Minimising the pain of a tax enquiry

In January I explained how your tax return can be at risk of being picked for enquiry if the figures reported differ significantly from those returned in earlier years or from the standard statistics of profits and expenses normally made by other Dental Practices. This month I examine how the financial damage and stress of a tax enquiry can be minimised by taking some sensible precautions.

When the Inspector of Taxes opens an enquiry into your practice accounts the first stop for his pen is always fees. The Inspector is looking for hidden or double counted income, so he will compare the amount banked in the practice bank account with the fees recorded in the accounts. He should be able to easily reconcile the total banked with fee invoices and health authority claims issued plus fees paid relating to the previous year, less fees outstanding at the year end. If this reconciliation can be done for the Inspector, it blocks the first juicy line of questioning.

A keen Inspector may also examine the extensive records you are required to keep for private dental work and try to match the treatments with the income shown as received in your accounts, and to invoices for laboratory and technicians fees. The Inland Revenue carried out a survey in 1995, which found that in an average general dental practice laboratory charges amounted to 15% of all costs and dental consumables were 10% of gross fees. The Inspector of Taxes will still be using these old statistics as a measure for your practice, but the ratios will vary for valid reasons. Laboratory fees and staffing costs are much higher in some areas due to a shortage of skilled technicians and hygienists. Some GDPs use a higher quality range of dental appliances than others. If your costs are radically different from the Inspector's ratios you need to have your explanation ready.

Many GDPs only record fees in their books when an invoice is issued, or possibly only when it is paid. If the dental treatment takes a few weeks or months to complete this approach can delay the taxation of some income into the next accounting year. The Inland Revenue no longer allow Dentists to account for income only when the treatment is paid for, on the so-called "cash basis". You should at least record a fee as earned when the invoice for the private work is issued or when the treatment is signed off as complete. This is known as the conventional basis of accounting for fees.

All GDPs should have switched from the cash basis, if that is what they were using, in the first accounting period that began after 6 April 1999. If you still use the cash basis the Inspector of Taxes will insist that an adjustment is made to your accounts. This adjustment is likely to increase the tax due for year in which it is made. The extra tax charge can be spread over ten years, but you must make sure that the conventional basis of accounting for fees is adhered to once the switch is made.

The Revenue are always particularly suspicious where patients pay in cash, as ready money can be diverted to a private pocket so much more easily than a cheque or credit card payment. Always issue a receipt for fees paid, whether the payment is made by cheque, cash or credit card. Add up the receipts issued and match them to the total of fees banked on a regular basis. Any discrepancies should be investigated without delay, as the error could be a sign of petty pilfering by staff.

Keep a separate petty cash account to pay for the small expenses of the practice such as staff refreshments and magazines for the waiting room. Record amounts drawn from the bank to top-up the petty cash float. Do not take money directly from fees received to use for these minor expenses. Also try and avoid paying for practice expenses from your own pocket. If you do buy a jar of coffee for the staff room keep the receipt and get a reimbursement from the petty cash account.

Talking of cash, paying the spouse is always a sensitive area. Does he or she actually work for the practice? Asking about the spouse's wages is one of the topics raised most frequently during an Inland Revenue enquiry. If the practice accounts show wages due to a family member those amounts should be paid into a bank account held in that individual's name. If the wages are not actually paid the Inspector will refuse to believe that the work was carried out, and will not allow the wages to be treated as a valid expense of the practice.

When you employ a close relative, even on a very occasional or casual basis, it is worth setting out the duties to be undertaken and the terms of payment in writing. If your spouse is performing a skilled service for the practice such as bookkeeping, find out what it would cost to employ a similarly qualified person by asking a local employment agency for a written quote. The Inspector of Taxes will always try to argue that your spouse is paid over the odds for the work performed, but independent evidence of the market rate for the job should stop this line of questioning in its tracks.

Motor expenses are another ripe area for making adjustments to the taxable profits of the practice. Many Dentists include all the running costs for a car within the practice expenses and then take off a proportion to reflect the non-business or private use of the vehicle. The Inland Revenue normally argue that your business is based at your surgery, so any travel between your home and that base is not a business journey. If you drive to the surgery, treat patients all day, complete your paper work and drive home you will have very minimal business mileage. You need to assess whether the business use you claim for the car is realistic. When the point is discussed during an enquiry the Inspector will want to see contemporaneous records of all journeys in the form of a diary entry or mileage records to support the motor expenses in the practice accounts.

You may be able to claim that your practice is indeed based at your home if a substantial amount of the business administration is carried out there. In this case the mileage between your home and the surgery will be a business journey, but the argument with the Inspector could be a tough one.

If you use your home as an office you can also claim a proportion of the household costs such as heat, light and insurance as business expenses. You should review the amounts claimed every year to check whether they are still reasonable. The amount claimed must always be justified as a proportion of the actual total costs, a round sum figure should never be claimed. The Inland Revenue are always suspicious of round sum estimates.

Precise accounting records are always the best defence against the Inspectors accusing finger. Keeping such records should not be a bind. Think of it like dental hygiene; a little good work every day prevents that nasty tax extraction in the future.