New tax and benefits checks on the self employed

The normal targets for Working Tax Credits Examinations, which started in 2012, are newly self-employed claimants and those already claiming with consistently low earnings. No-one actually knows how big the Examination team is, but I would take the 12,000 initial annual target for examinations as a conservative estimate. If the money saved by denying benefits through examinations exceed the employment costs this will become the love child for all future benefit strategy.

I assume that the selection of cases is by profiling, based on sharing information with other government agencies. There is enough evidence to confirm that it is not simply a random process.

The information required is usually recent business and personal financial records for the last three months. You must supply the documents forthwith and await their decision. Generally, all WTC Examinations are carried out by letter. Touchingly, you are give the phone number of a real person you can speak to rather than the normal call centre jockey.

Having helped a number of claimants through an Examination, there are a few common areas of “concern” – the hours that they calculate you to be working against the hours actually claimed and whether your business is viable.

Whilst total hours worked per week is a major criteria in WTC awards, there is nothing in the guidelines relating to earnings and business sustainability. These are controversial changes being introduced in Universal Credit and these Examinations seem to be a training exercise to justify the new policy by stealth.

The hours worked per week can be contentious. As a self-employed person, you are responsible for getting your own work, according to HMRC Tax Credit guidelines, and for sales activity and marketing, together with maintenance work and admin tasks. These all count as unpaid work and towards the total number of hours. The difficulty seems to be in getting over to the Officer the fluctuations of running your own business. If paid work is scarce, however temporary, you are going to have problems.

The Officer in charge of the examination will not be a business expert so this often frustrates claimants trying to explain the ins and outs of the business. The cosy world of a civil servant is black and white. Their side of the judgement is “rules” and the ultimate defence is that they are just doing their job.

Ironically, the 30-hour rule does not apply in Universal Credit. Yet many are being disqualified from WTC, even on the narrowest of margins. The worst case I have seen is a an employed cleaner whose contract of work declared 30 hours per week, but recently this had fallen in some weeks to 28.5 hours. This was “discovered” through an Examination and her WTC was completely withdrawn. Proof from her employer and recent payslips proving that this was temporary has not got her tax credits re-instated or abated the demands to remit her “overpayment”. From surviving just over the breadline, she now has a hole in her finances and a £1,800 debt.

I have seen great swings in the fortunes of certain claimants who have been in business for several years. One, whose work suffered through local council cutbacks went through two years of very poor profits – he is only now starting to recover. Several other long established businesses have seen work drop off dramatically because their services were aimed at a strapped consumer – for example, learning to drive in poorer areas is a unaffordable luxury for many.

Under Universal Credit, a struggling Driving School is likely to be told to find more gainful employment, presumably a job in a call centre or stacking shelves at the local supermarket, paying scant regard to the years of training and investment that person has made in his business.

For example, many instructors were seduced by the lifestyle choice of being their own boss having decided that working for someone else was not for them. What retraining and prospects exist for a 50 something year old? Instead, under Universal Credit he is likely to be “invited” to his local Job Centre to explain to someone who is only interested in why he is not working hard enough.

The officials appear to have no sympathy and to be applying the rules ruthlessly. You are not earning enough, therefore you are not working 30 hours and do not qualify for Working Tax Credits. Only precise records will allow you a defence.

The transition rules from WTC to Universal Credit are both elastic, unwritten and a WTC Examination could be seen as an opportunity to ride rough-shod over genuine hardship. Uniquely we have two different welfare systems operating simultaneously and a significant number of people are being caught in the crossfire to achieve political targets.

HMRC Business Record Check

Business Record Checks started as a pilot in 2011 with HMRC targeting specific businesses that they considered high risk following a vow by Deputy PM Nick Clegg that “this government was going to spend twice as much to catch tax cheats”.

The first pilots were regional and homed in on specific sectors that many would consider sitting ducks – restaurants, takeaways and the second hand car trade.

The BRC created an outcry from victims and their accountants and were suspended in the middle of last year and re-introduced in a modified, softer form late last year .

ANY SELF EMPLOYED BUSINESS COULD BE SUBJECT TO A BUSINESS RECORD CHECK.

While there is a long list of well known “high risk” trades such as taxi drivers, HMRC are using an unspecified method to select businesses. I had a client who was neither cash based nor a typical self-employed trade. Nor had he any previous tax problems. In fact, he was an exemplary tax payer paying above average tax and NI.

Rather like a lottery ticket in reverse, it appears anyone could be randomly selected.

The BRC group at HMRC seems to be set up in teams of two per major town or city, indicating a nationwide force in excess of a hundred. Each full-time team member is expected to make six BRC visits per week.

The above indicates as many as 30,000 visits per annum, or about 1 in a 100 small businesses. Presumably HMRC will be contacting considerably more and some are allowed to pass the initial telephone survey.

The first sign of trouble ahead

The first sign that you are facing a BRC will come in a letter informing you that you have been selected and given an approximate date to complete a 15-minute telephone survey.

HMRC apparently are unable to follow business practice and courtesy and set a firm time and date. The letter gives no clue which phone number they hold for you on their system. Even when the call is received you may find the number withheld so identifying the call may be a frustrating experience. Missed calls may prove to be impossible to call back and count against you as in the example below.

In my client’s case they clearly had the wrong phone number. He had even rung them and re-arranged the call beforehand. Nevertheless he “failed” the subsequent survey and the HMRC Officer said it was because he had not responded to the three calls they had made earlier to his incorrect number.

