Are HMRC right to focus on Business Records in isolation?
When I predicted in a recent article that I foresaw no push on the part of HMRC towards making traders keep contemporary records of sales and expenses, I had not seen HMRC’s Business Records Checks Consultation document.
HMRC feel that the absence of proper business records leads to underassessment of tax and quote the Organisation for Economic Cooperation and Development (OECD).
The Consultation Document states ….
Whilst the need to keep proper records in order to comply with tax obligations is widely acknowledged, HMRC’s random enquiry programme indicates that poor record keeping is a problem in around 40% of all of SME cases (circa 5 million). Research by the OECD indicates that poor business record keeping generally leads to an underassessment of tax even where there is an audit-type check into a return for the period covered by such records.
I went on the OECD website and I found a Report from 2004. One of the aims of the Report was (and I quote)-
Promote effective record-keeping
171 One of the keys to more effective treatment of the risk to revenue collection from
the ‘shadow’ or ‘cash’ economy is better record keeping by taxpayers and third
parties.
172 Better record keeping increases the visibility of cash by creating an audit trail. One of the most effective counter measures to money laundering and tax evasion is for
citizens and organisations to take steps to establish the identity of people they
transact with and to keep adequate records of transactions such as invoices and
receipts. The potential ‘win-win’ for the revenue authority is that good record
keeping is an important element of running a successful business — the foundation
of good financial control. The challenge for the authority in establishing
record-keeping requirements is to strike the right balance between the value to the
business and the cost of compliance. Demands must be consistent with what is
required for good business practice.
Note the mention of “cash” to which I will return later.
HMRC say in the Consultation that a trader will fulfil his legal record keeping obligations if he accurately records business ‘money in’ and business ‘money out’, in whatever form, showing the matters in respect of which the money was received and expended.
Several examples are given
Trader ‘A’ issues a paper invoice for every job he does, keeping a copy for himself.
He obtains a receipt for every business expense he incurs. Day by day he puts all of
those bits of paper into a box to be sorted out later.
Trader ‘C’ has a sophisticated record book into which he neatly enters details of
business income and business expenditure, accurately separating capital and
revenue. However he records only some of his business takings and only some of
their business expenditure.
HMRC feel despite the absence of record books, the business records of ‘A’ are capable of being turned into a correct and complete return of taxable business profit and that he will have fulfilled his statutory obligations, but Trader “C” will not.
To me this is not about “C’s” records, however good or bad they are. It is simply about C evading tax.
HMRC want to make greater use of the penalty legislation for inadequate records and are looking at the level and timing of penalties.
They say that record keeping penalties for VAT have previously been set in fixed amounts and where a trader has failed to keep the required records it has been HMRC practice not to impose this penalty in the first instance but to warn the trader and safeguard the future position by serving a formal ‘Notice of Requirement’ to keep specified records. At the moment therefore penalties have been imposed only if has been a failure to comply with the ‘Notice’. HMRC regard this as a ‘free go’ and feel that it does nothing to deter record keeping failure from the outset. They want to adopt a consistent approach for IT, CT and VAT and penalise traders straight away when significant record keeping failures are identified. They are looking at levels of penalties which could be anything from perhaps £50 to £3000.
There is apparently no statutory power to suspend collection of a penalty for a record keeping failure which is a shame if HMRC are looking at charging more and higher penalties. This to me would be a reasonable middle way ie no free go but neither does the trader suffer penalties straight away without being given the opportunity to put things right and with penalties being charged only where a follow-up Business Records Check showed there were continuing and significant record keeping failures.
HMRC are intending to use Schedule 36 Finance Act 2008 to enable an officer of HMRC to enter a person’s business premises and inspect statutory business records, where that is reasonably required for the purposes of checking that person’s tax position. Any premises on which the statutory records are kept are, for these purposes, ‘business premises’ but this power does not cover entry to any part of premises used solely as a dwelling.
It is intended that Business Records Checks be pre-arranged with at least 7
days notice and appointments made. It is envisaged that typically a Business Records Check will consider a ‘sample’ of the records kept (not the records in totality), to check that a full and clear record is being kept of all business ‘money in’ and ‘money out’, and that the records allow an accurate interpretation to be made as to the nature of those receipts and expenditures
It is envisaged that there will be 50000 checks per year taking up to 4 hrs each
and that an estimated £600m extra revenue will be collected over 4 years.
HMRC want to begin Business Record Checks (BRC’s) in Sept 2011.
By way of explanation of their approach, HMRC refer to 2 main changes in the law.
Firstly “the new penalty legislation for inaccurate returns, introduced by Schedule 24 Finance Act 2007, does not allow for any record keeping failures to be reflected in the size of the penalty for any understatement of tax. The penalties can no longer be ‘rolled into one’. “
Secondly, Parliament has given HMRC powers, in Schedule 36 Finance Act 2008, to make checks of business records whether or not a return has been made.
