The public is taxed by new laws

Mike Truman warns of the potential pitfalls behind self-assessment taxation

Self-Assessment is the biggest change in the 200-year history of the UK's income tax system. It has been in force since 6 April this year, and although most business owners will not have noticed any real change, they would be mistaken if they thought it was all a storm in a teacup.

Self-assessment only affects income tax, and to some extent capital gains tax. Companies are not directly affected, although their employees and directors' personal tax liabilities may be. The paradox of the income tax system is that it is always nearly a year in arrears; so most of 1996 is taken up with agreeing liabilities for the tax year which ended on 5 April 1996. It will only be during 1997 that the taxman's mind turns to the current tax year, and the full impact of self-assessment will be felt.

To understand how the new system works, it is necessary first to understand the old one. Under the old system the theory was that the taxpayer sent in their return (and accounts, if he was self-employed), the Inspector of Taxes checked them over, and if he was satisfied he issued an assessment of the income and the tax due on it.

But in practice the return and accounts were frequently late, so the Inspector issued an estimated assessment. The taxpayer would appeal against this, and eventually, after being threatened with appearing before a tribunal to explain why he hadn't sent in the necessary information, the return and accounts would be submitted.

Under the new system of self-assessment, there is a fixed filing date of 31 January following the end of the tax year by which the tax return must be submitted. The Inspector does not have to issue an assessment, because the return will be the taxpayer's own assessment of his income. The taxpayer also has to calculate the amount of tax due on the income, unless the return is submitted four months earlier, by 30 September, so the Inspector has time to do the calculation for him. Gerry Hart runs The Tax Team, a network of fixed fee tax advisers set up specifically with self-assessment in mind. He is also a former President of the Chartered Institute of Taxation, the premier professional body for tax specialists. He has no doubt about who will be hit hardest by self-assessment.

"The self-employed," he predicts. "The Inland Revenue have been emphasising the fact that most taxpayers will have to give less information on the new tax return than on the old one, but the self-employed will find that they have to give more."

This is because the Inspector will no longer look at the accounts of a self-employed taxpayer to see the profit earned; in fact they say that they don't want the accounts submitted at all. Instead, the tax return sent to the self-employed will have a special schedule asking for the income and expenses of the business to be reported in a set format, known as the Standard Accounts Information, or SAI.

However, the headings used for the SAI do not necessarily correspond to those that provide useful accounting information for the business owner. "Farming is a particularly problematic area," says Mr Hart. "Trying to take the information from a set of accounts for a farmer, set out in the way that is useful for him, and then to rearrange the figures to fit into the SAI format is very difficult, and does not provide worthwhile information to the Inspector of Taxes. That is only one of a number of businesses which are going to have problems."

Another area of concern is record-keeping. There is now a statutory requirement on taxpayers to keep records, for approximately six years if the taxpayer is self-employed or two years if not, with a penalty of up to pounds 3,000 for failure to do so. "Most businesses will not have too much of a problem," says Mr Hart, "as they will typically have a record-keeping system already. But directors of companies may not realise that they have to keep details of their personal tax affairs so that the Inland Revenue can check the information given on their return."

The concept lying behind the checking of returns is described by the Inland Revenue as "process now, check later". Tax returns will all be processed on receipt, and if there are minor arithmetical errors these may be picked up immediately by the computer system into which the information is being fed. If necessary, the taxpayer will be asked for more information to correct these errors, and may be forgiven for thinking that once they are agreed the return has been accepted. Not so. For a further year after the 31 January deadline, the Inland Revenue can ask the taxpayer to justify the information shown on the return. Some returns will be looked into because the Inspector of Taxes suspects there may be something wrong with them, but some will be investigated purely at random. This approach of "random audit" is new to the UK, although it is common in other countries with self-assessment, such as the USA.

After the year has elapsed, the only way for the return to be challenged is if the Inland Revenue "discover" tax undercharged. Crucially, they cannot discover something which the taxpayer clearly tells them about on the return. Gerry Hart recommends that taxpayers and advisers have to have a clear policy for filling in the return with discovery in mind. "If you put something into the return knowing that the Revenue would claim it should not be there, then you must tell them what you have done. Equally if you exclude something which you know the Revenue believe should be there, you also need to tell them."

It is here in particular that the advice of a qualified tax adviser will be most useful, since he or she will have detailed knowledge of what the Inland Revenue considers to be correct. So 1997 will be a brave new world for tax advisers and their clients, particularly the self-employed.

Those running their business through a company will have fewer problems, but will still need to ensure that they have the necessary records of their personal taxation liabilities. The "phoney war" of self-assessment is about to end, and the real battle is beginning.