If HMRC investigate your business (or your personal tax affairs) they will normally look at the most recent year for which you have submitted accounts, and if they find the profits have been understated by a significant amount they will usually try to include previous years. In order to go back more than four years, they have to show that you have been ‘careless’, and they can then go back six years. If they can show that the understatement of your tax liability was ‘deliberate’, then in extreme cases they can go back twenty years!
Taxing other years
When deciding how much tax to charge for the earlier years, HMRC tend to rely on a principle known as the ‘presumption of continuity’ which broadly says that if you were understating your tax liability in your most recent return or accounts, then you were probably doing it in previous years as well. At its crudest, the ‘presumption of continuity’ involves HMRC scaling back the understated profits of the latest year by reducing the amounts according to the retail price index (RPI) for the earlier years, to arrive at profit additions for those years.
This approach is taught to HMRC inspectors in their training, and they are told that the case of Jonas v Bamford is the authority for the assumption that misbehaviour in the present probably occurred in the past. In Jonas v Bamford (which dates from the early 1970s) a director was helping himself to additional, undeclared, money from his company. The Court agreed with HMRC that the onus was on the unfortunate Mr Jonas to prove he had not been doing this in previous years, and when he could not do so, they upheld the assessments made on him for undeclared income for years back to 1958!
If HMRC seek to apply this ‘presumption of continuity’ (and the RPI to arrive at earlier years’ profits), it pays to consider whether they are justified. In particular, if the errors in the current year relate to one specific transaction then why should it be assumed that the same thing took place in earlier years?
Is HMRC correct?
HMRC also tend to overdo it when recalculating sales figures after they have proved that some have been omitted from the accounts. In one recent case (W Chapman v HMRC) they used the RPI to produce figures for a car dealer’s turnover that the First-tier Tribunal described as ‘wholly unrealistic’ and ordered the assessments to be discharged. They also said that the use of the RPI was ‘not a legitimate way of proceeding’.
Other recent decisions of the First-tier Tribunal such as Andrew Barkham v HMRC (another car dealer) and Aeroassistance Logistics Ltd (a company involved in logistics for the aviation industry) have also chipped away at the ‘presumption of continuity’ and (in the Barkham case) said that instead HMRC and the taxpayer should look at the actual records and negotiate, and in the Aeroassistance case they held that a large (incorrect) claim for the cost of business entertainment related to a one-off event and there was no presumption that such costs had been incurred in previous years.
Do not assume HMRC will win based on the ‘presumption of continuity’ if a case goes to the Tribunal. If you can produce evidence that previous years were correct, and that the current year was a one-off error, the Tribunal is likely to give you a sympathetic hearing.
Practical Tip:
Disputing additions to earlier years on the basis that the ’presumption of continuity‘ has been discredited by recent cases may work for you, but bear in mind the costs of such a dispute, and the costs of negotiating with HMRC – all too often, the practical, cheaper option is to accept HMRC’s incorrect figures. They have deeper pockets than you, and they know it.
