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HMRC internal manual

Enquiry Manual

HM Revenue & Customs
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Recalculating Profits: Private Side - Cash Flow Tests

A trader is not obliged to create a balance sheet and so may not provide balance sheet details in the SA return; therefore you will not always have details of the Capital Account or a figure of drawings on the SAI.

During the course of the enquiry you should establish, from your records examination and discussions with the taxpayer, details of the taxpayers personal drawings.

The taxpayer should keep a record of any money taken for their own or their family’s personal use from

  • business cash
  • business bank account(s), or
  • any monies transferred from their personal bank account if they do not have a separate business bank account.

When opening your enquiry you may have asked for accounts or particulars including an analysis of drawings. This may reveal that the drawings figure is a balancing figure.

In cases for which a balance sheet has been prepared, the accountant should have drawn up a cash reconciliation. A copy of this, or at least details from it, will be of great assistance in preparing a cash test, and you may find it worthwhile requesting such early on in the enquiry.

Any balancing figure taken as cash drawings in the business accounts, will if it is correct, ‘balance’ the proprietor’s personal finances. The information on cash withdrawals can be expanded into a full cash-flow analysis along the same lines as the business cash-flow test EM2960+. Such a test can be used to check the reliability of a balancing, estimated or recorded figure of drawings, and the credibility of the accounts. Where the test shows that the figures in the return or the accounts are insufficient, and the taxpayer cannot provide a reasonable explanation, it is realistic to assume that the shortfall will relate either to additional drawings from the business or an undisclosed source of income.

Cash available (the debit side) will include all cash drawings from the business, cash withdrawals from private bank or building society accounts, and other known cash receipts such as child benefit. The cash expenditure (the credit side) will include all cash deposits to private bank or building society accounts and a reasonable estimate of personal cash expenditure.

(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)

An overall test for the whole year could be supplemented by a weekly analysis for a few months. It is also possible to test business and private cash together, if the two are inextricably bound up. Calculate cash available by taking total expenditure (business and private, capital and revenue) and deducting payments made by cheque. The expenditure paid in cash should then be equal to the cash available to meet it, subject to fluctuations in cash held. Any shortfall requires explanation and could be attributable to diverted profits.

Any deficiency will depend upon the estimate used for cash expenditure. Cash expenditure is very difficult to quantify, and so the deficiency is likely to be a minimum figure. Diverted cash could also arise from capital receipts or false capital expenditure, which would again mean that any cash test figure will not be the full extent of diverted profits.