What is an HMRC tax investigation?

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 experience 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.

When does HMRC investigate the self-employed?

There are several reasons why HMRC might investigate a business’s tax affairs. This could be because:

• it receives a tip off
• you make a mistake or fail to include something on your tax return
• there are large fluctuations in your reported figures, for example income or business expenses
• your figures look dramatically different to what’s normal for a business in your industry
• you report that the company directors are earning less than employees
• it suspects you’re not including all your income

What happens if HMRC investigates you?

A self-employed tax investigation can look into fraud and other criminal offences relating to:

• income tax
• capital gains tax
• Construction Industry Scheme
• corporation tax
• VAT

It’s also possible to be investigated when something looks suspicious to the tax body, but it can be explained or a genuine mistake. That’s why it’s important to keep accurate records of your tax returns, receipts, invoices, and bank statements in case you need to provide these as evidence.

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 are the different types of HMRC investigation?

Not all enquiries by HMRC are the same, and the type of investigation depends on its suspicions or concerns. There are three main types of tax investigation:

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.

Random check

Of course, sometimes there’s seemingly no reason to be selected for a HMRC check. Random checks can happen to your business whether or not HMRC notices errors in your tax return.

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 cooperation 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 likely are you to be investigated by HMRC?

As mentioned, HMRC investigating small businesses and sole traders can be triggered by a number of things.

For example, if you work in an industry or area HMRC considers high risk or perhaps if you take a lot of cash payments in your business.

How do I know if HMRC is investigating me?

The first indication that HMRC is investigating you is when they send you a letter in the post. This letter will inform you that an official investigation has begun and also let you know what aspect of your business is being investigated – whether this be your latest tax return or something wider.

How long does a HMRC investigation take?

The length of your HMRC tax investigation will depend on why your business is being investigated. A smaller investigation may be completed within three months, but a full tax investigation covering your whole business could take up to 18 months.

HMRC investigations into smaller businesses will often take less time to complete than those into larger businesses.

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 doesn’t believe the errors were made fraudulently or negligently, you’ll be told how to correct the return.

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 you’ve acted with negligence or fraudulently, you’ll be made to pay penalties, extra tax, and interest.

You’ll normally need 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.

How legal expenses insurance can help

If you have legal expenses insurance as part of your Simply Business policy, you have access to a number of useful services through DAS Businesslaw (you’ll just need your voucher code found in your policy documents to register).

DAS has a legal advice helpline, available whether you’re facing a serious legal issue or just want to check something with an adviser.

More small business tax guides

• What is IR35? A guide for the self-employed
• How to get a tax refund if you’re self-employed
• Being inside IR35 and outside IR35, what does it mean?
• What type of business insurance do I need?

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

Photograph: Tupungato/stock.adobe.com