I feel that HMRC’s approach is based on two flawed premises.
Firstly the premise that there is a significant loss of tax from poor record keeping. There is a significant loss of tax from people who go out of their way to evade tax but keeping poor records does not mean that you are a tax evader neither does keeping a perfect set of books mean you are not, as can be seen from HMRC’s own examples above. People can keep very impressive records of what they want to. They will have a record of business incomings and outgoings and the records may be very good but the incomings may not be all the income of the business and the outgoings may not all be business. The proper place to test this is in a targeted Enquiry as part of a serious check of the accounts and returns.
And this is also the proper place to impose penalties, not to have one set of penalties for understated tax and another set for poor record keeping.
Poor record keeping is commonly the result of ignorance and /or a trader being too busy and with one exception it may well result in very little income being omitted but almost certainly results in some genuine business expenses not being claimed. This is because bills and receipts may be lost and the relevant expenditure not included by the trader in the business books because he has not kept the books contemporaneously but writes them up at best after the quarter end in VAT cases and annually in non VAT cases, if he writes them up at all.
The one exception is cash trades. Even here if the cash trades involve a modern till then the till records can be very good indeed. A failure to keep such basic records as till printouts could merit a penalty but to deal with this outside of an Enquiry into returns and accounts seems incongruous, and if an Enquiry involving a case of poor records discovers nothing untoward then it seems wrong to impose a penalty for poor records. Better to threaten the penalty and return at a later date to see if records have improved. If they have not, impose the penalties then and if the records have improved, then apply the tests of the records that it was not possible to apply before. If irregularities are found at this second visit then the trader can be penalised in the normal way depending on the seriousness of the case. In other words penalise people for understating their tax and for not keeping records but do not impose a penalty just for poor records.
So the second flaw in HMRC ‘s approach is to separate Enquiry work and record keeping even if the penalty legislation seems to push them in that direction. The fact that the legislation gives HMRC the power to look at business records independently from the return is surely so that HMRC are not stuck looking at just one years records relating to one tax return when they may need to look at records and gather information for other years whether or not there is an Enquiry into those years. It is not a reason in itself to go for 2 tiers or types of penalties. The legislation could be changed. This might be desirable if it lead to a restricting of HMRC powers which some already feel are too widespread.
I guess HMRC think that their proposed approach will be quick and inexpensive. A short visit to the premises, a penalty for poor records and move on to the next one.
If this initiative is not properly targeted, all that will do is annoy the majority of traders who do their best to pay the right tax and more or less succeed with any income that slips through being offset by expenses that are not claimed but whose record keeping leaves something to be desired.
HMRC may well fail to achieve their target. 50000 visits pa at say an average of 2 hrs per visit is 100000 man and women hours pa x 2 because no doubt 2 officers will be required at each visit, never mind the hours taken up with recording the visit, the records seen and what was said (even if on hand held computers), and with the issuing penalty notices. Where are HMRC going to find say some 400 – 500 officers in their current state particularly as along with other government depts they come under pressure to make further staffing cuts?
Surely all HMRC need to do is to focus Enquiry work on cash and other high risk trades and force those trades to keep more accurate records, then revisit them when they do and fine them if they don’t.
If the evidence is clear that poor record keeping leads to significant tax loss, then HMRC could invite a statement in the Additional Information box of the Self Employed section of the Tax Return about the records being kept and could use this or its absence to help them evaluate risk. All good accountants include notes about the basis of adjustments such as private adjustments or the source of capital introduced in Additional Information boxes. The Tax Return notes could state clearly HMRC’s view on poor records, what they expect and encourage the taxpayer to specify briefly what records he or she kept for the year of the return and whether the taxpayer needs advice to improve their record keeping. Assistance could be provided mainly by telephone.
HMRC could contact the clearly high risk trades via their accountants of course (we don’t want contact with traders generally and a repeat of the Interventions policy a few years ago which did not work) and obtain a written statement of the records being kept. The involvement of the accountant ie a 3rd party should give HMRC some comfort that the statement had been considered and was correct. HMRC could then consider a full enquiry at that point or at a point further down the line after giving the trader a chance to improve his records. HMRC could take a hard line then if the trader had done nothing.
HMRC should encourage and assist with better record keeping and penalise only the recalcitrant or those they demonstrate have used records to evade tax in the course of normal Enquiry work. I do not believe that it is good use of HMRC resources even if they have them to look at 50000 traders records pa. The resources would be much better employed in improving compliance using the prime document of tax collection for the self employed, the tax return, and its notes, plus gathering information for the high risk cases and then making Enquiries into those high risk cases. I certainly believe it is a big mistake to overcomplicate and make 2 penalty issues of what is essentially one.
I wouldn’t be surprised if Inspectors felt the same way.
This article was forwarded to HMRC in time for the closing date for the consultation.
I am indebted to Taxation and to Will Silsby in his recent article “Checking It Out” for bringing this issue to my attention.