What to do in the event of an Enquiry

In March I outlined some preventative measures you can take in advance to minimise the pain of a tax enquiry. This month I explain how it is still possible to limit the financial damage once a tax enquiry is under way.

A key part of the tax enquiry into your practice accounts is the meeting between you and the investigating Inspector. This is where your performance can significantly influence the Inspector's approach and can have a bearing on the final amount you pay at the conclusion of the enquiry. Unless you are very lucky you will have to pay up something at the end of the enquiry. An adjustment to your accounts is likely to generate additional tax, which will carry interest and at least a small penalty. Even if the Inspector finds nothing at all to warrant an adjustment you will have to bear the costs of paying an adviser to help fight your corner. Going into the ring alone against the Inland Revenue is extremely foolhardy.

The investigating Inspector normally requests a fact-finding meeting early in the enquiry process, shortly after he has examined the practice accounts. If the Inspector has technical queries about how the accounts were constructed from your records those issues should be resolved with your accountant before you agree to meet the Inspector.

You are under no legal obligation to attend a meeting the Inspector of Taxes, so you can decline his request if you wish. Some advisers prefer to conduct the entire enquiry by correspondence, but this approach can lengthen the process and add to your costs. Before you attend a meeting you need to be confident that you will be able to think on your feet and not lose your head under pressure. Think back to your interview for Dental School, that was scary but you prepared well and passed. The same applies here; preparation is the key.

Remember the aim of the Inspector is to prove that there is some flaw in your business records, which will allow him to reconstruct your accounts showing a higher profit figure. An alternative line of attack is to undermine your own honesty by demonstrating an omission from your tax return. If he finds an error or omission the Inspector can recalculate your tax bill for the five previous tax years assuming that the same fault applied in those periods. Thus a relatively small adjustment for the year under enquiry can result in a large sum being paid over to cover several tax years.

You should not meet with the Inspector until he has sent you a Code of Practice leaflet. The particular Code of Practice issued gives you an indication of the seriousness of the tax default suspected. Normal local tax office enquiries are conducted under Code of Practice 11. If you receive a Code of Practice 8 or 9 you should seek the assistance of a tax investigations expert without delay, as the Inland Revenue Special Compliance Office will be involved, which could mean they suspect serious fraud. If the Inspector does not issue a Code of Practice leaflet he is either diverting from Revenue practice or he could be considering a criminal investigation, in which case you will need legal representation.

The next step is to ask the Inspector for an agenda covering the main areas to be discussed. This is not a list of the precise questions to be asked, but it should be specific to your case and include all the major items. The agenda will allow you to focus your preparatory work. From my experience the Inspector's questions will fall into four broad areas: cash control, private fees, the practice expenses, and personal matters. I have listed below some typical questions asked of Dentists during a tax enquiry interview together with an explanation of what the Inspector is trying to establish.

Cash queries:
What is the average amount of cash in hand in the surgery?
The Inspector may construct a cash flow model from your business records to see if a negative cash position is ever encountered. Negative cash indicates the accounting records are clearly wrong. Any answer you give here will be taken as applying consistently week on week. So if you don't know precisely what the figure might be, do not give an estimate.
How do you work out how much you will bank?
This targets the same answer as above, i.e. the level of the regular cash float held.
Are any cancellation charges made?
Such charges are not generally recorded on treatment records so can be an easy source of undeclared earnings, especially if they are paid in cash.

Private fees:
What proportion of the GDP patients are private?
This is very important as private fees are considered to be more profitable and easier to hide. Are private patients' appointments distinguished in the appointment book? The Inspector may try to estimate the time available for private work by calculating the NHS work and assuming balance of surgery hours are devoted to profitable private work.
What records are kept on a patient's treatment?
The more records you have for each patient the more difficult it is to charge for a treatment that is not recorded. The Inspector may well try compare the appointment book to patients' records.
Do you have a consistent fee structure?
Recall when the current fee structure was introduced. What changes have been made over the last five to six years? Are discounts ever given for family or friends? Inspectors have been known to assume the current treatment prices have applied for the previous five years.
Are your fees the same as other GDPs in the area?
If you say 'yes' the Inspector will use the most unfavourable comparison to reconstruct your GDP profit figure.

Practice expenses:
How do you keep your patient base?
A large throughput of patients will affect the practice profitability. You may spend more on advertising or patient reminders than similar GDPs.
Do you suffer any unacceptable level of wastage?
What are the levels of wastage? If you do not have specific figures on this, don't guess but offer to provide an analysis at a later date.
What do you do with waste materials?
Do you get any additional income from selling metals for scrap? If so do you get paid in cash by the scrap dealer or by cheque? What account is that money paid into?

Personal:
Do you have any other sources of income?
Be honest here and recall any small amounts you receive however irregularly. Do you let out your holiday cottage, receive travel expenses for attending committee meetings, or write journal articles for a small fee? Even if you believe that the income is not taxable you should declare it at this stage.
Tell me about your hobbies?
The Inspector is trying to gauge whether your life style is supported by the amount you draw from the business plus the other declared sources of income. If you have habits that can potentially generate cash, such as competition prizes or gambling, you should declare them even if any winnings were in the distant past.
How do you normally pay your domestic bills?
A payment by cash is less traceable and the money must come from somewhere. If the cash drawings from your private bank account, don't cover the extend of your household bills the source of cash could be undeclared earnings.
How do you take your drawings?
This means by cash, cheque or bank transfer and how regularly. A low level of drawings compared to your private expenses could indicate that patient fees are diverted to your pocket rather than through the practice accounts.
Have you had any windfalls, gifts or legacies in the year?
The Inspector is trying to block the classic excuses that are used when an unexplained cash receipt is found in your bank or deposit account. If you have received gifts of money, or loans from friends or relatives be precise as possible about the dates and amounts.

This gives you an idea of the areas you need to research in advance of the meeting. You also need to bear in mind the six golden rules for an interview with the Inspector of Taxes:

• Keep cool head and take an adviser or at least a note taker with you.
• Give concise clear answers, don't blather out information that is not asked for.
• If you don't understand the question, ask for clarification rather than guess the Inspector's meaning.
• Do not give an approximate or estimated answer. If you don't know precisely say so, and offer to provide details following further research.
• Never, never lie. If you have difficulty answering a question ask your adviser