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This case study of COP9 Investigation is based on real events, with names and identifying details changed to protect privacy. It provides an in-depth look at the intricacies of business tax compliance and the critical need for financial prudence and correct advice.
Background of Case
John and Jane Matthews started a small art framing shop, Creative Frames, in the early 2000s in the UK. It was a simple partnership operation at first. Jane kept a manual record of daily sales, John handled framing costs, and their external accountant prepared annual financial statements. In 2007, they expanded into apparel and giftware, buying inventory from overseas suppliers. With new lines of business, sales grew rapidly over the next two years.
In 2008, John and Jane incorporated the business as Matthews & Co. Ltd. They opened dedicated business bank accounts and hired a bookkeeper. Operations ran through the corporation going forward.
The business continued its upward trajectory over the next decade, selling at fairs and events across Britain. John travelled for new sales opportunities while Jane managed the day-to-day. Financially, Matthews & Co was doing well on paper. But some foundational cracks in their tax compliance practices would eventually surface.
Underreporting Business Income
A consequential issue was that Matthews & Co substantially underreported its cash sales in certain years. With their framing origins, a portion of sales had always been in cash. As the volume increased, tighter controls were needed.
Jane provided summarized cash receipts to the bookkeeper for recording. However, analyses found that the totals provided were less than the actual cash taken in. The difference was deposited into personal accounts and not disclosed for business accounting. This enabled underreporting of income and VAT to HMRC.
Our accountants identified over £250,000 in undeclared cash sales over nine years by forensically auditing bank accounts and expenditures. Cash deposits couldn’t be tied to sales or explained as non-business income.
The Impact
The underreporting had a multiplier effect across taxes owed:
- £47,000 owed in VAT from understated sales
- £80,000 underpaid income tax for John
- £57,000 underpaid income tax for Jane
With no business linkage, personal tax returns were also inaccurate.
Use of Hidden Funds
The unreported cash was directed towards Matthews’ real estate investments. Early on, they purchased rental properties in the UK. The cash infusions helped fund down payments and renovations to get them income-generating faster. Later, once the housing market recovered, proceed sales of these properties needed to be properly reported. They also used cash to buy two flats in Dubai as UK housing became more expensive. These, too, were rented out without declaring the foreign income. So underreporting business sales fed into incorrect reporting of rental income, property sales, and foreign income in subsequent years.
Accounting Irregularities
Matthews & Co’s external accountants failed to notice flags in the company’s books:
- Bank statements provided showed deposits didn’t match reported sales trends
- There was no reconciliation done of business bank transactions against VAT returns
- Transfers to personal accounts went unquestioned
- Foreign bank accounts weren’t disclosed, though beneficial ownership was known
For tax compliance to work, financial reporting has to be accurate and complete. But the accountants needed to apply proper diligence in their reviews.
COP9 Investigation
In 2016, after foreign properties were voluntarily disclosed, Matthews & Co became the subject of an HMRC COP8 inquiry. John and Jane hired an advisor, Mr Davies, to represent them. However, Mr Davies only fully analyzed the case after recommending they request a Code of Practice 9 investigation. This initiated an exhaustive HMRC investigation for the last twenty years. With their livelihood now in jeopardy, the Matthews engaged us to review their tax affairs comprehensively. A clear pattern of underreporting emerged across their various business and investment activities.
Our Approach
Our team of tax specialist accountants used a systematic approach to untangle the Matthews’ financial situation:
- Interviewed John and Jane extensively to understand the business history and key events
- Obtained bank and credit card statements for all known personal and business accounts
- Accessed previous VAT, income tax, and financial filings
- Studied accountant’s working papers for income and expenses detail
- Reconciled third-party paper records against tax return reporting
Through meticulous transaction tracing and timeline reconstruction, they quantified the full extent of underpayment year by year.
Rental Income Issues
Problems extended to Matthews’ UK rental properties as well. Several investment properties were acquired, with ownership between spouses mixed across entities. True rental income varied from what was reported each year. Amounts were attributed incorrectly, or expenses were duplicated. Cross-referencing bank statements against property records could allocate proper income and expenses. Over £100,000 in mismatches were identified.
Resolution Approach
With goodwill built, our Tax advisors worked constructively with HMRC on Matthews’ behalf to arrive at a fair settlement. John and Jane took accountability for compliance failures and implemented corrective measures. They segregated personal and business accounts, recorded all transactions properly, and retained thorough documentation. Given the impact on their now-incorporated business, the full tax bill of over £150,000 could not be paid immediately. So a substandard offer and long-term payment plan were negotiated. HMRC agreed to waive penalties based on the cooperation received.
Lessons Learned
The Matthewses realized that inaccurate recordkeeping and financial negligence led to their situation over 15 years. They should have had a better handle on compliance requirements as business owners. Poor counsel also failed them at a critical juncture. The right tax expertise could have avoided the aggressive investigation and guided more strategic corrective action.
However, they shared their experience transparently to help others avoid similar mistakes. With the proper controls and tax awareness, major compliance pitfalls can be averted. The case illustrates the heavy price of non-compliance. But also the value of upfront prevention, honest disclosure, and constructive resolution when mistakes occur.
For COP9 Tax Investigations, tax resolution or compliance, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.