Alan Pink explores an HMRC myth about keeping receipts and invoices for expenditure incurred.These august words come from the oath which juries are made to swear before a case. They are to try the defendant according to the evidence, and arrive at their verdict without fear or favour.
Evidence is rightly a very important element in any legal process, and that includes determining how much a person’s tax liability should be. But, dare I say it, there are times when HM Revenue and Customs (HMRC) puts more emphasis on the importance of evidence than is actually justifiable.
Needless to say, the rules differ depending on whether you are talking about direct tax (such as income tax, corporation tax, and capital gains tax) or indirect access such as VAT. Whoever invented VAT did so in a sort of vacuum, as far as UK taxation is concerned. VAT shows signs of its ‘foreign’ birth in all kinds of ways, including in the importance it attaches to bits of paper.
Tax on profits or gains
This is usually referred to as ‘direct’ taxation, because the government is taking a slice directly of income as it arises, from the people who are in receipt of that income. The basic principles (see for example the taxing scheme set out in ITTOIA 2005) is that a person is chargeable to tax on the profits made from whatever activity they are carrying out: perhaps a trade, or the letting of property. The important point to note here is that tax applies to the profits that a person has actually made: not to the profits that he cannot prove he has not made.
That’s all very well in theory, you might say. But without the evidence to prove that I’ve made a profit of ten, how can I counter a claim by HMRC that I’ve made a profit of twenty? And this leads us on to the importance of evidence.
HMRC start, of course, with an immense natural advantage, given to them by the tax law of this country. If they take it into their heads to raise an assessment on a person’s profits, the onus of proof isn’t on them to show that their assessment is correct: the onus is on the taxpayer to show that it’s wrong. So one thing we’re definitely not preaching in this article is a slapdash approach to keeping records. What we’re interested in, particularly, is the true rights and wrongs of the matter, in the event of a dispute between HMRC and the taxpayer as to how much in the way of profits should be being taxed.
All or nothing?
Make no mistake about it: HMRC officers are trained to bring as much extra tax in as they possibly can, in these days of spiralling public debt. Somewhere along the line, it looks very much to us as though any concept of collecting the ‘right amount of tax’ has disappeared within HMRC: regardless of the lip service they pay to this concept in their public material.
The way some investigating HMRC inspectors talk, you would think that obtaining tax relief for an expense that you have incurred is a kind of obstacle course where only the fortunate or preternaturally scrupulous get as far as the finishing post. If you can’t satisfy the taxman or woman that the expense in question was incurred, duly paid, and properly laid out for the purposes of the business in question, you have failed to obtain the necessary relief. The pass mark is set at 100%, and 99% isn’t good enough.
No vouchers? No problem!
The true rights and wrongs of the matter are very different from this. Let’s take an example.
Kalamazoo Ltd operates a pretty accurate accounting system, comparatively speaking. Payments out of the bank are recorded in a cash book (computerised, of course, these days) and each entry recording a payment is cross referenced to an invoice or voucher backing up the amount paid: what it is, and who it is paid to.
Unfortunately, as so often happens, someone important in the organisation (who out-ranks the book-keeper) has grabbed the lever arch file off the shelf and taken an invoice out for some purpose of his own. So when the taxman asks to see back up documentation relating to this particular payment (which, let’s say, is a payment to a lawyer for collecting a debt) the book-keeper is unable to show any voucher to back it up.
The cashbook entry is quite clear: it says Messrs Sue Grabbit & Runne, Solicitors – collecting the Smith Ltd debt.
‘Tough luck’ , says the investigating HMRC inspector, ‘you can’t show me an invoice from these lawyers, and therefore I’m not going to let you have the expense.’
Error. Quite apart from the possibility that exists, in this particular example, of asking the solicitors to produce a further copy of the invoice, the taxman has no real grounds for suspecting, in this instance, that the description of the payment in the cash book is wrong. On a balance of probabilities, a tribunal is likely to decide that the payment is a valid one. Don’t listen to the bullying comments of the investigating inspector.
What ‘must have’ been
The situation gets a bit trickier where there aren’t such formal records, and payments are made from all kinds of different sources. Take the example of Doctor Phibes. Phibes is a busy consultant (ok then, we should be calling him ‘Mr Phibes’). There’s absolutely no way he can operate his private practice without using a secretary. Unfortunately, his admin skills, or more correctly record keeping skills, are as near zero as makes no difference. He has, in fact, paid a part-time secretary £500 a month for keeping his chaotic working life in order for some years; unfortunately, he just hasn’t kept any record of the payments.
This is a gift for the HMRC person on the warpath for more revenue for the government. ‘No voucher: no deduction!’ is the forthright and uncompromising verdict.
A switched on accountant or tax adviser won’t let them get away with this, though. There is such a thing as basic common sense, and, in this instance, basic common sense says that Doctor Phibes couldn’t last five minutes in his job without secretarial and administrative help. It then just becomes a question of not, whether? but, how much?
CGT on properties
If there is one area where, more than any other, lack of complete records presents an apparent tax problem, it is in the case of properties which have been bought, held for rent, improved, and then sold.
Take the example of Susan, who buys an old pigsty which is in a ruinous condition. She completely restores it, putting the roof back, installing services, and basically turning it into a ‘des res’. She then goes on to sell it for ten times what she paid to get the original ruin.
Susan is also pretty lousy at record keeping, and, although she knows she’s spent at least £50,000 on the property, she’s got next to nothing to show for that expenditure in the way of vouchers and receipts.
So does Susan have to pay tax on a capital gain, when she sells, which she hasn’t actually made?
Not at all! The evidence of the expenditure may not be there in the form of bits of paper, but it is unquestionably there in the form of the improved property itself. Again, it’s obviously much harder to justify any given figure for the improvement expenditure if your only argument starts with the words ‘it stands to reason...’ However, in our view a blanket disallowance by HMRC of any improvement expenditure, simply because there’s no easily traceable audit trail, is completely out of order.
With VAT things are rather different, as we’ve already hinted, because the rules have been written completely differently. In order to claim back input tax for the purposes of a vatable business (the indirect tax equivalent of claiming an expense) you explicitly need to have a properly issued VAT invoice. It says so, right there in the regulations.
But even here things aren’t quite so black and white in favour of HMRC, and against the taxpayer, as you might of thought. HMRC have discretion to allow input tax where it is clear that the paying business must have incurred it. And they have been wrapped over the knuckles for failing to exercise this discretion, on more than one occasion.
What arises from the above statement of basic principles is not so much that it doesn’t matter whether you keep records or not. It’s an essential duty, imposed on you by the law, that you keep the appropriate records of amounts which are relevant for working out your tax. However, it’s also true to say that the taxman will come out with statements which are apparently authoritative on the subject, to the effect that you need the paper to claim the relief, when the statements are actually completely unjustified by the law. Don’t let yourselves be bullied!
This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.