How to make a tax inspection less taxing

When a tax inspector calls it can be a stressful time for any salon owner, but tax expert Rebecca Busfield says it doesn't have to be.

Her Majesty's Revenue & Customs (HMRC) has begun to increase the number of enquiries into hairdressers, and inspectors are under increasing pressure to deliver results, particularly since the recession. Tax enquiries are an unfortunate fact of life for all taxpayers, which cannot be avoided, although they can be carefully managed to reduce the size of the settlement and the length of the enquiry. Inspectors should be prevented from prolonging enquiries when adequate information has been supplied.

HMRC needs to make certain checks to ensure that taxpayers are paying the correct amount. It has powers to undertake random enquiries and does not need a reason to start one. HMRC tends to focus its resources where it believes common errors arise, such as under-declared purchases of stock or sales, particularly where payment is received in cash - making hairdressers vulnerable targets. 

How tax is assessed

HMRC assesses the turnover and profits reported by a salon in comparison with detailed economic research for specific locations and declared figures for earlier years to decide whether to initiate an enquiry. It undertakes sales and purchase mark-up calculations to establish gross profit margin (GPM) models. HMRC has stated that it expects sales to be eight-nine times the purchases. Other test factors include the level of wages, commissions, liquidity, loans, growth in assets and return on capital.

 

Accountants have reported GPM for hairdressers between 75-90% and HMRC should reasonably accept anything within that range. Some salons have a significant retail side including products and equipment or specialist services such as extensions, which inspectors may not be aware of. It is useful to show these separately in the financial statements as they will have a different GPM (HMRC expects this to be between 45-50%). Sometimes simply providing seemingly obvious background information to the business can alleviate an inspector's concerns. Where turnover or gross profits have decreased, say due to theft, excessive wastage, unexpected competition, or a recession, it is shrewd to explain the shortfall in the white box on the tax return.

HMRC is likely to ask questions about staff payments. It expects tips and commissions to be received. If tips are paid to the employer, then the employer should declare these through the PAYE system and deduct tax and National Insurance. If tips are paid directly to the employee, then it is the employee's responsibility to declare them in their personal tax return. Where a self-employed stylist rents a chair in a salon, the rent received must be declared by the owner. HMRC may challenge the self-employment status of the stylist.

If errors are established, HMRC adopts a 'guilty until proven innocent' approach and can demand to see assessments going back six years - 20 years in some circumstances - as well as charging late-payment interest and a tax geared penalty. In very serious cases of tax fraud, HMRC can prosecute.

Counter claim

A trader who keeps a complete set of books has evidence to counter any potential claims by HMRC. Where written evidence is not available, HMRC is unlikely to believe the taxpayer. Make sure that all till rolls are retained, write full descriptions in paying-in books and cheque books, and record reasons for wastage at the time.

Unvouched expenditure, such as trade purchases where invoices are missing, will invite questions from HMRC. Invoices and receipts should be obtained for all cash payments. This extends to parking charges, stamps, rail tickets and taxi fares.

An enquiry normally starts with a standard letter from an inspector requesting specific information and documents. Enquiries  can be stressful and costly for the individual involved. They can also divert significant time away from running the business.

Top 10 tips for managing

an enquiry:

1 Find out which team initiated the enquiry. Civil Investigation of Fraud teams handle cases where the tax underpaid is between £75,000 and £500,000. Specialist Investigations handle cases where they believe the tax underpaid is more than £500,000. Both teams have specially trained inspectors, so it is worth consulting a specialist investigations adviser, especially where Code Of Practice 9 is involved (which covers cases of suspected serious tax fraud).

2 Consider whether HMRC's requests for information are reasonable and within its powers, and clarify why it needs the information. For instance, does it need to see your private bank statements, or can you provide them alternative evidence such as an interest certificate? HMRC is not allowed to ask for legally privileged information and accountants' working papers. HMRC is likely to regard the appointments diary as part of the hairdresser's statutory records - therefore there is no right of appeal against a notice to produce this document.

3 Treat the inspector with respect. Maintaining a professional front will keep the inspector on your side, which might be useful when the penalty is discussed.

4 Comply with all time frames and you will appear to be in control of your tax compliance obligations. If you are aware you are in a busy time of year, then let the inspector know straight away that meeting a deadline will be difficult.

5 Consider a request for a meeting carefully. There is no statutory obligation to attend a meeting. Sometimes a meeting can be helpful if the taxpayer is professional as it shows co-operation and it reduces the need for protracted postal correspondence. An agent can attend on your behalf.

6 If inspectors need to visit the business premises, be careful they do not wander off and speak to other members of staff who may say something misleading.

7 It is best not to sign a mandate for HMRC allowing it to write to third parties directly, such as a bank.

8 Do not accept blindly HMRC's technical analysis or penalty offers. It may be unaware of the full facts and there are many grey areas. Although, there are set penalty levels, they can still be negotiated.

9 Request a closure notice where you are experiencing unreasonable delays, or HMRC is asking for information that has already been fully dealt with.

10 Provide all relevant information,otherwise you will be vulnerable to a discovery assessment in the future. Do not sign any statements or certificates if they are materially inaccurate as they could lead to large penalties or even prosecution.