Mistakes or suspicion of a misclaim are prime reasons why HM Revenue and Customs may select a tax return for investigation.
In addition, any return in which income, expenses or profits fall outside the ratios or guidelines used by HMRC to compare with the previous year, and with other similar businesses, would also attract attention.
A proportion of returns are also pulled out at random for a closer look each year.
Taxpayers are most likely to be asked questions as a result of HMRC opening what is known as an aspect enquiry.
This is where particular areas of expenditure in farm accounts and tax returns are targeted and subjected to close scrutiny, says Jonathan Smith, tax partner at Strutt & Parker’s Lewes office.
“Usually the first stage will be a request from HMRC for a detailed analysis of a particular item or items, together with invoices to back up the claim made in the tax return.
“Although HMRC can look at any aspect of your tax affairs, the most common areas of review for farms and estates seem to be repairs, property expenses and professional fees.”
Genuine repairs are likely to be 100% allowable against income, but improvements and new capital expenditure should not be confused with repairs. This happens most commonly when there are improvements or new building happening alongside repairs and refurbishment. Improvements and capital expenditure on buildings can only be written down at 4% a year on a reducing balance basis if they are agricultural or industrial, otherwise there is no relief at all. However, there are some aspects of plant and machinery investment, for example, grain driers, where the moving parts such as fans and belts may be eligible for 40% first-year allowances. These enhanced rates of allowance may amount to a significant part of the total project cost. Professional fees often include personal work, for example advice on wills and inheritance tax, which cannot be charged against the farm or against any other income. Professional advice relating to capital improvements or new assets should also be put in the balance sheet as part of the capital investment. Expenditure relating to let property must always be set against property income only, not against farming income. This could be helpful in some cases in avoiding the sixth year rule for farm losses. The costs of farm labour used to work on let property should be charged against the income from let property.
If additional tax is found to be payable as a result of an aspect enquiry, interest will probably be charged on late-paid tax and the aspect enquiry can lead on to a full enquiry, warns Mr Smith.
“A full enquiry means a detailed review of the whole of your business or personal affairs.
This will include reviews of all income and expenditure items, with a particular interest, again, in any expenditure which might be private or capital in nature,” he adds.
HMRC’s annual report shows that 38,873 aspect enquiries and more than 33,400 full enquiries were carried out in 2004/05.
In the same year, 9.8m self assessment tax returns were issued.