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HMRC internal manual

Enquiry Manual

Recalculating Profits: Private Side - Introduction

Where a return has been selected for full enquiry EM0092 the enquiry officer should aim to identify and examine all the significant risks of error in the return, including the risk that it is fundamentally incorrect.

A full enquiry should always involve a comprehensive review of the underlying records. For business taxpayers this would include, where appropriate, a review of the private financial affairs of the taxpayer as well as the business books and records.

Once you have established that the business records are not as accurate as they should be, you need to look at the private side.

Where the underlying business records were completely inadequate the enquiry might proceed almost entirely by review of the private side.

Business and private side reviews should not be mutually exclusive. Although one method may be used to establish and quantify omissions it is always worth giving a little time to the other to see whether or not it confirms your results EM3520.

Look at the private side of the taxpayer’s affairs if your examination of the records not only casts doubt on the accuracy of the figures in the Return but suggests that the taxpayer’s level of income, derived from the business, also lacks credibility.

Certain omissions may not show up in the records examination or in a business model. There might be a second trade with sales and purchases wholly in cash. However a private side review may show that there had to be additional cash coming from somewhere.

The main techniques are

  • cash tests EM3555, a cash-flow exercise on personal rather than business money
  • means tests EM3570+, a simple calculation of the approximate amount available for private expenditure after savings and specific items have been excluded. The adequacy of that figure will have to be considered in detail
  • capital statements EM3580+, a full reconciliation year by year of the taxpayer’s capital worth, income and expenditure.

You and your manager should decide, in the light of the importance of the case and your findings from your review of the business side, how far these tests should be taken.

In an enquiry where sizeable and possibly fluctuating understatements of business profits are suspected, it may be necessary to prepare capital statements for each year in the enquiry period.

In a smaller case, a means test for the year under enquiry or a reconciliation of income, expenditure and capital for the period covered by the investigation may be sufficient.

Whatever method you choose, the depth to which you wish to take it, should be governed by the need to arrive at reasonably accurate figures of understated profits as quickly as possible in the circumstances.

If your approach has been through construction of a business model, you should consider the effect of any resultant understatement on the level of income available to the taxpayer from the business. Is the revised figure too low or impossibly high?

It is often difficult to establish the full extent of private expenditure. It is very easy for us all to underestimate our own spending on non-essential items. Taxpayers may well underestimate when asked about their spending. To try to compensate for this, you should give some thought to possible areas of personal expenditure.

During the initial risk assessment, the Risk Team may have included information in the Standard Intelligence Pack (SIP) which may provide clues to the sort of lifestyle the taxpayer enjoys?

A field visit may have been undertaken to the private premises.

The house in which he or she lives will give you some idea. You may be aware of local press coverage, the taxpayer’s position in the local community, ownership of assets (such as a boat), which tend to indicate an expensive life-style with a lot of conspicuous expenditure and other information in the SIP. How does this compare with the money available?

In cases of any size the cash will rarely be absolutely low, but it will often be out of line with a realistic appraisal of spending habits.

Any examination of the private side, including any attempt to recalculate profit from the private side, will require you to review private accounts, credit, debit and store card statements and so on EM3560.

Clarification on access to non-business bank details is set out in EM2220.