The tax man turns hard man

With a newly aggressive Revenue, rushing a return could cost you dear, accountant Richard Murphy says

Many employed people have problems with tax returns but their task is far easier than the nightmare faced by the self-employed

People working for someone else can be reasonably confident that the largest number on their returns - that for their income - can be copied safely straight from the P60 form their bosses given them each year. The nightmare for the self-employed person is calculating this figure.

Some people think the easy way to do this is to pay an accountant. But beware: It's not the accountant that signs the return, it is you. The declaration on page 8 of the form says: 'The information I have given is correct and complete to the best of my knowledge and belief'.

Yet no accountant will say that about a set of accounts. The most they can say is that the books are true and fair, which, broadly speaking means "they're OK or thereabouts" because the figures are yours, not theirs, and only you can know if they're right. So it is you who pays the penalty if they aren't.

Getting accounts right is harder under self assessment than it used to be. Tax inspectors are more aggressive now. As a matter of policy they now have to find something wrong with 75% of all the returns they see. This means small, innocent human errors - in adding up, for example - aren't overlooked any more. And anything that is hard to explain, such as why you recorded an invoice as being for £80 and not £800 (because, say, of a typing mistake) is automatically seen as fraud, not error.

So although in 1999-2000 the Revenue got only 72%t of its own self-assessment work right first time, it has zero tolerance for your errors.

The second reason why the tax return is harder now is that since 1996 there has been a requirement for a business to keep books and records that support its return. Nowhere is it defined exactly what these are. But, as the Revenue now believes that the self-employed income declared on a tax return must be calculated in accordance with the accounting rules appropriate for limited companies, you can be fairly sure that if a firm needs the information, so do you.

Businesses must say where all their income has come from, and precisely what expenses were incurred in generating it, with evidence to support this.

If you lack this information for the last accounting year, don't try to do your return now. Get your accounts in good order first, and do it later, even if you have to work out the bill. It will be safer and cheaper in the long run.

Having got your accounts sorted out, what are the problems with the return? Potential pitfalls include:

1 You have to decided which page to fill in. If your sales are less than £15,000 (and quite a lot of self-employed people start in this way) then you can just fill in three lines of information on sales, expenses and net income on page SE1 of the return. I strongly recommend you don't do this, however. The Revenue thinks this part of the return is being abused. Officials say they can't believe the number of businesses that consistently make sales of just over £14,000 a year. So they're planning to investigate an above average number of people using this part of the return. As a result it's safer to use the full return on page SE2.

2 Make sure you use the right accounts to prepare the return. These are those that ended during the year preceding 5 April 2001. For this reason it is often easier to have a 31 March or 5 April year-end for your books.

3 Make sure you declare the right sales income in the accounts. The right income is invoices issued in the year, not cash received. And don't delay invoicing at the year-end to try to reduce the income. The Revenue thinks this is fraud and will charge extra tax and impose penalties if it finds that you have done this deliberately.

4 Make sure you don't claim the cost of buying equipment as an expense. It isn't one you can directly offset against tax. You have to claim what are called capital allowances. The rules for doing this are in the Tax Return guide, which is also available in the Inland Revenue web site. But first you have to be able to identify equipment: generally this is something that costs more than £100 and is used for more than one year. So your computer is equipment, and you can't claim it as a direct expense.

5 Don't claim for things that are not allowed as expenditure for tax purposes. The most obvious are personal expenses and entertaining. If you take someone with you for a meal you can be pretty sure it's entertaining, so there is no tax relief on it. Private expenditure is harder to identify. A telephone line used for business and domestic use is by definition in part business spending. The only reliable thing to do is keep a log of all the calls that you can prove were for business. The same applies to cars, where a mileage log is needed.

6 Only claim for domestic costs that are really incurred for the business. Don't claim for your mortgage. Don't claim council tax. The actual direct costs of working from home are low because the Revenue knows that people buy their homes to live in, not as places to work. And if you did buy it to work, remember you have to pay capital gains tax when you sell it.

7 Only complete the balance sheet page of the form if you really have prepared a balance sheet. The Revenue does not look for one for most businesses turning over less than £100,000. But if you have prepared one, or your accountant has, do complete the page. Because if you don't you're not disclosing complete information, and that can be penalised.

8 If in doubt about anything, research it. Call your tax office to get the advice of the staff. Make a note of who told you what. And then attach a note to the return saying you followed their directions.

Remember above all else, you must at least attempt to be right. Which is difficult when no one ever really knows whether a set of accounts is right or wrong - they can only ever be "OK or thereabouts".