HMRC tax investigations: when does HMRC investigate the self-employed?

An investigation by HMRC is rarely a welcome prospect for small business owners and sole traders. It can be a stressful process that takes up a lot of time – and it may lead to a higher tax bill.

Everyone hopes they won’t be the subject of an HMRC investigation, but it’s important to be prepared just in case. So whether you’re facing one or want to make sure you won't have to deal with one, our guide explains some key points to be aware of.

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When does HMRC investigate the self-employed?

There are several reasons why you might attract HMRC's attention and eventually be investigated. These include:

• it receives a tip off
• your returns show you haven't been making a profit for multiple years
• your returns regularly include mistakes
• there are large fluctuations in your reported figures, for example income or business expenses
• your figures look dramatically different to the normal position for a business in your industry
• you report that the company directors are earning less than employees
• they suspect you're not including all your income
• you don't have an accountant – it's been suggested that HMRC is less likely to investigate those who have an accountant prepare their returns

What are the different types of HMRC investigation?

Not all enquiries by HMRC are the same, and the type of investigation you may be subject to will depend on its suspicions or concerns. There are two main types of HMRC enquiry:

Full enquiry

These may take place when HMRC believes there's a high risk of errors on your returns. If you’re subject to a full enquiry, the tax authority will look through all of your business records – and, potentially, the personal records of any company directors.

Aspect enquiry

An aspect enquiry happens when HMRC is concerned about one or more specific elements of your finances. This type of enquiry is much more common in the case of genuine mistakes, as opposed to wilful tax evasion.

What can HMRC check?

If HMRC launches an investigation into you or your business, there's a range of records and documents it might check. They'll contact you or your accountant in advance to set out the evidence they want to see or information they're collecting. Generally this will include:

• information on the taxes you’ve paid (remember that this isn’t just limited to income tax or Corporation Tax)
• your books, and details of the tax calculations you’ve made
• annual returns, if the investigation is into a limited company
• your Self Assessment returns, if the investigation is into a sole trader. In addition, HMRC may wish to see Self Assessments for company directors, if the investigation is into a limited company
• PAYE records, where applicable

What happens during an HMRC visit?

HMRC needs to stick to strict procedures when visiting. You might want to ask for a copy of the rules in advance (or your accountant may be able to advise).

The tax inspector may ask to visit you at your business premises, home, or your accountant's office. Or, they may ask you to visit them. They can't legally force you to attend, but doing so willingly is generally seen as a sign of co-operation and may have an impact on the outcome of the investigation. You're entitled to have an advisor such as your accountant present.

HMRC must tell you what it wants to discuss in advance of a visit. You're also entitled to ask for the agenda in writing before the appointment, and the HMRC officials must stick to this agenda. It's important that you answer the questions to the best of your knowledge, and that you give complete and accurate information.

How far back can HMRC investigate your taxes?

In most cases, HMRC can investigate a taxpayer's returns for the past four years, to see if it’s owed any money by the taxpayer under investigation.

If your returns are full of obvious mistakes, HMRC can go back six years in its investigation. And if it looks like you've been deliberately trying to avoid paying tax, it can go back through 20 years’ worth of your tax returns.

What happens after an HMRC investigation?

Once the investigation finishes, HMRC will write to you to explain the outcome.

If HMRC finds something wrong on your returns but don't believe the errors were made fraudulently or negligently, they'll tell you how they think the return needs to be corrected. You have 30 days to make the correction. If you fail to do so within this time, HMRC can correct the return itself.

If HMRC believes that you’ve acted with negligence or fraudulently, you'll be made to pay penalties, extra tax, and interest. You'll normally be required to sign a contract pledging to do so, in exchange for HMRC waiving its right to prosecute. It's important to get legal advice if this happens to you.

Can I get tax investigation insurance?

Tax investigations are not only stressful – they can also be expensive. Aside from a potential extra tax bill plus penalties, investigations are time-consuming.

To protect against the cost of this lost time, you may be able to take out tax investigation insurance. Simply Business offers tax investigation cover as part of our business legal protection insurance.

This article is just a guide – you should always seek professional advice if you face a tax investigation.