The client said what?
Russell Cockburn has come across some unusual ‘cultural’ issues and explanations in tax enquiries – and here he shares some of them with us.
One of the more interesting, often infuriating and sometimes even rather amusing aspects of tax enquiry work that I encountered as a young and enthusiastic tax inspector many years ago was the creativity and variety of explanations taxpayers occasionally came up with for unidentified sources of funds that had come to light during the course of my enquiries. Indeed, the inventiveness of taxpayers always surprised me! Now that I have to represent my own clients vis-à-vis HMRC when their affairs are under review I sometimes have to remind myself that all is not as cut and dried as it may at first seem.
The examination of private bank accounts during the course of some tax reviews and HMRC compliance checks almost invariably throws up some unexplained deposits. As an inspector I was always advised by my superiors to be sceptical when taxpayers claimed that they could not recall “where the money came from”, even though the sums involved could on occasion be considerable. Claims of betting winnings, gifts from relatives and similar explanations were something that I had been trained to regard with a healthy degree of suspicion, despite that fact that on many occasions they did indeed turn out to be correct.
When during the course of a compliance check a tax inspector has established that (a) business records are inadequate and inaccurate and particularly when there is prima-facie evidence that business income may have been understated (perhaps by reference to a business economics testing model or similar exercise), then (b) the presence in financial accounts of unexplained funds or the presence of investments that cannot be verified as regards the original sources of funds, or even where (c) the taxpayer apparently had a lifestyle at a level significantly above their obvious means, often inevitably lead to a presumption that the unexplained funds must simply be undeclared business income – a scenario with which many readers will be familiar.
Now this is, of course, not necessarily the case and an inspector must be able to demonstrate all three of the factors mentioned above before he can displace a properly prepared set of business accounts, even when these records are “inadequate or evidently inaccurate”. Displacing a set of properly prepared business financial accounts required all three tests to be met; that is inaccurate records, evidence of inaccurate accounts and evidence of unexplained income, investments or apparently excessive personal expenditures. If these three features are not all present then displacing a properly prepared set of financial accounts is arguably very difficult for HMRC, as evidenced by case law decisions such as that in Farthings Steakhouse V MacDonald. (1996) SP C 91.
Of course, when a taxpayer makes claims of family cash gifts or betting winnings this will always be tested to destruction by the inspector, and if they cannot verified will be met with healthy scepticism. I dealt with a specific case where the taxpayer claimed to have found a large cash hoard in a biscuit tin under the bed when his elderly father had died. He maintained that he had used this money to buy some new and otherwise unexplained investments and open two deposit accounts in his own name. While to this day I remain unsure whether or not the claim was actually correct, the fact that the amount of cash he claimed to have found could not physically have fitted into the biscuit tin he claimed it had been found in (unless it had been all in £100 notes which I had previously established that it was not), pointed to the claim being suspect to the degree that the explanation given could be shown to be inaccurate at best and false at worst.
On the other hand, in today’s world it has become increasingly common to meet with explanations about both income and expenses along these lines, involving overseas aspects of taxpayers’ affairs that when examined closely may have more merit that at first seems to be the case.
Two examples will serve to illustrate this point. It has to be said from the outset that HMRC is increasingly cognisant of these sorts of matters and, indeed, can access specialist advice and information when dealing with such overseas issues, especially where ‘cultural aspects’ come into the picture by way of such ‘unusual’ explanations.
Not so long ago I was dealing with a case involving an individual who runs his own limited company providing specialist consultancy services on construction projects in the Middle East and Far East. His accounts and tax returns had been chosen for detailed compliance check by HMRC; largely, I still believe, because of the high level of overseas travel and hotel expenses that he was claiming as business deductions. Staying in high end hotels where the room rate is far in excess of what most of us can afford seems to attract attention every time.
The inspector had legitimately asked for and been given access to the company’s financial records. On reviewing these he then queried the hotel and subsistence expenses, which showed that on several occasions during the year in question the client shareholder/director had taken his wife with him on these business trips to the Middle East when he had stayed in a very expensive hotel in Dubai (you know the one I mean). The inspector queried this and pointed out that the client’s spouse was not an employee of the company, so that ostensibly her expenses for travel and accommodation ought not to have been claimed as legitimate company business expenses.