The initial letter also makes clear to the client that he may want to contact his Tax Adviser. Many recipients would take this as a natural reflex reaction but many an accountant could only dispense basic book keeping advice if he is acting simply as a tax preparer at the year end – the scope of the BRC is recent business records relating to the current tax year.

Would I advise you to tag your accountant along to the meeting? Your decision has to be made on the judgement of how well he knows your business, then how much input he can provide and last but not least, the cost. 

Is your accountant a possible shield?

Unlikely- unless he is also being employed as your book-keeper, an expensive option for most small tradesmen. The tightening of record keeping started in 2009 through accountants being told to warn clients of a potential £3,000 fine for poor records through spot checks.

However, this dire message cut no ice with a significant portion of the self employed often referred to as the “shoebox brigade” who (unfairly) saw it as the accountant’s job to sort out their receipts and create accurate accounts and tax returns from the minimum of information. Indeed, many clients felt that they were using an accountant for exactly the purpose of protecting them from HMRC problems, so it became a difficult message to deliver to the intended audience. Accountants are human with normal powers of deduction.

Mainly they work on what they see and usually mind-reading skills relating to missing documents are strictly limited.

How should I prepare for an HMRC visit?

Have at hand all documents relating to your income and expenses, including bank statements, sales invoices and expense receipts for the period specified.

Be prepared to start the meeting by giving a description of your business and any peculiarities to it such as seasonality, uneven flow of work, recent illnesses, high material costs and stock holding.

The inspecting officer is likely to give you a hard time if your business is receiving cash for services and there is no diary or paper trail of work carried out and corresponding log of payments made to you. Suspicion will also be aroused if your lifestyle appears to be greater than your income allows.

Expenses you have listed will be checked as being relevant to your business and any personal use of cars, vans, phones and items such as computers are expected to be taken into account in your books. I was actually amazed by this line of questioning. Normally personal use is an end of year adjustment made after discussion with your accountant. A major red flag would be unexplained high expenses, such as materials purchased that could not be matched against corresponding earnings.

A BRC inspection is likely to last two hours so it is going to be pretty detailed. So be prepared to back up the information you present.

The outcome

You will either be told your records are satisfactory save for any recommendations and given a clean bill of health or the officer will warn you of a penalty of £500 which will be suspended if you can prove in a follow-up visit within 3 months that you have rectified all the shortcomings identified.

The worst case scenario applies to those who think they can simply bluff without preparation. The consequences can be HMRC calling into question the accuracy of your previous tax returns and launching a full investigation of your affairs.

At the end of the meeting I told the officer that far too many sole traders would fail a BRC examination, an observation that was readily acknowledged. Record keeping is a huge previously unspoken problem within very small businesses where lack of training, advice and support by business agencies, accountants and HMRC has created a culture of complacency and mistrust, leading to senior politicians condemning so called cash in hand tradesmen.

The new simplified tax system for small businesses

In my extensive experience in this sector, I think the vast majority of self employed are honest and do worry about running their business properly. The current tax system is complex, time-lagged and inscrutable.

So in 2011, the Office of Tax Simplification was charged to create a simpler system and this was quietly introduced for the 2013-2014 tax year.

This legitimises Cash Basis Accounting so both income and expenses are counted only when payment is received or made. For those who adopt it, (it is optional) ugly, complicated often inscrutable calculations performed by accountants such as accruals, capital allowances and depreciation will disappear.

With the concurrent introduction of simplified expenses for items such as cars, use of home and lodgings at business premises, the idea is to make business records easier to keep and at the same time, provide basic business management information to the humblest of businesses.

One man businesses make major decisions, living on gut instinct such as the right time to purchase equipment and vans. Equally banks accused of not supporting this sector are far more likely to support loan applications from clients with up to date records rather than ones that are 12 months out of date.

A by-product of a simpler system is the ability to see tax liabilities building up during the tax year. This is a vast improvement on the way many people do it at the moment – they usually don’t have a clue until they visit their accountant.

Good record keeping habits therefore allow small businesses to grow and thrive, but will involve more than the “nudge” given by Business Record Checks. HMRC are investing heavily in an education and support initiative for new businesses promoting the simpler tax system and it will be interesting to see the results over time.

The economic recovery is heavily dependent on ambitious plans for tax simplification, but these are also heavily linked to the changes in benefits and tax credits which are claimed by as many as 25% of existing self employed traders. In fact, Government work programmes encourage many long term unemployed to start their own businesses, using tax credits as a support in the formative stage.

Universal Credit, which is being phased in, will require the self employed to report their income and expenses on a monthly basis. Without basic record keeping, tens of thousands could miss out. The tight reporting timescales (within 7 days) make it impossible to obtain professional help even if it was financially feasible, which clearly by definition it would not be.

This unique administrative burden that applies only to the self employed, together with tougher tax compliance, forms a pincer movement driving people to improve their business records.

So what can you do?

When questioned, many complain that they are too busy earning a living to worry about paperwork. Besides this they do not get paid for it, whereas practising their trade, they do. Others complain about the complexity and the lack of training.

This article demonstrates that good business records are a necessity not an optional extra and a failure to comply could have an enormous impact not only on your business but on your personal and financial well being.

*Des Desai is an accountant and owner of a tax advice software company Mr Tax software and Text 2 Save Tax, which aims to make book-keeping for smaller businesses more straightforward and accessible.

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