UK Tax Investigations: Everything You Need to Know
Author: Russell SmithJanuary 17, 2020
The idea of UK tax investigations is likely to fill even the most cautious and financially responsible business owner with a sense of dread. The fact that HMRC could end up combing through all your facts and figures leaves you questioning every tax return you’ve ever filed, every invoice you’ve ever recorded and every expense you’ve ever claimed.
The reality is, UK tax investigations are rarely an experience that should cause concern. Fear often comes from a misunderstanding of a situation. Today we look at everything you need to know about tax investigations, so you can be ready for what’s to come and make sure they have as little impact on your personal and professional life as possible.
What Is a Tax Investigation?
In very basic terms, a tax investigation is a financial audit conducted by HMRC — Her Majesty’s Revenue and Customs — a publicly-owned department of the British government.
A tax investigation is precisely that, an investigation into your tax payments. If HMRC selects you for a tax investigation, they will contact you by telephone or email. Through this contact, HMRC will tell you exactly what kind of information they want to look at. It is at this point they will request specific documents and business records from you.
HMRC has the legal right as a governing authority of the United Kingdom to audit your finances, which means you must comply with their requests. They may ask to see any number of things, including VAT information, PAYE payment evidence, details of your income tax, etc.
What Happens During an HMRC Investigation?
The detail HMRC will go into, and the amount of information they request varies depending on the type of tax investigation you face. There are three different tax investigation processes that HMRC follow:
- Full Enquiry — If they select you for a full enquiry, HMRC will be investigating all aspects of your tax and tax history.
- Aspect Enquiry — During an aspect enquiry, HMRC will look at one specific aspect of your tax. For example, they may take a closer look at income tax.
- Random Enquiry — Exactly what it sounds like; HMRC will do a range of randomised checks.
Once they have all the information they need to start their tax investigation, HMRC will begin to probe. Throughout the audit, they will be checking your accounts in line with other aspects of spending, as well as asking you questions about your finances — sometimes in person, other times via electronic communication. HMRC are searching for holes in the sources they have, making sure numbers haven’t been missed and everything is as it should be.
It’s quite a complicated process for HMRC, but for business owners being audited, the biggest problems come from the stress factors involved and the time it takes to comply with all the requests HMRC makes. Outside of this, for you, a tax investigation is quite simple. All you have to do is provide HMRC with the data they request and answer any questions they have.
You won’t need any additional accounting knowledge or financial training.
How Long Does a Tax Investigation Take?
There is no set answer for how long a tax investigation can take. The length of the inquiry depends on the severity of any problems found, how well you keep records and the size of the business. It also depends on whether it is a full enquiry or a quick look into your documents.
For small businesses with no history of financial wrongdoing and good accounting and business records, a tax investigation can last as little as three months. If there is evidence of problems like tax fraud, or you have a large company that has existed for many years, a tax investigation can end up being a very time-consuming process that lasts anywhere up to two years.
How Can I Prepare for a Tax Investigation?
If you are guilty of tax evasion, you can prepare by getting yourself legal counsel and owning up to any acts of wrongdoing now, because HMRC audits are thorough and conducted by professionals. They will uncover illegal activity.
For the greater majority, though, this is not going to be the case. Law-abiding citizens needn’t secure themselves legal advice or prepare themselves for a storm of accusations. However, that doesn’t mean you cannot and should not prepare.
Good preparation for a tax investigation is helpful for a number of reasons. First, it can ease personal anxiety and help stop stress from building up around your tax investigation. Preparation can also make tax investigations a lot easier, run a lot smoother, and end a lot faster. If you can give HMRC what they need to do their job, they can do it more efficiently.
Here are our top tips for tax investigation preparation:
- Always Be Prepared
It’s better to be proactive than reactive to tax investigations. If you are always ready to face a tax audit, then you’re in a strong position. This means proper tax planning, understanding your tax liability and making sure your bookkeeping is accurate and up-to-date.
- Locate Your Evidence
Once you are notified of an impending tax investigation, start collecting all your financial documents so HMRC can easily access them. This includes copies of invoices, receipts, transaction records, financial reports and any other accountancy data you have.
- Seek Representation from an Expert
Getting help is not an admission of wrongdoing — however, it can be helpful. Tax investigations can be difficult and time-consuming. If you aren’t confident in your ability to manage HMRC yourself, support from an expert, such as an online accountant, can make all the difference. At RS Accountancy, we’ve handled countless HMRC tax investigations. We can liaise with HMRC on your behalf, help you get together the information required and guide you through the process.
- Audit Your Accounts
Conduct an internal audit of your accounts by looking through your historical data or have an accountant do it for you. Many services, such as RS Accountancy, offer a personal tax investigation service. The purpose of a self-audit before a tax investigation is to go through compliance checks and identify any possible problems before HMRC spots them. If your audit shows any discrepancies, you can report them to HMRC early to display transparency and ensure you are not held accountable for innocent mistakes, and so can dispute any accusations of dishonest taxes.
What Happens If I Don’t Have the Information HMRC Needs for the Tax Investigation?
In the digital age, it’s difficult to lose access to all evidence and documents HMRC might need. With everything being transmitted and stored online, you shouldn’t have to worry about not being able to provide information required for the service.
But let’s say, for argument’s sake, you don’t have a piece of evidence. In this example, HMRC could be looking into your expenses and find you claimed for a computer two years ago, for which you paid cash and no longer have the receipt. What do you do if you experience this?
