The vast majority of audits and accounts preparation work carried out will identify at least some minor financial errors in the company’s records or accounts. While these may be correctly treated as non-material for audit purposes, there is no directly comparable concept of materiality in tax.
If the errors identified demonstrate:
- under or over-declaration of income
- under or over-statement of expenses
- the use of company funds to pay directors’ personal expenses, or personal funds to pay company expenses, without the appropriate adjustments to the Director’s Loan Account
- incorrect deductions under PAYE, or even
- an error on a VAT rate applied.
There will potentially be an impact on the tax paid by the company.
These errors may need to be disclosed to HMRC in order to correct past underpayments (or in some cases overpayments) of tax. Maybe the errors are also repeated ones, and so happened in earlier years as well. Choosing not to disclose an error to HMRC once it has been discovered could be seen as tantamount to fraud if the business knows that tax of some sort is wrong but chooses to do nothing about it, even if the original error was a wholly innocent oversight. The directors’ decision to reject advice to disclose an error once it has been described to them is seen by HMRC as a positive action, made deliberately and carries the associated risks of higher penalties, HMRC assessments for a maximum of 20 years, and possible prosecution.
As that is the case, in order to protect themselves from (at best) damage to their professional relationship with their client and (at worst) possible legal action, auditors and accounts preparers should always inform clients of errors identified and explain that this could have a tax effect.
However, making a tax disclosure to HMRC is, by definition, a non-audit service, and carrying out non-audit services for audit clients can potentially cause problems, as ethical standards place auditors under an obligation to maintain independence and objectivity in both fact and appearance. Failure to do so can have serious consequences for the individual auditor and the firm they work for, with possible damage to professional reputations, or even disciplinary measures including sanctions or financial penalties imposed on the individual or firm by the ICAEW or other professional body.
Given the potentially dangerous pitfalls described above, many accountancy firms sensibly decide that they will avoid carrying out any non-audit services for an audit client; but how do auditors balance this potential conflict of interest with the need (as described above) to inform their clients of any errors identified and give the company directors the opportunity to disclose any tax implications to HMRC.
The necessary conversations with client companies following the discovery of an error that may have tax implications can be tricky, especially as tax sits firmly outside the comfort zone of many auditors. In addition, strict regulations govern the non-audit services that can be provided to audit clients, and overstepping these boundaries can expose both the individual and the firm to unnecessary risk.
At Crowe UK, we have a specialist Tax Disputes and Investigations (TDI) team, with extensive experience in handling these matters. It is part of our role to support auditors by having these difficult conversations with clients and advising on how to disclose errors to HMRC, with a view to achieving the best possible outcome in terms of limiting the years included in the disclosure and minimising penalties.
In cases where auditors or accounts preparers have identified errors, Crowe’s TDI team is happy to have a no-names, no-fee, no-obligation call to discuss the issues and provide an initial view on whether there are tax implications for the company. Where appropriate, we can then be introduced to the client to advise on disclosure and provide a fee estimate for the specific one-off work needed to regularise their past tax affairs.
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