Working the enquiry: reviewing earlier years: approach to quantification
Before quantifying profits for earlier years, you must establish the true profits of the period under enquiry as accurately as possible. You will often not look at any other period in such depth, and importantly whatever is agreed will set the pattern for future accounts.
In making the case for reviewing earlier years, you will be relying on inferences drawn from the examination of the returns under review and any third party information you have suggesting that returns are incomplete.
At this point all the evidence should be brought out whether it has been revealed so far or not. If you have already established sizeable understatements for the enquiry year resulting from faulty record keeping of a continuing nature, you are unlikely to have difficulty in demonstrating a case for looking at the earlier years.
Where you hold evidence in a business case that earlier returns are incorrect it will usually be advisable at this stage to give the taxpayer pointers as to what may be wrong. Take the opportunity to clear up this and all other omissions from returns and, in the course of so doing, get a statement from him or her about the extent of his assets and liabilities at the present time or enquiry period. The statement need not be accurate to the last pound. At this stage the objective is to make sure that the existence of all important assets is disclosed.
Where the capital accumulation reflected by a preliminary statement of the taxpayer’s assets and liabilities cannot readily be reconciled with the business results, a minimum initial requirement will be a formal and signed statement of assets and liabilities at the current time and at a selected earlier accounting date (depending on how far back it is decided to go) so that the capital growth during the chosen period can be ascertained.
Other documentation may also be needed and EM3550 outlines the basic requirements where traditional private side methods are to be used. If a private side enquiry is to ensue, it will be worth putting on record at once a statement by the taxpayer about the following matters which may later may be used to explain the results.
- Cash holding habits - EM2050+ concerning any claims to cash hoards.
- Receipt of legacies and other non-business sources of funds (for example, sales of jewellery) during the period under enquiry.
- Gambling habits.
- Unrealistic levels of personal and private expenditure.
Where it is intended to scale back the additional profits for the enquiry year, you are unlikely to need much extra documentation.
In smaller cases where it is admitted that the records on which accounts are based are defective, there is no objection to profits being agreed on broad lines, but unrealistic figures should not be accepted simply for the sake of reaching agreement. You should advise the taxpayer concerning future record keeping as part of our enabling initiative.