A case before the tax tribunal, T I Khawaja v HMRC TC01878 illustrates the use of a business economics test in estimating takings when record keeping is challenged.
When a business involves taking one product and turning it into something to sell, HM Revenue & Customs look at the raw materials and scale them upwards to work out sales. This calculation is known as a business economics exercise. Having worked out what can be created HMRC looks at what units those creations are sold in and then checks out the selling prices and calculated expected sales according to the levels of your purchases.
Business economics exercises work very well for businesses in anything from catering to manufacture, however you are most likely to see them in cases involving take-aways and restaurants.
Any figures HMRC creates in this way need to be adjusted for wastage, if applicable, and they need also to be backed up with some “walk through’ data which tests whether the methodology is sensible if they are going to stand up to any detailed scrutiny under cross examination.
HMRC can (budget and case management permitting) also rely on other information including mystery shopper type checks; an officer of HMRC poses as a customer and sees what they are sold and then during a subsequent visit the receipt given to the “shopper” will be checked to ensure that it is declared. Ideally this will link back to the business economics data and HMRC will be able to present quite a robust sounding set of data from the exercise to a tax Tribunal.
The problem behind such a strategy is that while a business economics exercise might be useful for quite large and well organised businesses the smaller the entity under enquiry the less likely it is to have a standardised pattern of sales. Very small business, or what are referred to in official statistics as “micro businesses” tend to often stay that size because it takes a huge about of resource to change from micro to very small, and then an even bigger push to change from very small to small (within the EU definition of small).
From an investigations perspective there are many micro to small businesses that do not fit neatly into an average purchases/average sales business economics test because just a small ripple in the daily routine is all that is required to upset the daily figures. For example, if the owner is ill, or there are the gas company is digging up the road outside and putting off customers for a week or two, or there are family troubles, the disturbance to the business can create huge ripple to distort sales and the economics of the business for that while.
So, the major problem for anyone who is facing a tax enquiry or investigation under Civil investigation procedures and disputing figures estimated by HMRC during a business economics exercise is how to:
- disprove what HMRC have created, and discredit its methodology
- prove without doubt that other factors were involved affecting sales-turnover, or the operation of the business during the period
- produce a better methodology
At the end of the day it is all about evidence though, so if you do not keep sales records expect your profits to be estimated for you.
A 2012 case featuring business economics:
Tahir Iqbal Khawaja v HMRC [2012] TC01878 was a case featuring tax penalties and a long old battle.
The business was a restaurant/take away, with unreliable recording keeping. The tribunal found there was negligence not fraud, and gave an abatement of penalties of 40%. A business economics test for a restaurant was conducted and included HMRC’s evidence from surveillance and an expert from meat producers.
