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HMRC internal manual

Enquiry Manual

Working the enquiry: reviewing earlier years: capital statements

If there is difficulty in obtaining business records for earlier years, any attempt to recalculate omissions fairly precisely for individual periods will usually rely on the capital/income/expenditure reconciliation method (that is, `capital statements’).

This approach has been used for many years but it has drawbacks.

  • It can be immensely time consuming and the requirement for documentary proof of worth at annual rests can lengthen the duration of your enquiry considerably.
  • Where the capital statement reveals an excess of private money over known income and there is no direct tie in with the business, HMRC will infer that the source is omitted taxable income. Taxpayers may claim the source is non-taxable and their explanations can take time to dislodge and may even be accepted in whole or part by the tribunal.
  • The accuracy of the statements relies upon the accuracy of the figure of personal and private expenditure. It is genuinely difficult for anyone to remember what was spent last month, let alone last year. Capital statements are therefore unlikely to produce more than a minimum level of evasion.

This is not to say that capital statements should not be used in appropriate cases. These will normally be those where substantial liability is involved and there has been considerable movement of or between assets. If you have established the existence or likelihood of omissions in the year of enquiry, you are in a stronger position to ensure that capital statements provide a realistic measure of omitted profits.

In particular you should

  • ensure that the onus is on the taxpayer to prove any explanation of the source of any deficiencies. It is up to him or her to produce evidence to overcome the inference to be drawn from omissions and the capital statements.
  • not accept what you consider to be inadequate figures of personal and private expenditure. If you already have evidence of omissions you should be prepared to include a reasonable estimate and let the taxpayer disprove it. Careful consideration of business records and private bank accounts may enable you to establish that cash spending must have been higher than the taxpayer has admitted.

Even if the private assets seem to be out of line with the business results you should not necessarily insist upon the production of capital statements at annual rests. There could be several explanations for apparent discrepancies. For example

  • the private wealth could be long-standing
  • there may have been exceptional receipts, such as legacies
  • profits may have been noticeably higher than in the past.

You must find the correct explanation. You could ask for a statement of assets and liabilities at an accounting date (say six years previously), so that the private capital growth during the normal time limit years can be considered. If this is greater than you would expect and it seems likely that the source is the business, you must consider your next action, which might be to scale up the profits of the earlier years using broad approximations or to switch to full capital statements in important cases.

There will be cases in which the capital statement method is the only one likely to produce acceptable results. These are usually where there are substantial private assets, no recent dependable accounts, no simple yardstick by which to measure current profits or the possibility that profits will have fluctuated over the years and are likely to have been high in the past. It is also likely that capital statements will be more suitable for enquiries into partnerships and private companies controlling complex businesses.

The mechanics of capital statements, along with the general approach to the `private side’ are dealt with in EM3580+.