The Transparent Benchmarking Team within HM Revenue & Customs (HMRC) has selected a number of trade sectors to test the use of ‘benchmarks’. The benchmarks provide businesses, within the chosen trade sector, with a guide to see whether the net profit rate they are achieving is comparable to their competitors and within the ‘parameters’ expected by HMRC.
As one of the selected trades, painters and decorators have started to receive letters telling them that HMRC has compared the tax returns submitted by all painters and decorators over the last three years. The turnover declared and expenses claimed on all of the returns have been used by HMRC to determine a ‘net profit ratio’. The net profit ratio benchmark range for painters and decorators has been calculated at between 59-79%, to reflect the fact that every business, even comparable businesses within the same sector, are run differently and have their own unique characteristics.
The letters go on to state that if the painter or decorators net profit ratio does not fall within the benchmark range, this could be down to two common reasons:
- Numbers – have the right numbers been put in the right boxes?
- Expenses – have any expenses been claimed by mistake or not claimed for?
However, the key question really is, what will HMRC do if a painter or decorator files a tax return which is outside the benchmark range, in other words achieving less than 59%? Is a full blown investigation the inevitable outcome?
Titled ‘Helping you complete your 2013-14 tax return’, the HMRC letters read word for word as follows:
Dear Mr Xxxxxx
Do you want to save time by avoiding unnecessary contact with us?
Do you want to know how your business compares to others in your trade?
Then we can help by using something called a benchmark, which is a guide you can use to help compare your business to others in your trade sector.
Why are we writing to you?
We are testing the use of benchmarks because we think it could help business owners to make sure that their Self Assessment returns are correct. If anything is wrong with your Self Assessment return, it may mean that you have to spend valuable time putting things right – instead of being able to get on with running your business.
Research in other countries has shown that telling businesses in the same trade how similar businesses are performing, can help them get their return right. We want to see if this works in the UK. To test it, we are looking at a small number of trade sectors. One of the trades we’ve chosen is painter and decorators and our records show that you are a painter and decorator.
What is the benchmark and how has it been created?
We’ve used information from returns from all painter and decorators for the past three years. We’ve taken the numbers for business income (turnover) and expenses and worked out a ratio from them. (We call this the ‘net profit ratio’).
Net profit is often called the ‘bottom line’ for business.
People in the same trade run their businesses differently, so we do not expect everyone to have the same net profit rate. Instead we are giving a range:
The net profit benchmark range for painters and decorators is 59 – 79 per cent.
How do we work out yours?
You can easily work out the net profit ratio for your business:
Step 1: Work out how much money your business has made for the financial year 2013-14 – this is your business income (turnover).
Step 2: Work out all the expenses you can properly claim and subtract this amount from the turnover. This will give you your net profit.
Step 3: You then take your net profit and divide it (/) by your turnover and then multiply it by 100 – This is your net profit ratio.
What should you do now?
When you are completing your Self Assessment return, use the steps above to work out the net profit ratio for your business and then see if it falls within the range of businesses like yours.
If you have a tax agent (e.g. accountant) please let them have a copy of this letter as soon as possible.
What if you are outside the benchmark range?
Don’t worry as there can be good reasons why your business might fall outside the range, for example if you are using the simplified expenses scheme.
However, if the net profit for your business doesn’t look right, it could be a sign that some of the figures on your Self Assessment return aren’t correct. There are two common reasons for this and we’ve listed these below:
1. Numbers – For example, have you put all the right numbers in the right boxes?
2. Expenses – For example, have you claimed all the expenses you are entitled to? Have you included any expenses by mistake? (such as private use, capital spend, your own wages.)
If you have checked and you are happy your figures are correct then you should submit your return as normal by the deadline.
Help and advice
You can find further information and definitions to help you complete your Self Assessment return on our website:
We have also set out examples of business expenditure and what can and cannot be claimed as expenses.
Transparent Benchmarking team
Some people may remember Eric Morecambe, during a classic comedy sketch with Andre Previn on the Morecambe and Wise show, saying ‘I’m playing all the right notes, but not necessarily in the right order.’
This could be argued as being very similar, with HMRC saying ‘ You’ve got all the right numbers, but not necessarily in the right boxes.’
Author: Guy Smith, Senior Tax Consultant on the ReSource Tax and VAT Consultancy Team.