When you run a small business, paying taxes is part of the deal. From Income Tax to Corporation Tax to VAT, there’s a lot to keep on top of. And, whether you’re working on side hustle ideas from home or running a retail premises on the high street, there’s always a chance that HMRC will investigate your tax affairs.
While the prospect of a tax investigation can undoubtedly be alarming, keeping your finances in order will help make sure things go as smoothly as possible. In this guide, we’ll walk you through what you need to know, including what triggers a tax investigation, how it will typically unfold, and the possible outcomes for your business.
We’ll also include tips for dealing with tax investigations more effectively, from being properly prepared for the possibility to getting through an investigation unscathed.
In the 12 months leading up to 31 March 2023, HMRCopened 1,091 serious tax investigations and received 12,332 appeals. 14% of appeals related to late payment or late filing penalties and surcharges.
Tax investigation types
HMRC can initiate different types of tax investigations, each with a different focus and level of scrutiny.
Full enquiries
These are thorough investigations where HMRC reviews a business’s financial records in their entirety. For limited companies, they might also look at the records of company directors. These investigations take up to 16 months on average, but more complex cases might take longer.
Aspect enquiries
Usually lasting between three and six months, these focus on specific areas of your tax return or financial records. For example, HMRC might look into:
Your company accounts and tax calculations.
Your Self Assessment tax return.
Your company tax return.
If you have a team, your PAYE records and returns.
Random compliance checks
In addition to targeted enquiries, HMRC also conducts random checks to ensure compliance. Your business may be selected for a routine audit even if your records are in order and you always file your tax returns on time. These checks are often resolved within a few months, provided there are no significant issues.
What triggers a tax investigation?
There are several reasons HMRC might want to check out your small business finances. Here are some of the most common.
Simple mistakes
You might have missed a box, skipped a section, overpaid or underpaid, or left out necessary information on your tax return. It could even be as trivial as a typo, like entering £240 instead of £420.
Targeted sectors
HMRC sometimes focuses on specific sectors where tax shortfalls are more likely. If your business falls into one of these areas or if you have multiple income sources, you might get extra attention.
Risk
Certain activities, like cash trades or significant capital movements between your personal and business accounts, can trigger a tax investigation.
Third-party information
HMRC might receive information from third parties, such as customers or suppliers, that prompts them to take a closer look at your finances.
Industry benchmarks
If your business performance is significantly different from industry standards, HMRC might investigate to understand the reasons behind the variance.
Large income fluctuations
Significant changes in income can trigger tax investigations. For example, if you’re in the hospitality industry running a small hotel and your income spikes one year due to several large events, then drops the next year because of renovations, HMRC might take notice.
Suspicion
HMRC will investigate if they suspect tax fraud or criminal activity. Remember, even innocent actions, like elevated small business expenses compared to income or filing consistently late returns, can look suspicious until explained.
When can tax investigations start?
HMRC generally has specific time limits to start tax investigations. Typically, their enquiry needs to be launched within 12 months of the date you filed the return under review. This means if you submitted your return on or before the deadline, HMRC has up to a year from that date to get the ball rolling.
How far back can HMRC investigate?
There are limits on how far back HMRC can look into your accounts. These depend on the circumstances.
Genuine errors
HMRC can look back four years if an honest mistake is suspected.
Carelessness
If carelessness seems to be the underlying reason for the investigation, an enquiry can go back six years.
Offshore matters
Offshore matters extend the review period to 12 years.
Deliberate tax evasion
Suspected tax fraud or deliberate evasion can lead to an investigation spanning 20 years.
These time limits are counted backward from the end of the relevant tax period. HMRC may extend the scope if they uncover more serious issues during their review.
HMRC has different record keeping requirements based on your business type. Sole traders and partnerships should keep records for five years after the self-assessment deadline, while companies need to retain them for six years from the end of their accounting period. If you file returns late, you might need to keep records for longer.
How does a tax investigation work?
There are usually 5 stages of tax investigations. Let’s go through these in turn.
1. Opening investigation
HMRC starts with an internal review of your finances. If they decide to go further, they’ll open an investigation.
2. Notification
You’ll get a tax investigation letter from HMRC. This will outline what they want to do, whether it’s to review a part of your tax return or conduct a full audit. There’s a possibility HMRC will phone rather than send a physical letter.
3. Document submission
HMRC will request records like account statements, sales invoices, VAT records, and emails. If you use digital records, they might need access to your software.
