Whether accounts had been prepared in accordance with generally accepted accounting practice and if not whether this constituted negligent conduct by the accountant enabling HMRC to issue discovery assessments

The case involved an appeal by a taxpayer in respect of the decision of the First-tier Tribunal that the taxpayer's accountants had adopted the wrong accounting practice in drawing up the taxpayer's trading accounts which amounted to negligent conduct entitling HMRC to raise discovery assessments.

Facts

The taxpayer traded as a ground works subcontractor. The contract terms typically required the business to make applications for payment. As such when preparing the taxpayer's accounts, the accountant did not include as an asset or income, valuations made by the quantity surveyors for the business, on the basis that these were not realised until agreed by the customer's own quantity surveyors. Only when a valuation certificate was issued by the customer was the income and asset then recognised in the accounts.

Under Section 29 TMA 1970, HMRC had issued assessments in respect of the years 1998 to 2000 and 2002 having opened an enquiry into the taxpayer's 2001 return within the relevant time limit. Discovery assessments for earlier years were then issued in 2008.

The First-tier Tribunal dismissed the taxpayer's appeal against the assessments on the basis that the taxpayer's accountants had not prepared his accounts for each of those years in accordance with GAAP. As this constituted negligent conduct by a person acting on the taxpayer's behalf which then resulted in a tax loss, HMRC were entitled to make discovery assessments.

The taxpayer appealed against the First-tier Tribunal's decision in relation to the date at which income was recognised in his accounts but did not challenge the Tribunal's decision in relation to recognition of stock and work in progress.

Issues

The case involved two main issues as follows:-

1. Whether the point at which to recognise income was when the application for payment was made rather than when the valuation certificate was issued by the customer's quantity surveyor; and
2. Whether the Tribunal had erred in making a finding of professional negligence or applied the wrong test for negligent conduct leading to an erroneous conclusion that discovery assessments were appropriate

Decision

The Upper-tier Tribunal dismissed the taxpayer's appeal.

Whilst the method of income recognition adopted by the taxpayer's accountants had been chosen for what they believed to be good reasons, the First-tier Tribunal gave clear reasons for concluding that that approach was erroneous and there was indeed sufficient evidence of the asset at the date of the application for payment.

The Tribunal did not find that the taxpayer's accountant was guilty of professional negligence however; it found that there had been ‘negligent conduct’ by a person acting on behalf of the taxpayer. Whilst that person was not a party to the proceedings the Tribunal was not prevented from making a finding that there had been negligent conduct on his?part.

Where HMRC asserted that there had been negligent conduct by a person acting on behalf of the taxpayer, the burden lay upon HMRC to prove that. Where the person acting on behalf of the taxpayer was an accountant engaged by the taxpayer to prepare his accounts, the accountants’ conduct had to be judged by reference to the standard of the ordinarily competent accountant.

The Tribunal explicitly concluded that the approach adopted by the accountant was not in accordance with generally accepted accounting practice at the time. The essence of the Tribunal's reasoning was that, in this particular business, there was only one method of income recognition under generally accepted accounting practice and the approach adopted by the accountant did not comply.

The tribunal's decision was clear as to who made the discovery, what had been discovered and what years were involved namely that in preparing the taxpayer's accounts, the accountant had not recognised as income sums which thereby understated the taxpayer's revenue and profits.

On this basis, the appeal was dismissed.

The full text of the case can be accessed at http://www.bailii.org/uk/cases/UKUT/TCC/2011/B16.html