HMRC internal manual

Enquiry Manual

EM2012 - Working the enquiry: reviewing earlier years: scaling back accounts figures

You should check the other guidance available on GOV.UK from HMRC as Brexit updates to those pages are being prioritised before manuals.

Where you discover understatements in the profits for the enquiry year and there is no reason to suspect these do not represent the taxpayer’s normal practice, the most appropriate way to calculate adjustments for earlier years is to scale back the current year figure by reference to the Retail Price Index (RPI). Providing the pattern of trading has been reasonably consistent over the years and you have established an accurate figure for the current year, this will produce an acceptable result. It is easy to explain to the taxpayer and is far less costly for all concerned than trying to calculate earlier years individually. There is no reason why the method should not be applied as far back in time as seems worthwhile. There is an RPI Backdate calculator within the SEES menu.

If you are considering reviewing pre-incorporation years, where the company took over a business previously carried on by a partnership or sole trader, see EM3309. The way in which the current year’s adjustment will be scaled back will depend upon its nature and the way it was agreed.

If, for instance, the taxpayer had been taking £50 a week cash from the till to augment living expenses, you could simply scale back that amount to take inflation into account by using the RPI.

If, however, the taxpayer has not been taking money in any regular pattern but merely when business was good, it might be more appropriate to convert the adjustment to a proportion of declared turnover and add back the same proportion in earlier years. When the understatement has been calculated on the basis of a revised profit ratio the revised total profit for the year can be scaled back using the RPI.

If the taxpayer does not agree with the figures which you have produced by scaling back, and you are unable to reach a settlement on any other basis, you should offer them a review of your decision. They may accept your offer or notify the appeals to the tribunal. For detailed guidance on the appeals process you should refer to the Appeals, Reviews and Tribunals Guidance (ARTG2100).

If you have to go before the tribunal, and seek determinations that will lead to increases in the assessments or self assessments, then TMA70/S50 (7) requires evidence to support your proposals. The profits in one year are not strictly speaking evidence of the level of profits in any other year, but see EM3309 about the ‘presumption of continuity’. However, where there is no reliable evidence of the true level of the taxpayer’s profits, it is the tribunal’s duty to make their best estimate Brittain v Gibb 59 TC374 EM3710. If the method of scaling back which you have used is appropriate to the circumstances of the case, then you may reasonably ask the tribunal to determine the appeals in accordance with the figures that this produces.

However, if the taxpayer produces evidence which casts doubt on any of the assumptions on which the scaling-back exercise is based, or can show that the circumstances were not identical in all of the years under enquiry, then your figures will not be a reliable guide to the true level of profits. If you have any reason to suspect that this is how the taxpayer will run his case before the tribunal, then it would be wise to conduct separate business economics exercises for some or all of the years under enquiry, if time and resources permit. In any event, if you intend to ask the tribunal to increase the assessment for any year that you have not looked at in detail, careful preparation will be necessary.

Well before your case goes to the tribunal, you should check whether

  • you can justify re-opening all of the years in question either by clear evidence of under-declarations or on the basis of the ‘presumption of continuity’ EM3309+. If you are relying on the presumption of continuity, have you made appropriate enquiries and satisfied yourself that there is no evidence of a change in practice during the period under review?
  • you are able to justify all the figures used in your business economics model. Those which have not been supplied by the taxpayer - and especially those which differ from figures which the taxpayer has supplied - need to be supported by evidence which shows them to be appropriate figures to use
  • your method of ‘scaling back’ (or forward) from a Business Economics Model for one year to arrive at figures for other years, is appropriate to the type of deficiency that you have identified in the accounts, and that you can justify all of the assumptions which are inherent in that method of scaling back. This might involve making further enquiries, which may produce evidence casting doubt on some of the assumptions. For example, a simple RPI adjustment to total profits relies upon the assumptions that there was a steady level of trading throughout the period in question and that both prices and costs moved broadly in with the RPI during that period. If your enquiries showed that the taxpayer had doubled his staff during the period under review, or that he had held his prices at the same level for five years, then it would not be appropriate to use a simple RPI adjustment because it is based on assumptions which are not supported by the facts. In such a case, you would need to alter your method of scaling back to take account of the known facts.

Making these additional checks and enquiries will mean that your figures are fully supported by evidence.