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HMRC internal manual

Enquiry Manual

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HM Revenue & Customs
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Recalculating Profits: Business Models: Preparation

EM3081 to EM3100 looks at the application of certain business ratios and tests which you might consider applying when examining the underlying records or accounts of a business. Which ratios you look at and which tests you apply will depend on the size and complexity of the business you are enquiring into.

The purpose of the record examination is to find out whether they are comprehensive and reliable.

If you find, and can demonstrate, that the records are not comprehensive and reliable, you have found evidence to support your dissatisfaction with the figures in the SAI and with the accounts.

You should make early contact with the agent, if one is appointed, to discuss your initial review of the records. There may also be instances where it would be useful to meet and discuss the construction of the accounts before the examination of the records.

However to obtain detailed information about the business you are enquiring into it will nearly always be necessary to meet with the taxpayer. The Enquiry Framework (Working Together issue 8) again sets out the structure for this.

Meetings should, wherever possible, be held on the business premises. This provides you with the opportunity to see the business and to discuss in detail with the taxpayer how the business is run.

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)

Which facts are important for the model will depend upon what is being used as the base for calculation. If it is gross profit rate you will need cost, volume, mix of purchases and pricing policy. If it is a price-out per hour you will need to know the number of hours worked per week by proprietor and employees, the proportion of chargeable hours, the effect of peak periods, and the charge-out rates. In addition, you should explore with the trader whether there are any wastage or own use features likely to reduce the turnover below the theoretical maximum.

Every effort should be made to obtain some corroborative evidence. If the trader says he or she has been cutting prices, detailed information of pricing policies and examples of what has been done, and the effect it has had on the business should be requested. A list of some typical current prices might help you form a view on how low or competitive prices are. Similarly, where wastage is being discussed, the taxpayer can be expected to know why it is happening and be able to demonstrate some rough and ready method of quantification. An attempt to quantify wastage is often resisted as impossible but, although there are obvious difficulties, most instances of wastage can in the last resort be quantified, at least approximately. (This content has been withheld because of exemptions in the Freedom of Information Act 2000)

You should examine a sample of purchase invoices and sales invoices (where appropriate) to assist in establishing mark-up and as a check on product mix. In seeking and examining samples of invoices it is as well to establish at the outset whether there are any seasonal factors affecting the trade and to try to make the sample as representative as possible. For example, in businesses in holiday areas sales of soft drinks and postcards will be higher in summer than winter.