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HMRC internal manual

Enquiry Manual

Recalculating profits: personal and private expenditure: general

Once you have established that the business records are not as accurate as they should be, you will need to look at the private side, the taxpayer’s personal and private expenditure EM3550.

Establishing levels of personal and private expenditure is difficult and the taxpayer may be uncomfortable with questions that they consider intrusive.

Details of private and personal expenditure are usually best established during a meeting. The agenda for the meeting should state the main areas of concern to enable the taxpayer or the agent to carry out any necessary research.

For example you might state on the agenda your intention to discuss certain items in the private bank accounts and aspects regarding levels of household expenditure, investments, holidays, private assets, other areas of personal spending. You want to establish certain facts about the income of a spouse, civil partner or domestic partner.

It is reasonable to ask for access private accounts, credit cards, store cards etc where the record keeping system upon which the Return or the accounts have been based is found to be inadequate.

In your discussions, you should be precise. Avoid using terms that have different meanings in different contexts. ‘Living expenses’ might be felt to cover only expenditure on food and shelter, while ‘personal expenditure’ could imply spending on clothes and entertainment.

It can be very difficult to quantify exactly what is spent on individual items. Could most of us say how much we spent last month? We can work it out fairly easily because we can refer back to monthly pay slips, bank statements etc. even saying how much cash was spent from cash withdrawals from the bank account. But even so remembering what the cash was spent on can be difficult.

In an enquiry case you will often be examining the possibility that the taxpayer has spent unrecorded cash. So actual cash expenditure has to be built up or estimated. It is likely that if you work back from your net monthly salary you will identify much expenditure quickly, but as the amount remaining to be tied down diminishes it gets progressively more difficult to say on what it was spent. Your task in an enquiry is to get the taxpayer beyond what is easily remembered into those areas which are easily forgotten or underestimated.

Where amounts are unrealistically low it is relatively easy to show that they are inadequate to meet the taxpayer’s needs. However, as income levels rise it becomes more difficult to be precise about spending, unless the bulk of it is done through bank accounts or credit cards. There may be little apparent difference between the life styles of someone spending £18,000 and his or her next door neighbour who is spending £20,000 - it could easily be accounted for by a dinner out for two every week.

For these reasons, you should not rely on a method of profit recalculation involving personal and private expenditure, without some other back-up check, unless you have to. It will only be as accurate as the figures which you agree for personal and private expenditure. Therefore, if in an important or large case you are preparing capital statements, it is essential that you take adequate time and trouble to establish as far as you can the correct level of spending.

You should look critically at the information the taxpayer provides. Does the level of spending fit with what you know about the taxpayer and their lifestyle? Does it fit with what you know about general levels of household expenditure?

The UK Family Expenditure Survey (FES) is a continuous survey of household expenditure and income and can provide you with guidance as to general levels of household expenditure. Information can be obtained through Experian on the internet.

The taxpayer’s life style and approach to spending will not necessarily be like your own. You know your salary will be paid each month. Some people are very cautious; others have an approach to spending along the lines of: ‘If I’ve got it I can spend it, if I haven’t I can’t.’

Is there a certain life style which is imposed on the taxpayer by their business? Some will be drawn into circles where a lot of money is spent on maintaining a conspicuously expensive standard of living. It is vital to try to get the feel of the life style of the taxpayer and how their business affects it. Are they the type of person who has a pattern of spending? Re they likely to be spending large amounts on a whim?

If the trade is seasonal, is this reflected in the private spending pattern?

At the end of the day you are attempting to gain as accurate a picture as possible of the taxpayer’s standard of living, spending and savings patterns and lifestyle. Be prepared to challenge the details given if you have reason to believe that these appear inadequate or lack credibility.

Where the underlying records have been shown to be inadequate and you base your re-computation of profits on the results of a personal and private expenditure review, the acceptance of figures that are unrealistically low will mean that you will not arrive at a realistic figure of revised profit.