4. Interview
HMRC might request a meeting, but you can often provide information in other ways. For serious cases, they might conduct an interview under caution or make arrests if necessary.
5. Conclusion and consequences
The investigation concludes with a letter telling you the results of the investigation. Outcomes for your business can include:
A tax refund with interest.
A bill for additional tax with interest, payable within 30 days.
Penalties for deliberate wrongdoing (up to 200% of the tax due).
If you disagree with a tax decision, you have 30 days to appeal.
Tips for handling tax investigations
Dealing with a tax investigation can feel overwhelming, but being prepared and knowing how to navigate the process can make a big difference. Here are some tips for getting through it as seamlessly as possible.
Be prepared for a tax investigation
Good planning can save you a lot of stress down the line. Let’s look at some steps to get your business ready just in case HMRC comes knocking.
Keep business and personal finances separate
Mixing business and personal finances can lead to confusion and awkward questions being raised during a tax investigation. If you’re thinking about how to start a business, one of the first steps is to open separate accounts and keep clear records.
As well as ensuring tax investigators will know what’s what during any enquiry, keeping business finances separate also lowers your risk of making honest mistakes when managing your tax affairs.
Make bookkeeping a regular habit
Regular bookkeeping for small businesses is important, as is keeping financial records like invoices and receipts well organised. If you have the resources, it may be a good idea to hire employees with skills in this area. This can free up your time for other tasks, like working on business growth strategies or customer loyalty schemes.
Choose the right software
Picking software that fits your business needs can optimise your operations. Using software to keep VAT records and file VAT returns is obligatory, but the right accounting tools can also help with other areas like invoicing, expense tracking, and how to do a payroll.
Expect the unexpected
While it’s impossible to predict every scenario, conducting a SWOT analysis for small business can identify potential risks and areas for improvement. This can help you address tax issues before they escalate. Regularly updating your cash flow forecast also makes it easier to anticipate and manage potential tax problems.
Stay informed and educated
Keep yourself updated on tax laws and regulations. Understanding the legal requirements for starting a small business and the ongoing obligations can prevent mistakes. Consider joining small business networking groups to stay informed about best practices and new developments.
Get an accountant or tax adviser
Getting professional advice on how to run a business and navigate tax laws is smart. A tax advisor or accountant can offer valuable insights and small business tax tips. They can help with tax investigation insurance options and provide other assistance, such as preparing annual accounts and helping with setting up a limited company.
File returns on time
HMRC is more likely to select your business for an investigation if you submit tax returns late. Whether it’s a quarterly VAT return or your annual Self Assessment return, meeting the deadlines might help you avoid the disruption of a tax investigation.
Leverage technology
Smart technology can help keep business finances accurate. For example, SumUp’s point of sale systems and self-service kiosks automatically add VAT at the correct rate, cutting down on manual errors. Using these technologies makes transactions smoother and helps you stay compliant with tax regulations.
Navigating a tax investigation
If you’re already in the middle of a tax investigation or received a notification that one is about to start, don’t panic. Here’s how to navigate the process smoothly.
1. Be transparent and cooperative
If HMRC contacts you, respond promptly and provide the requested information. Make sure to meet all deadlines and be as transparent as possible.
Transparency and cooperation can go a long way in resolving any issues quickly and efficiently, and are looked on favourably when deciding any consequences.
2. Keep documents organised
Keep all documents related to the investigation in one place. This includes any correspondence with HMRC and details of any information you’ve submitted. Having easy access to accurate documentation can speed up the investigation process and help you get back to running your business quicker.
3. Seek expert help
If you don’t already have professional accountancy services for your business, now is the time to get them. During an investigation, expert tax investigation help is vital. Specialists will guide you through the process, help you understand what to expect, and can even deal with HMRC on your behalf.
4. Deal with the consequences promptly
After the investigation, address any outcomes quickly. If you owe penalties or back taxes, pay them within the given deadlines or agree a time to pay arrangement that fits your cash flow and small business budget. If you want to appeal a decision, you should do so within 30 days.
On the flip side, if you receive a tax refund, you could use this unexpected income to invest in new equipment, like card machines for your shop. Or you could consider new business opportunities, such as expanding your operations or exploring how to start an online business.
Disclaimer: The contents of this page are intended for informational purposes only and should not be construed as professional advice. For matters requiring legal or financial expertise, it’s recommended to seek guidance from qualified professionals.
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