reference to his copy invoices or from the hospitals where he has worked, which hopefully will be few in number. There must be readily available evidence of his engagement diary, fee rates, etc. – Mike.
I am surprised that the Inspector is going back 10 years. In most cases, the normal time limit of six years is used unless there are special circumstances related to the size or seriousness of the case. I would have though that omitting one third of the profits, if this is what an error rate of 30 per cent means, is very negligent, but do not know the size of the errors to decide if an enquiry looking back ten years is appropriate. However, if we are looking at ten years prior to 1996-97, the Inspector should be asked for the grounds on which she is making the earlier assessments. For some of those years we will be into the realms of fraud, wilful default or neglect when the rules differed between assessments aimed at making good tax lost as a result of the different categories of failure.
At least, the Inspector will have to tell 'RAK' why she is going back so far.
Having looked at the basis of raising the assessments, we can now turn to the basis of the calculation of understated profits. 'RAK' should not be surprised that the Inspector is looking back at earlier years and should have been ready for such a possibility from the start of the enquiry. It is a reasonable inference that, if mistakes are being made now, they have always been made. That inference, however, is no more than that, an inference. It is not fact. 'RAK' must now show that there was a reduced level of error in the past. The most effective way of doing that is to find a year when there was no error or when the error rate was less than 30 per cent. I have said 'the most effective way' rather than 'the best way' because it may be impossible to reconstruct the earlier years.
All is not lost, however. 'RAK' should look for reasons why the error rate might have been less in the past. Such reasons could be a changing pattern of work so that there were more sources and more possibilities for mistakes in recent years, an increasing workload reducing the time for looking after the books, or any other valid reason. It may even be that, as the client realised nobody was picking up the mistakes, he became more careless. This is not an argument to advance because it will increase the penalty loading on later years because it implies increasing negligence.
Whatever the facts, the question is now one of negotiation. If the Inspector cannot be persuaded, it will be necessary to persuade the Commissioners and they will need proof rather than a negotiated deal to resolve the matter. – JWG.
Extract from reply by A St John Price:
If this were a VAT case, one would have the immediate sympathy of the VAT tribunal when pointing out that haphazard and innocent errors cannot be supposed to repeat systematically. However, if the income has been understated in one year, the very fact of that understatement, however innocent, must cast suspicion on earlier figures.
A VAT assessment on this basis might well be thrown out as not to 'best judgment' because the Inspector has not made further enquiries. However, it would be taking a risk to go as far as a hearing without making such enquiries oneself, so I would discuss the matter with the client. It would be preferable to check the arithmetic of one or, better still, two earlier years so as to have a factual basis for denying a consistent level of error. Of course, that would carry the risk of discovering even worse mistakes, but 30 per cent already sounds horrendous! It does suggest that there has been an error level but, if one is able to demonstrate much lower results in two other years, that seems likely to defeat even the most obdurate Inspector. Of course, a really satisfactory outcome would be to discover mistakes the other way, giving an overstatement of income!
In short, when the tax authorities concoct a demand based on suppositions, the most effective answer is fact! Sadly, the facts are often unknown but, assuming that the records are available, they must be easy to ascertain here.
Editorial note. There are several issues arising from this query. The first is the importance of professionals of other disciplines obtaining proper advice and assistance regarding their own affairs. Accountants and tax consultants would be unwise to diagnose and treat their own medical problems. Similarly, a surgeon should have retained an accountant or tax consultant.
Secondly, there is the question of evidence. Are books and records available for the previous nine years? If so, do the figures justify extensive work in order to disprove the Inspector's assumptions – for at least the previous five years?
Finally, there is a major error of principle by the Inspector. Under self assessment the Inspector can only enquire into the years 1996-97 to 1998-99 if she makes a discovery. On what grounds has she provisionally enquired into 1996-97?
1995-96 to presumably 1990-91 come within old investigation criteria, and are now more than five years past. As 'Mike' suggests correctly, the Inspector can only include these years if fraudulent or negligent conduct is proved – which seems unlikely.
I would obtain the evidence and then, if facts are favourable, apply to the General Commissioners for a closure of 1999-2000 under section 28A, Taxes Management Act 1970 on the basis of the agreed figures. The basic error of principle will embarrass the Inspector, and if she does not withdraw her assumed figures for previous years, then the Commissioners may well do so on the basis of a well-prepared case. This is a case where the Revenue's bluff needs to be called!
