Most of us have yet to experience the final element of self-assessment.
The enquiry process may have already begun, but the number of investigations underway is still comparatively small. Once the 31 January deadline goes by, though, all that will change.
Earlier this year, the Revenue published a detailed guide for its staff on how to organise and conduct enquiries, called The Enquiry Handbook. All of the matters discussed below are highlighted in its pages.
Any return or individual displaying key characteristics will automatically become a candidate for deeper examination. Forewarned is forearmed.
Be unlucky
Self-assessment does not re-quire the Inland Revenue to check every return as it comes in, but it does allow the department to enquire without giving a reason. This power of random enquiry is clearly critical to preserving the regime?s integrity. The risk of random selection is intended to deter anyone tempted to understate their income or inflate claims and expenses.
The random element in the enquiry programme will not be that big – probably around 10,000 cases each year. Revenue head office will make the selection from the whole self-assessment population, business and non-business taxpayers.
Taxpayers and their advisors should not be able to distinguish random from specific enquiries: the handbook tells officers not to let on how a return has been selected. Every one is worked as a full enquiry with the usual demand for access to records to verify entries in the return. The random audit programme for 1996/1997 runs to something like 8,000 out of the eight million returns issued (0.1%). Taxpayers will have to be pretty unlucky to get hit.
Turnover less than #250,000
The Revenue?s enquiry strategy starts by putting taxpayers into six groups ranked according to turnover: *small business – less than #15,000 *medium business – #15,000 to #250,000 *large business – #250,000 or more *very large business: mainly dealt with by the Large Business Office or cases worked in tax districts which are subject permanently to technical review *non-business with complex affairs: typically directors, Lloyds underwriters and individuals whose annual income exceeds #100,000 *other non-business: anyone not dealt with under the five other headings.
Small and medium-sized business taxpayers are the prime enquiry target but the matrix in the table opposite summarises how the Revenue plans to spread its resources.
Business accounts information must be supplied on the face of the return as standard. This is meant to streamline the processing of returns and pave the way for computerised risk assessment.
Before the era of self-assessment, there were three main reasons for selecting accounts for investigation: apparently unsatisfactory rates of gross profit (or critical ratios in service trades), information held by the Revenue already and low personal drawings. These are likely to go on weighing heavily.
The Revenue intends to have automated risk assessment available on its computer system from early 1998, but the department stresses that this will support rather than dictate selection.
The core rules will apply to all cases, with an extra set used selectively to assess certain types of taxpayer – the self-employed, for example, or company directors. To begin with, the Revenue will use information either from the return or stored on the taxpayer?s record. Later on, it may be able to turn to other data sources, such as Construction Industry Scheme returns.
Information from the old regime is not going onto the Revenue?s computer. But, as the system develops, the risk assessment rules will be able to take into account and make comparisons with data from earlier self-assessment years.
As well as data captured from returns, officers will be able to flag up taxpayer records manually to help in the risk assessment process. Each case will get an overall risk score based on all the information held on the computer. Compliance managers within districts will be able to view details of the assessment and use it to help decide whether to open an enquiry.
Mandatory review
There are some circumstances which, if present, will make a return the subject of a mandatory review. That doesn?t mean that there will automatically be an enquiry but an officer will definitely look at the return and take a view.
There is a box for taxpayers to tick if the self-assessment return contains provisional figures. This is a big risk area for the Revenue. If it does not challenge considered estimates or valuations, identified as such in the return, before the enquiry window closes, then the only option left is a ?discovery? assessment. For this, there has to have been inadequate disclosure or tax lost through fraudulent or negligent conduct.
The Revenue has the same problem with Capital Gains Tax valuations. Now, negotiations with Shares Valuation Division, Valuation Office Agency or Capital Taxes Office can only happen in a formal enquiry.
If the existence of the valuation is adequately disclosed, it is unlikely that the Revenue will be able to assess any tax loss resulting from incorrect figures after the enquiry window has closed. That is, unless it can show fraudulent or negligent conduct. So a considered valuation not selected for enquiry before the deadline cannot later be renegotiated.
The Post-transaction Valuations Service has been available since 1 April 1997. Taxpayers approach their tax office and agree valuations, on capital gains tax or some other specific item, before submitting their return. Officers must confirm that the return uses the agreed valuation. Finding a different figure would trigger an enquiry.
In the case of Lloyds underwriters, some of them will not be dealt with by the Lloyds underwriters unit. Those no longer actively involved in the market will go through the same tax office that handled their affairs before 1996/1997. Returns handled at district level are likely to be subject to mandatory review.
If taxpayers fail to notify chargeability or the return is late enough to involve a possible tax-geared penalty, then there will be a mandatory review. The officer will consider whether this indicates an unsatisfactory attitude to compliance generally, which would make it more likely that the records on which the return is based are unreliable.
Random element
But there are a number of other reasons which can also make a return the subject of an enquiry. These really carry through into the new regime from the pre-self-assessment era: an enquiry may be generated as a spin-off from other investigations, or kick off because of a letter from an informer, a tip-off from Customs & Excise or information gleaned from the local press and other sources.
Professional advisors are currently under pressure to complete self-assessment returns and submit them in time. In the rush to beat the 31 January deadline, they must find time to review the paperwork before filing it with the Revenue. They can then discuss any areas of concern with the client in advance. That way, there may still be a chance of forestalling an unnecessary enquiry by including supplementary information.
Because of the random element of the enquiry programme it is impossible to guarantee trouble-free passage through the Revenue, but advisers can improve their clients? odds.
Legislation covering the Inland Revenue?s right to enquiry
*At the moment, self-assessment only applies to individuals and trustees. It will not extend to companies until the 1998/1999 tax year. Until then, when opening an enquiry into a company?s affairs the Revenue still has to give its reasons for doing so under Code of Practice 2.
* The Revenue?s power to enquire (generally under TMA 1970, s9A for individuals and trustees) is time-limited. It has a year beyond the normal 31 January deadline.
*It can only enquire once into any particular self-assessment return.
*Once the right to enquire has expired, the Revenue can only go back over the year concerned either if tax has been lost through fraud or negligent conduct, or if there has been inadequate disclosure.
*There is no right of appeal against the issue of an enquiry notice under section 9A. But any time after that the taxpayer can approach the Commissioners under section 28A(6) and ask them to direct the Revenue to close down the enquiry. The Revenue has to justify continuing.
*The legislation not only covers instances when the Revenue suspects that income has been culpably understated, but also allows it to make technical enquiries into tax liabilities. This is another area where the line between the evasion and avoidance has become blurred.
*The Revenue will distinguish ?full? and ?aspect? enquiries. A full enquiry will examine all the books and records underlying the return; the process will be equivalent to an in-depth investigation under the old system. An aspect enquiry is likely to deal with a particular point in the liability for the year and will generally be technical in nature, although it may develop into a full enquiry. *At the end of an enquiry, the legislation requires the Revenue to issue a completion notice to the taxpayer. In the case of culpable understatement of income or gains the department will go for a contract settlement reflecting the lost tax, interest and penalties.
At the moment, The Revenue does not intend to issue a formal completion notice in such cases, which means the enquiry will remain open forever and a day. The Revenue will be able to revisit the year concerned at will. Advisers must make sure that clients are not left exposed in this way, probably by including an appropriate clause in the offer document that forms the basis of the contract settlement.
Michael Reader MA FCA FTII is the author of Enquiries Under Self-Assessment published by Accountancy Books and available to readers of Accountancy Age for #42 post-free (normal price #48) by calling 01908 248000 (please quote ref: PG7Q)