When it comes to HMRC commencing enquiries into the tax returns of self-employed individuals, it would not be surprising if cash businesses were seen by HMRC as something of a ‘soft target’. The record keeping standards expected by many HMRC officers appears to be very high, and even the smallest discrepancy can result in proposed additions to turnover and/or disallowances of business expenses. However, a recent tax tribunal case, Stephen Ho v CRC  UKFTT 387 (TC) TC00669 perhaps offers the self-employed (particularly potentially vulnerable cash traders) some comfort.
The case concerned Mr Ho, who is a taxi driver mainly working in and out of Heathrow Airport. HMRC enquired into Mr Ho’s 2004 tax return. Following the completion of the enquiry, HMRC increased Mr Ho’s self-employed profits for that year, and also raised discovery assessments for the tax years ended 5 April 2003, 2005, 2006 and 2007, resulting in additional liabilities for those years. Mr Ho Appealed.
HMRC contended that Mr Ho underestimated his takings and taxable profits. Mr Ho argued that his profits had not been understated, except for two specified days.
With regard to Mr Ho’s records, each working day he would purchase fuel at the start of the day, and write the fares received on the back of the fuel receipt. He worked principally out of Heathrow Airport, which operates a system of ‘cab tags’ (these are purchased in batches, and must be handed over before the taxi driver can make his cab available for hire at the airport). A list of cab tags enabled Mr Ho to account for all but two working days. Both sides accepted that there was a small error in Mr Ho’s records in respect of those days.
HMRC’s case against Mr Ho was based around the expected number of trips out of Heathrow. No account was apparently taken of certain health problems suffered by Mr Ho. HMRC also relied on a cashflow test, based on business receipts and private cash expenditure. HMRC’s conclusions about Mr Ho’s private expenditure were also based on assumptions.
The tribunal held that Mr Ho failed to declare income for two days due to the accidental loss of receipts, but that this was insufficient to amount to negligence under the discovery assessment provisions. The tribunal also rejected HMRC’s contentions about Mr Ho’s working pattern, and the conclusion of HMRC’s cashflow test (which the tribunal considered was ‘fundamentally flawed’). Mr Ho’s appeal against the HMRC amendment to his 2004 self assessment return and the discovery assessments for other years was therefore allowed.
Interestingly, the tribunal made a direction for costs against HMRC. The tribunal concluded that there had been ‘unreasonable conduct’ by HMRC, on the grounds that HMRC’s arguments lacked sufficient evidential foundation, and that the cashflow test was flawed.
Mr Ho was perhaps fortunate that the taxi ‘tagging’ system at Heathrow Airport enabled him to verify his journeys to and from the airport, which in turn helped to substantiate his income. Unfortunately, many business owners are not so lucky. HMRC’s guidance states: “In an enquiry case you will often be examining the possibility that the taxpayer has spent unrecorded cash” (EM3651). The importance of keeping full and accurate business records cannot be overstated, particularly for cash based traders.
In practice, it may prove difficult to satisfy HMRC that a taxpayer’s business records are adequate. HMRC’s Enquiry Manual gives the following advice to its officers (EM3683): “Even where the Return figure appears to be based on contemporaneous records, you should consider whether the nature of the trade or business is such that there are opportunities for unrecorded cash transactions. Even where the business is said to be mainly cheque based, transactions may be settled in cash.”
The Enquiry Manual provides an interesting insight into HMRC’s approach, such as in respect of personal and private expenditure (EM3650 to EM3685) and accounting records (EM2851 to EM2876).HMRC also cites (at EM3711) another case of a London cab driver (Coy v Kime 59 TC 447). In that case, the taxpayer used notebooks to record daily takings, which were not considered to be an accurate record and therefore enabled HMRC to assess further profits. Hopefully, the subsequent taxi driver case of Mr Ho should encourage HMRC officers to proceed with caution when dealing with enquiries into small and cash based businesses in the future.
The above article is reproduced from ‘Practice Update’ (November/December 2010), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.