My initial reaction was one of dismay, that the client had been so naïve as to put these costs through the company books without drawing them to my attention for review. But on more detailed examination of the facts an explanation came to light. The client claimed that he had been asked to bring his wife to the last five visits to the overseas locations he had attended when contract signing and final negations were to take place. The explanation given was that the individuals with whom he was negotiating would be bringing their respective wives (who were also shareholders and partners in the business that was buying my client’s services) to these final contract meetings and that under their particular religious code the spouses would be “unable to attend these meetings” unless the client was also accompanied by his spouse. I must admit that at first I thought this was a spurious explanation and that the client was clutching at straws, but as it turned out the inspector knew better and had indeed come across this sort of situation previously and was quite prepared to allow the expenses. It just shows that not all tax matters are cut and dried where ‘cultural’ constraints impinge.
In another case I have been dealing with recently I came across the classic situation where significant sums of cash were moving around between multiple bank accounts for no apparent reason, some involving overseas accounts in the Far East. Inevitably, the inspector queried these many transactions and demanded evidence of the sources of the funds, which were mainly being shown in the businesses books as capital introduced and personal withdrawals. The client’s explanation was that these were transfers of funds from members of the Buddhist community in the Far East, mainly Vietnam and Cambodia, and that these were moneys being transferred to and from relatives, and also loans among community members who dealt with large sums in this manner as a matter of custom and practice rather than using banks or the established money transfer service companies. The explanation given was that this was a very well-established financial practice among members of their community, which is based entirely on integrity and trust. The inspector has now indicated that he is actually again very familiar with such situations and has simply asked for signed affidavits for a couple of sample transaction in order to satisfy him that the explanation can be believed .
Now some might suggest that in these cases we have been lucky to meet with such a sympathetic approach from the Revenue authorities. I might agree, but on close examination of the facts it became clear that actually the explanations given by the clients were in all probability the most likely answers to the problem at hand. I have learned to expect the unexpected when dealing with the small business community over the years and, despite my own inbuilt scepticism, to adopt a pragmatic approach before dismissing such explanations out of hand.
HMRC has an increasingly large array of information gathering systems to hand these days and a considerable amount of experience in dealing with unusual situations involving overseas jurisdictions and customs. When one encounters something this unusual for the first time it should not just be assumed that it will be refuted by HRMC automatically. Clearly, having evidence of financial transactions, a clear audit trail, and in particular situations notarised affidavits from witnesses to verify transfers of sums where there is no other paperwork will be essential. However, increasingly it can be possible to obtain acceptance of what may at first seem rather ‘off the wall’ explanations when dealing with unusual or very different cultural regimes and circumstances.
Of course, no tax inspector worth their salt is going to accept an apparently spurious explanation for unidentified movements or sources of funds during a tax compliance check and will almost always reject ‘cash hoard’ explanations or betting winnings stories unless these can be verified. As something of an obsessive I still have, somewhere in our attic, two betting slips for the £100 and £75 I won years ago on Little Polveir (1989) and Maori Venture (1992), the only times I have ever won anything on the Grand National – just in case HMRC ever ask me where the money came from! Over the top I hear you say?
It is possible that as a former tax inspector I am generally more cynical and sceptical when dealing with some of my clients than others might be, especially when offered what can clearly be seen to be questionable explanations for unidentified funds introduced to a business or dubious expense claims. However, recent experience is showing that in this globalised world of fast movement of people and finance it is increasingly commonplace for such transactions to take place, especially within communities where the traditional extended family perhaps persists more than it does in Western society.
To their considerable credit, in my opinion, HMRC has developed a comprehensive set of resources dealing with international aspects of finance and movements of funds. When one encounters something unusual along the lines discussed above it may well be worthwhile asking their officer dealing with the case to refer the matter to a specialist to obtain confirmation that the circumstances and explanations that have come to light may not in fact be all that unusual at all.
Of course, one will always meet explanations that are clearly erroneous. I recall once as a junior inspector finding myself taken aback when a farmer claimed that his stock of young lambs at the year end for his farming business was much lower than it normally was because the ‘great storm’ that year had apparently blown a large part of his flock “clear off the fellside, young fella!”. Needless to say, I established the wind direction from the Met Office and then looked at the stock of the farmers downwind to see if theirs had gone up! It had not.
- Russell Cockburn is a tax consultant, lecturer and author, and a former HMRC inspector. He can be contacted on 01909 824542 or by email at firstname.lastname@example.org
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