Back in the day the Inland Revenue trained their officers to understand that different taxpayers required different approaches, and to use their discretion to smooth out the difficulties which real life throws up. Nowadays their approach is: one penalty fits all, and business profits are compared to standard benchmarks as we explain below. We also question how deeply you should delve into a client’s expenses, and have news on how to reclaim s 455 tax paid on directors’ loans. 
Benchmarking of profits
In our newsletter on 17 April 2014 we explained how the HMRC “transparent benchmarking team” was writing to sole-trader businesses in selected trade sectors to nudge them into reviewing their reported net profit ratios. The trades targeted were: painters and decorators, driving instructors, taxi drivers and pharmacists.
The HMRC benchmarking team has now turned its attention to car mechanics and furniture shops. However, this time it is looking at the VAT returns of up to 7500 businesses, rather than the gross profit figures reported on the SA tax returns. 
The HMRC letter asks the trader to work out its VAT mark-up ratio by comparing the difference between sales and purchases (ie gross profit), as a percentage of all purchases as reported on the VAT return. It provides a range of mark-up ratios which HMRC say are standard for the trade.
HMRC ask the business to compare its VAT mark-up ratio for the last 12 months of VAT returns to the standard mark-up ratios. If it’s mark-up ratio falls outside the standard range, it should review the figures to be included in boxes 6 and 7 on its next VAT return.  
This is where you come in. In spite of asking some fairly complicated questions about profits and mark-up, HMRC has decided not to copy the letter to the tax agents of the businesses they have selected for this experiment. Fortunately the HMRC letter does not require a reply, so it can be safely ignored if you are confident that your client’s VAT returns are correct. 
However, the HMRC letter will certainly generate some alarm the business owners who receive it, so be prepared for some panicky phone calls – just what you need at this busy time of year.


This is an
extract from our tax tips newsletter dated 15 January 2015. The newsletter
itself contained links to related source material for this story and the
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