A recent decision of the High Court, coupled with a case I am presently involved in with IR, is a timely reminder of the need to keep proper accounting records.
The two cases only similarity is that ultimately, the failure to maintain appropriate records may be the downfall of those involved.
In the High Court case, IR’s chasing of $7m plus, including evasion shortfall penalty impositions, is certainly suggestive here that the taxpayer was up to no good, including post IR’s audit commencing, transferring assets out of the company to directors and others closely associated to the company.
IR, on the basis that the company never kept any ledgers, cash books or other such documents that would have allowed its financial position to be determined at any time, applied to the Court to have the company liquidated due to its breach of section 194 of the Companies Act 1993 – the requirement that accounting records must be kept by a company. In this regard, a court can appoint a liquidator in accordance with section 241(4)(b) of the Act, where a board or the company has persistently or seriously failed to comply with the Act.
The High Court agreed with IR’s submissions, and even though the disputes process surrounding the $7m plus assessments was still in play, ordered the appointment of a liquidator so that at least a full examination of the company’s transactions to date, could be undertaken by persons who had a full array of investigative tools provided to them under the Act.
I suspect unfortunately that a failure to maintain adequate records, may also lead to the downfall of a client I am presently acting for, purely in relation to their IR review. The client has a company with significant tax losses brought forward, and unable to utilise the grouping provisions due to the timing of the commencement of the profitable trading entities, the accountant has resorted to (and I’d have to say a relatively common technique used by us all) using management fees as the bread to soak up the gravy of historic losses.
When done properly, there would be a robust argument that a sole director/shareholder of a group of companies could legitimately sit under one company and have his time charged by this company to the other group members. However in this case, it was not hard to see when I first examined what records there were, that numerous dots and crosses were missing, and that the molehill had just become a mountain – why my colleague was perhaps in hindsight, overly eager to pass the file to me (the good old hospital pass).
In terms of records kept to justify the level of management fees charged, there are the financial statements of the payer (the provider entity has numerous outstanding tax returns) reflecting the level of fees paid, and then there is… well, nothing. There are no tax invoices issued by the provider entity documenting the charges, the basis for the calculation of the quantum of the management fees is not documented – in essence the fee basically corresponds to the profit level of the relevant entity, the management fees have been accrued as payables but the charging entity has no bank account (so there is a payment issue), the shareholder has filed his income tax return but with no reference to any salary being paid to him by the loss company (and he has overdrawn current accounts in all of the trading entities), and to cap everything off, the management company has not registered for GST even though the registration threshold has easily been breached (although the paying companies have not claimed the GST on the fees charged – which is still not a good argument as you will appreciate).
So, the battle has only just begun here. We’ve concluded our first three hour meeting with an IR lifer (she’s been with the Revenue since before I started my short stint back in 1987, so she’ll be in no hurry to find a quick resolution) and the client has an appetite to fight (he’s thinking at least two years and probably court, even post my gentle suggestions that he’s up poo creek without a paddle and economics should take precedent over emotions).
A timely reminder therefore, that should you wish to embark on a management fees strategy to assist your client with utilising historic company losses, at least take the time to dot all of your I’s and to cross all of the T’s, taking the proactive approach that you have no doubt that your client will eventually be reviewed by IR, with questions being asked which you should have robust responses for.
And by the way, do not overlook the personal services attribution rules, which is another issue my client may be facing I suspect even if we can get the lifer across the line with the management fees themselves – brought forward losses only able to offset current year personal services income, if the losses were originally incurred in the derivation of personal services income themselves. There was no suggestion by the lifer that she had the issue in mind presently (and she certainly wasn’t short of talking microscopically about anything and everything I can tell you) but watch this space…