In these situations, you must not panic. Instead, you will need to explain the situation to HMRC and find a realistic solution. You may not have evidence of the spend, but you may have proof in the form of the product you purchased. Auditors will work with you to secure a fair and reasonable outcome.
To avoid problems with not having the right information, we suggest that:
- With immediate effect, you make sure you are keeping digital records of all business transactions, so the evidence is not only available but easy to trace and share.
- Contact an accountancy expert to discuss your unique concerns and get their support in finding a satisfactory resolution.
How Far Back Do Tax Investigations Go?
HMRC tax investigations have the authority to investigate tax to whatever extent they wish based on any evidence they might find. In practice, there is a general set of rules that HMRC will usually follow when it comes to looking into historical data.
- If HMRC finds no issues within the last year’s tax return, they will often close the investigation, unless they have further evidence to suspect problems in more historical tax returns.
- If they find an error in your most recent tax return, they will usually extend the investigation to the previous four year’s returns. This will happen if the error was made by mistake without negligence.
- If you’ve made an error due to negligence — which would include failing to record expenses properly or not keeping evidence of income — then HMRC will usually look into the last six years of your returns.
- If at any point HMRC discovers you’ve been dishonest or fraudulent with your tax returns, and that you have intentionally broken the law, they will conduct a full tax investigation dating back up to 20 years.
So what does this mean for most small business owners? It means that providing you’ve attempted to honestly and accurately file self-assessment tax, you shouldn’t see tax investigations go back more than four years. Even if you’ve been a bit careless, you’ll likely have to manage up to six years worth of investigatory material.
What Happens If They Find Something Wrong during the Tax Investigation?
HMRC tax investigations are designed to ensure you and the government are contributing to the tax system correctly. They are not intended as a trap or a sting operation to try and catch businesses out and fine them excessive penalties for false accusations of fraud. In some cases, they can be good for your business. HMRC may find you’ve overpaid tax and you can receive a rebate.
If through a tax investigation, HMRC finds you have underpaid on tax through mistakes and/or negligence, you will be subject to pay HM Revenue & Customs the full amount of unpaid tax to get your tax affairs in order. That’s it. You will face no more ramifications or legal penalties. HMRC are not targeting businesses in the United Kingdom to punish them; they simply want to ensure that sole trader enterprises and limited company organisations alike are paying the right amount of tax.
This intention changes if you are found to be guilty of tax avoidance and deliberate illegal activity. In this circumstance, if you’ve committed a crime, your tax investigation will result in criminal action against you, which can vary from fines to court hearings and even jail time depending on the severity.
Legal action is not something a self-employed individual with a clear conscious has to worry about when it comes to tax investigations. Mistakes are very different from deliberate tax avoidance and any HMRC enquiry that finds faults will be willing to look at the evidence and consider your case.
Why Would HMRC Investigate My Tax Returns & How Can a UK Tax Investigation Be Avoided?
The assumption is you’ve been selected for a tax investigation because you’ve done something wrong, but that is usually not the case. Often the selection process is completely random and is actually designed to be that way to ensure HMRC is always performing tax investigations on a range of businesses, so they have an accurate overview of the financial landscape and accountancy practices of British business.
However, there are a few triggers that might alert HMRC to fraud in your tax affairs and result in them choosing you for a tax investigation. These include:
- High-Risk Tip-Offs
Perhaps the biggest trigger of targeted tax investigations is tip-offs. If somebody reputable informs HMRC your business may be conducting suspicious activity, they’ll likely investigate.
- Fluctuating Numbers
Big drops in your tax bill might indicate to HMRC that you’ve found a way of getting around payments and have started avoiding your obligations. If you used to pay a lot of tax but now pay a significant amount less, be prepared for HMRC to contact you. This is especially true if your profit margins haven’t changed.
- Years of Unprofitability
Some tax avoidance tricks aim to offset potential tax bills by claiming not to earn enough to pay tax. If your business is consistently unprofitable but continues to operate, HMRC will question how you can keep going without making money and may launch a tax investigation.
- Omission of Income
There is a temptation to miss off a payment here, a bit of cash there. The problem is, HMRC isn’t just managing your taxes, the organisation is managing tax for the entire country. That means if they audit another business you work with, and find they recorded payments to your company that you’ve failed to mention, they’ll immediately become suspicious. Full disclosure of income is always advised.
- You Don’t Have an Accountant
Professional accountants telling you that you need an accounting service to stay safe from a tax investigation? Sounds dodgy, we know. Even if you decide not to work with RS Accountancy, we still stand by this advice. Having a reputable accountant managing your finances means you are unlikely to make mistakes, be negligent or break the rules. That means HMRC are less likely to waste time investigating accounts that — in their eyes — are more than likely going to be spotless.
If you’d like to learn more about how HMRC catches people out for tax avoidance when conducting a tax investigation, watch this video from The Financial Times:
If you are concerned about the state of your tax history, or are facing a tax investigation by HMRC, get in touch with RS Accountancy today. Through our free consultation service, we can discuss your anxieties about tax investigations and find the best possible solution to set you on the path to success.
Russell Smith is an award-winning accountant and founder of RS Accountancy. With over a decade of experience running his company, he has worked with countless small businesses just like yours, helping them grow profits and manage their finances. Russell is also a prolific financial writer, having contributed to such publications as The Guardian, The Telegraph and The Daily Mail.