Recalculating Profits: Personal and Private Expenditure: Representative Years
In most cases it should be sufficient to work out the personal and private spending for the year of enquiry. Before doing so, you should check with the taxpayer whether the spending pattern varies a great deal, especially whether it is likely to be distorted by exceptional items like occasional faraway holidays. If the taxpayer can show that the year of enquiry was unrepresentative, then by agreement a representative year can be selected.
Because remembering the amount of cash expenditure is difficult, one option is to work back from the current week or month. That is, however, only a starting point. You will want to know amounts over a preceding year, so is the current month or week out of line with others? Bring in exceptional periods when spending will be higher such as Christmas and holidays.
Once you have established a current figure and agreed it with the taxpayer, you can relate that amount to the year under enquiry.
But you may need to know figures for personal and private expenditure for earlier years, perhaps for inclusion in capital statements. If so, you will often be able to use the agreed figure for the representative year, scaled back to take account of inflation. This does assume that the standard of living has been broadly unchanging through the years. However, if the trend of profits has been upwards, the standard of living is likely to have risen.
Major changes in life style may be indicated by
- moving home to perhaps a more expensive house
- acquisition of a holiday home
- private education of children
- children leaving home and becoming independent
Scaling-back may not be accurate when the pattern of expenditure is known to be irregular. This will invariably be the case where there are large amounts available for personal expenditure. It will not all go on day to day items, but will be accumulated in part to provide for expensive holidays, hobby items, furniture, etc.
In such a case detailed examination of all bank and savings accounts may be needed to establish large items of expenditure for individual years throughout the enquiry period and the taxpayer asked to explain any unidentified withdrawals.