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We’ve had some queries from clients wondering if the reports on Business Records checks, and, in particular the concerns about dividend, are a attempt to scare clients into taking up Fee Protection (formerly Tax Enquiry Insurance).

The answer is, of course, no.

The recommendation regarding fee protection is not from a sales perspective, its from service – basically for what the protection costs, versus the benefits it gives, we think its advisable to take it up. Furthermore there has been some legal precedent to suggest it may be construed as negligence on our part if we don’t at least alert clients to the availability of such cover.

Likewise the warning on HMRC business checks is just that, a warning, and a suggestion that clients should make sure their house is in order. Put simply its not us who will be paying any extra tax or penalties, nor bearing the costs of defending HMRC challenges – the law makes it clear that the responsibility for maintaing records and complying with tax regulation is that of the company directors.

Hopefully few businesses will selected, and where they are hopefully the HMRC officers will approach things with pragmatism and common sense, but you can assume neither.

Below is an extract from a newsletter that came into use this morning from an external consultancy, that prompted the round robin to everyone today:

Business Record Checks

“In December 2010 HMRC published a consultation paper on Business Record Checks, a programme that will look to review the adequacy of the business records produced by SMEs. The consultation period will be short lived, with a closing date of 28th February 2011 planned for comments.

“In the latter part of this year, HMRC appear certain to launch into a programme of 50,000 checks annually for the next four years. This appears first and foremost to be an attempt to raise revenue through the use of the existing penalty regime which, whilst rarely applied at present, allows a penalty of £3,000 to be levied for failure to maintain proper records. However in addition, this no doubt has the potential to lead to further enquiries.

“This further shows how HMRC intends to use the powers granted to it by Schedule 36 of the Finance Act 2008. Indeed, the use of a record review in respect of income and corporation tax is something that we have already seen HMRC use extensively as a part of cross tax enquiries (incorporating income corporation tax, PAYE and VAT in a single enquiry).

“We will continue to monitor this initiative and keep you updated.

“In the meantime tax enquiry numbers remain at their highest level for sometime, with month on month figures as much as 30% higher currently, when compared to 2009. More specifically, we have seen an increase in the number of PAYE and VAT compliance reviews. Plus, in addition, the number of informal ‘checks’ opened without reference to statutory notice continues to increase.”

Are Your Clients Dividends Legal?

“Due to the announcement by HMRC that late in 2011 they are to introduce a programme of Business Record Checks (BRCs) within the SME sector, we thought it wise to look at one of the areas that has already attracted the attention of HMRC – dividends.

“The BRCs will mean that following the ‘normal practice’ of making the correct journal entries to show the final amount declared in the correct place on the balance sheet as part of accounts preparation, will no longer be acceptable.

“It is now time to consider how your clients vote dividends and that a correct procedure is in place to ensure that HMRC will not claim the dividend to be illegal, nor that inadequate records have been maintained.

“To ensure the dividend is legal, consideration has to be given to the S830 Companies Act 2006 which states that ‘a company may only make a distribution out of profits available for the purpose’. Your clients need to be fully aware of what this means, for example, that even if the bank account is in credit the company needs to have sufficient retained profits to cover the dividend at the date of payment.

“For the purposes of the Companies Act S830(2) ‘Profits’ are “accumulated realised profits less accumulated realised losses”. Any dividend paid in excess of this profit, or out of capital or when losses are made is ‘ultra vires’ and, in effect, illegal.

“Where regular amounts have been withdrawn – including monthly payments taken in lieu of salary – the amounts will be deemed ‘illegal’ if at the date of each payment the management accounts show a trading loss or the profit cannot cover the distribution.

“Full or formal management accounts are not legally required for the calculation of interim dividends. Consideration must be given to the above facts to enable ‘a reasonable judgement to be made as to the amount of the distributable profits’ at the date of payment are acceptable (CTM20095 (17)). HMRC will argue that ‘in the majority of such cases’ the director/shareholder of a company will be aware, or had reasonable grounds to know that such a distribution was ‘illegal’ (CTM20095 (27- 29).

“If a distribution can be made then the procedure to approve the dividend and the record of payment must be correctly maintained. Under the Companies Act 2006, directors can authorise payment of interim dividends but final dividends need to be approved by ordinary resolution confirmed by a simple majority of shareholders. This can now all be done in writing – no meetings are required.

“The relevant date for an interim dividend is the actual date of payment because a resolution is not needed to confirm payment. An interim dividend can be varied or rescinded. It is important to note that HMRC consider the date of payment of interim dividends to be the date of entry in the company’s books. (CTM 20095 (8))

“With regards to final dividends, these become an enforceable debt when approved by resolution; therefore the relevant date is the date of declaration unless a later date is specified. Case law supports this position.

“Many accountants consider that backdating documents to confirm consideration of profit and payment of dividend is a paperwork tidying up exercise but technically it is fraud and again case law exists to support this position.

“As HMRC place more emphasis on in year compliance, whether through BRCs or Schedule 36 interventions, it is essential that clients are fully aware that dividends, whilst a tax efficient means of extracting profits from their company, are subject to legislation on when a legal dividend can be paid and how this must be recorded.

“Failure to observe the correct procedure could lead to not only additional tax liabilities but interest and penalties as well. ”