A tax investigation is a stressful time for a small business owner and adds to the list of challenges you face.
If you’re chosen for a tax check, you may have to spend hours gathering documents to fulfil HMRC’s request. But this will depend on how well prepared you are.
Some types of investigation happen more than others. Income tax and corporation tax aren’t checked very often. But if you’re chosen, being prepared and cooperating can help you secure a more favourable outcome.
Here’s our guide to dealing with a tax investigation, starting with what an investigation actually is.
Table of Contents
What Is an HMRC Tax Investigation?
To make sure you’re paying the right amount of tax and complying with tax law, HMRC is entitled to check your records at any time. You’ll receive an official HMRC tax investigation letter if your business is selected for investigation. Or they’ll give you a phone call, telling you what they want to investigate. This could include:
- Any tax you pay
- Your accounts and tax calculations
- Your self-assessment tax return
- Your company tax return
- PAYE records and returns, if you employ people
- VAT returns and records, if you’re registered for VAT
If you have an accountant, HMRC may contact them instead of you. But they will be able to tell you that you’re being investigated soon after.
Types of Investigation
HMRC can carry out 3 types of tax investigation:
1. Full Enquiry
HMRC will review all of your business records during a full enquiry, usually because they suspect there’s a significant risk of an error somewhere in your tax. If you’re the director of a limited company, they may look particularly closely into your tax records, as well as the records of the company itself.
2. Aspect Enquiry
This is when, as the name may imply, HMRC wants to take a look at a specific aspect of your accounts. This may include inconsistencies in part of one of your recent tax returns.
3. Random Check
A random check can happen at random, just as the name suggests. It doesn’t matter what state your accounts are in or if you’ve done anything to trigger an investigation. Random checks could happen at any time, for any reason.
What Taxes Can HMRC Investigate?
Some people think an HMRC tax investigation only applies to income tax. But this isn’t true. HMRC may wish to take a closer look at a variety of your tax affairs, including:
- Corporation tax
- Capital gains tax
- The Construction Industry Scheme
So, if your business has records for several kinds of tax, it’s worth taking a look around for an accounting software package to help keep your books in order, all year round. An accountant can support you with these tasks, too.
How Common Are Investigations?
Tax investigations are more common for certain kinds of taxes than others. If your business is VAT-registered, or you hire and pay employees through PAYE, you should be prepared for routine tax checks. HMRC will want to look closely at any areas where it’s common for mistakes to be made.
For income tax and corporation tax, routine check-ups happen a lot less frequently. HMRC’s focus here will be on anywhere they believe you’re making errors in your tax returns or suspect you’re trying to hide income on purpose.
Generally speaking, you can expect a tax investigation to happen around every 5 years. But the likelihood of tax investigations will increase if HMRC suspects any tax is being underpaid.
You may want to think about getting insurance to help you cover the cost of a tax investigation, or joining a professional body that offers support as one of their membership benefits.
What Triggers an Investigation?
Any unusual activity in your records or accounts may make HMRC wish to investigate your tax affairs. Their Central Risk team triggers most checks, using complex data mining tools to spot odd behaviour in accounts or unusual actions in certain industries.
The most common trigger is submitting a tax return with incorrect figures, so it’s always worth asking an accountant or financial adviser to review your accounts and look over your returns before you send these in.
But other triggers can include:
- Working in an industry that’s considered high-risk—something that involves many cash in hand transactions, for example
- Somebody informing HMRC about unusual activity in your accounts
- Inconsistencies in your tax return, such as big falls or rises in income from one year to the next
- Regularly submitting your tax return late
- Accounts that don’t match the figures that are common for your industry
As we’ve mentioned previously, it’s possible to be selected for a tax investigation at random. And in this case, it doesn’t matter if your books are in order or not.
How Will I Know I’m Being Investigated?
HMRC will contact you if they decide to carry out a tax investigation. This process will begin with you receiving a letter from them, asking for certain information. They will also want to check your tax records.
The letter will tell you if they’re looking into a particular aspect of your tax return or completing a full tax investigation. Your accountant may also be able to let you know why the investigation is happening.
Any tax investigation usually starts within 12 months of the due date for the tax return it’s investigating, or 12 months after you filed the return but missed the deadline.
What Happens During an Investigation?
HMRC may ask to visit your home, business premises, or the offices of your adviser. Alternatively, they may ask you to visit them. In this case, you’re allowed to have your accountant or a legal adviser visit with you.
If you don’t respond to their tax investigation notice, you may have to pay HMRC a penalty. However, you can avoid this penalty if you have a reasonable excuse, such as:
- Serious illness
You must write to the officer that sent you the notice if you think HMRC should stop the tax investigation, and explain your reasons for why this is.
You can also apply for alternative dispute resolution (ADR) if you don’t agree with the reasons for the check, or what they’re checking.
After the check, HMRC will inform you of the results.
- Repaid if you’ve paid too much tax, and you may be entitled to interest on the amount owed
- Asked to pay any extra tax if you owe more, and you’ll usually have to pay interest from its due date
You may also be charged a penalty. HMRC will review:
- Why you underpaid or overclaimed the tax
- If you informed them as soon as possible
- How helpful you were during the investigation
Tell the officer if you’re going to have issues paying, and appeal a tax decision if you don’t agree with it.
How Far Back Can I Be Investigated?
Depending on the severity of the tax investigation, how far back HMRC can check your records ranges from 4–20 years. Here’s an overview:
Normal behaviour, such as during a random check
- Capital gains tax: 4 years
- Corporation tax: 4 years
- Income tax: 4 years
- PAYE: 4 years
- VAT: 4 years
Careless behaviour, such as failing to self-assess correctly
- Capital gains tax: 6 years
- Corporation tax: 6 years
- Income tax: 6 years
- PAYE: 6 years
- VAT: 4 years
Deliberate bad behaviour, such as tax fraud
- Capital gains tax: 20 years
- Corporation tax: 20 years
- Income tax: 20 years
- PAYE: 20 years
- VAT: 20 years
Advice for Being Investigated
1. Keep Your Books Up-To-Date
Not only do HMRC require up-to-date books, but you always need a clear picture of your business financial records. Having accurate records helps with this.
You can spot important information quickly—like if you’re missing a payment on an invoice—and respond to any questions from HMRC without scrambling through paperwork or your tax payment history.
2. Make Sure Your Bank Balance and Account Software Balance Match
Connect your business bank account to your accounting software if your software enables this feature. You won’t have to enter any data yourself, and you may be able to select a reason for each transaction—such as travel or learning.
3. Keep Copies of Your Invoices
Keep records of all the invoices you’ve sent, which have been paid and which are overdue. This makes it much easier to keep track of who owes you what and contact any customers who are late paying you.
4. Keep Copies of Your Receipts
Keep track of all the business purchases you make. This means hanging on to all the receipts that come with these. HMRC accepts scanned receipts in most cases. If you have accounting software or a business bank account, this may allow you to upload photos of your receipts too.
5. Avoid Errors That May Trigger an Investigation
Make sure your records are as error-free as possible. If you think you’ve got something wrong, ask your accountant for support.
6. File Your Self-Assessment and VAT Returns On-Time
HMRC is more likely to want to review your affairs if you regularly file your tax returns later. So remember to submit your returns on time, every time.
Be Prepared for a Tax Investigation
Tax investigations are never fun. But whether you seek help or decide to face your audit by yourself, make sure you stay on good terms with HMRC. Be prepared to share any records that they ask for, and this will help the investigation proceed smoothly, with no stress coming to either of you.