HMRC enquiries – re-opening earlier years

Re-opening earlier years is an area where HMRC has regularly referred to case law.

The case of Barkham v Revenue and Customs [2012] focuses on the burden of proof following an enquiry. The general position is:

• HMRC enquiries into a tax return, particularly trading companies and the self-employed, may result in additions to income in the year of enquiry. For example a restaurant owner may be found to have declared insufficient cash takings and/or not have correctly accounted for goods used for own consumption. 
• This will result in HMRC amending the self-assessment for the tax year under enquiry but may also lead to HMRC issuing assessments for earlier years as well. HMRC refers to the practice of spreading additions to profits back into earlier years as the ‘presumption of continuity’.

Under normal circumstances, HMRC has until four years from the end of the accounting period for companies or the end of the fiscal year for unincorporated taxpayers to issue an assessment. Where it can establish careless behaviour, this is increased to six years. In the case of careless and deliberate behaviour, it can go back up to 20 years. (See ACCA’s guidance on time limits for claims and elections.)

HMRC uses case law as authority for spreading additions into earlier years and its officers are encouraged to follow the guidance in its enquiry manuals at EM3309, which states:

"If you have proven omissions for which there is no ready explanation and the business and way of life of the taxpayer have not changed you will be in a much stronger position to argue for addition to other years.

Taken together, then, the tax cases EM3310+ demonstrate that, in the absence of evidence to the contrary, a `presumption of continuity' can be made and the Inspector can be entitled to conclude that under-declarations in some years can be taken as a pointer to under-declaration in others and make discovery assessments accordingly."

The tax cases referred to are:

• Jonas v Bamford [1973]
• Rosette Franks [King Street] Ltd v Dick [1955]
• Nicholson v Morris [1977]
• Bi-Flex Caribbean Ltd v The Board of the Inland Revenue [1990]

Probably the most well-known of these cases is Jonas v Bamford, in which the judge expressed the presumption of continuity as follows:

"Once the inspector comes to the conclusion that, on the facts which he has discovered Mr Jonas has additional income beyond that which he has so far declared to the inspector, then the usual presumption of continuity will apply. The situation will be presumed to go on until there is some change in the situation, the onus of proof of which is clearly on the taxpayer."

However, the recent case of Barkham v Revenue and Customs [2012] now suggests that the presumption of continuity may not apply as liberally as HMRC might wish.

HMRC enquired into the taxpayer’s 2004/05 tax return. HMRC raised assessments for 2004/05 and also for 2001/02, 2002/03 and 2003/04, increasing the profits from his car sales and maintenance business for each of the years concerned.

The issues at stake were:

• whether the accounts for the year ended 31 December 2004 were understated;
• whether it was appropriate to issue discovery assessments for earlier years. 

During the enquiry, HMRC alleged that the turnover for 2004, which formed the basis of assessment for the 2004/05 tax return, was understated in respect of undisclosed cash sales. HMRC increased the 2004/05 self-assessment to increase the gross profits of the business to reflect a 58% interest in gross receipts. HMRC also used the same percentage to increase gross receipts for 2001/02, 2002/03 and 2003/04.

The taxpayer argued that the accounts submitted were correct but HMRC contended that the turnover figure for 2004 was based on bankings and did not include cash receipts. Furthermore, HMRC considered that under the presumption of continuity, where there is evidence of omissions from a return, they could infer that the omissions would also have occurred in earlier years.

The tribunal considered the evidence and concluded that there was no evidence that the bankings for the year ended 31 December 2004 included the total amount of cash which should have been banked. The assessment for 2004/05 was therefore upheld and the taxpayer's appeal dismissed.

With regard to the earlier years, the tribunal found the 58% uplift in turnover to be unfair, unreasonable and unrealistic in the circumstances, adding that ‘a simple projection of profits does not strike the tribunal as accurate or fair’. The discovery assessments were therefore dismissed and the taxpayer was invited to submit alternative increases, based on sufficient evidence.

The tribunal pointed out that, once HMRC has issued an assessment, the burden of proof is on the taxpayer to prove that, on the balance of probabilities, the assessment is excessive.

It is therefore possible for a taxpayer to disprove the presumption of continuity by providing sufficient evidence that the amounts should be reduced. The case emphasises that HMRC’s method of calculating income for earlier years on the basis of spreading is open to challenge where a more reasonable and accurate method is appropriate.