When HMRC opens an enquiry into you or your business, it doesn’t necessarily mean they think you’ve done anything wrong. HMRC regularly selects a percentage of tax returns at random to ensure that they are correct. Knowing what to expect can alleviate some of the initial panic, so what’s involved in an HMRC tax enquiry?
What triggers a HMRC tax investigation?
HMRC claims that compliance checks are triggered when figures submitted on a tax return appear to be wrong or ring alarm bells in some way. Here are some common triggers associated with HMRC tax investigations:
Regular mistakes on returns
A one-off mistake is sometimes unavoidable and HMRC will make certain allowances for genuine mistakes. However, if you continually make mistakes it will cause red flags with HMRC. Who will question whether these are genuine mistakes or whether things are not as they seem?
Some business owners are tempted to omit certain things from their tax returns such as interest paid to them from other businesses. However, the chances are slim that this will go undetected as other businesses will declare that the interest was paid. This can result in an investigation from HMRC.
You have a large fluctuation in income
It is highly unlikely that your business will have exactly the same levels of income each year, however – large fluctuations will cause HMRC to question why there is such a difference in profits. To avoid investigation, when you file your tax return put in as much information as possible to inform HMRC why these fluctuations occurred. If they are legitimate reasons such as prolonged illness or lack of available work you will have nothing to worry about.
You consistently file your returns late
Not only will this incur a penalty or fine but it will also raise concerns with HMRC as to why you are consistently filing your returns late.
Your figures are inconsistent with industry standards
HMRC has a rough idea of how much the average person working in different industries should earn. If your income is different to the industry’s average it is likely that HMRC will want to investigate to see why this is. To ensure you are not investigated for inconsistencies it is important to follow the correct business model for your level of income.
Years of unprofitability
If you claim each year that you do not owe any tax as you are yet to turn a profit then HMRC is going to question how this is possible and how you are still operating. If you want to avoid an investigation from HMRC, notify them why your business isn’t making a profit and how you are still able to operate.
Directors earn less than employees
A director who has the same salary as his employees or is earning even less is going to get noticed by HMRC for the wrong reasons. They would want to investigate whether you are pulling profits from the business and using a tax avoidance scheme instead of paying yourself legitimately and in accordance with how business wage structures work.
You do not use an accountant
Using an accredited accountant can prevent mistakes being made due to the lack of knowledge and experience in managing accounts and submitting tax returns. Especially if it is your first time submitting a tax return.
What types of investigations are there?
There are three different types of enquiry: full, aspect and random. A full enquiry is related to cases where HMRC believes there is a significant risk of error in a tax return. A review of all records will be undertaken as part of this enquiry and it can include business records and personal financial records of business owners or directors.
When HMRC are concerned about a particular element of your accounts and want more information they will conduct an aspect enquiry. Usually, this type of enquiry finds the error to be nothing more than a genuine mistake, however, it does sometimes highlight a deliberate attempt of someone to evade or avoid tax.
The final type of enquiry is completely random. A random group of businesses will be selected and checked to ensure tax returns are being filed correctly.
What happens when HMRC decides to investigate you?
Once HMRC decides to investigate your business you must provide them with all the information they request from you. If you have an accountant, allow them to liaise with HMRC on your behalf before doing anything as they will have experience in dealing with HMRC and the different types investigations. What you are required to submit depends on the level of enquiry. Usually, HMRC will request you submit business records for the year of the enquiry; an aspect enquiry will look into a part of a tax return and a full enquiry will require the entire tax return. Generally, HMRC will request the following:
- Payroll records
- Bank statements
- VAT records
- Job quotes or estimates
- Purchase invoices and expense receipts
- Cheques or paying in slips
- Computerised records (if applicable) – details of the software package and records
It is possible to appeal against an investigation if you believe the grounds on which you are being investigated are incorrect.
How long does a tax investigation take?
It depends on the severity of the investigation. However, the average length of a full investigation is around 16 months and 3-6 months in the case of an aspect investigation.
What are the possible outcomes of a tax investigation?
This depends on the outcome of the investigation but common outcomes include:
- A tax rebate if you have overpaid tax
- A formal request to pay back underpaid tax within 30 days and interest may be added
- Deliberate wrongdoing (such as underpaid or over claimed tax) will be escalated to a criminal case and may result in a penalty
How does a tax investigation end?
You will be issued a decision notice or a contract settlement and this will notify you of the outcome of the investigation and conclude it.
A decision notice will detail what the final findings are and will include a penalty notice or an assessment.
A contract settlement is a legally binding agreement between the taxpayer and HMRC and is when the taxpayer agrees to pay all the money owed back to HMRC.
Tips on surviving an HMRC investigation
An investigation by HMRC is not a pleasant experience and can be worrying and stressful for taxpayers. Remember that HMRC wants to increase its efficiency in enquiry work and will generally target taxpayers who represent the biggest risk of non-compliance.
Taxpayers who file their returns on time and pay their tax liabilities are at a lower risk of inspection. To further prevent an enquiry, make full use of the white space to explain any inconsistencies.
Finally, consider taking out ‘fee protection’ insurance which will ensure you against the costs of an investigation. Whilst it does not prevent an enquiry, it gives you the comfort of knowing if in the unlikely event it does happen, you will be able to enlist the help of an experienced and qualified professional.
Do you need more information?
Do you have any further questions about a tax enquiry? Seek the advice of a HMRC enquiry specialist who will be able to offer you professional and reliable advice in how to handle a HMRC enquiry.
Please keep checking the Bluebird Accountancy blog for more useful tips to help contractors and freelancers and to stay up to date on the industry legislation. Alternatively, you can visit our website for more information or contact us to find out more.