The thought of HMRC investigating your small business is an anxiety-inducing one. Even the most diligent of business owner will have worried about this in the past, perhaps due to a small accounting mistake or loss of paperwork. And then of course, there are business owners who have every right to be fearful of an HMRC investigation being triggered.
But what exactly does trigger an HMRC investigation or audit, and how do HMRC decide who to investigate? Here’s a quick guide which could help you make sure you don’t end up with that dreaded knock on the door.
What triggers an HMRC investigation? An HMRC tax investigation can be triggered by unusual activity on a tax return, filing tax returns late, being reported by someone, inconsistencies in revenue year on year, your accounts not matching your industry’s typical numbers, or simply a random check.
To reduce the chances of your business triggering an HMRC audit, read the following notes which explain in more detail what items tend to lead to an investigation.
What triggers an HMRC audit / investigation?
HMRC have upped their spending on investigating larger businesses. This is due to the increasing rate of returns they’re getting from those investigations on the top 0.5% of companies whose tax contributions equal 40% of the overall take.
For the tax year 2016/2017, HMRC returned £77 for every £1 they spent on an investigation. The Diverted Profits Tax, brought in during 2015 specifically for companies like Google and Amazon, has also produced impressive returns when investigations into these companies have been carried out.
Based on this, we can assume HMRC will continue to trigger investigations into large businesses for the foreseeable future.
However, more recent data suggest HMRC are not as successful as they were in this period. The FT Advisor website reported that:
HM Revenue & Customs returned no money on almost half (47%) of its investigations concerning individual and small business compliance during the 2020-21 tax year, when the pandemic first hit.
This should not be a cause to be complacent though as HMRC have some incredible technology at their disposal which is only going to get better as small businesses might soon find out.
There are 5.7 million small businesses in the UK and HMRC employs a very high-tech way of finding sole traders and directors of small businesses to investigate – their “supercomputer”…
HMRC supercomputer
Designed to make connections too subtle and nuanced for the normal human brain, HMRC’s latest software program, “Connect”, ploughs through information compiled from various other databases, such as the Land Registry, Companies House, and the electoral roll.
Connect can access data from a vast range of apps and platforms, including Apple, Amazon, and Airbnb. HMRC can compare credit card data, property transactions, bank accounts, and your self-assessment forms.
The programme then hunts down anomalies in the data that point to suspected tax-evading.
James Abbott, owner and head of tax at contractor accountant Abbott Moore says:
There is now more chance than ever that HMRC will spot your mistakes and draw your attention to them. If you have been telling lies, you will almost certainly be found out, because HMRC will use software to identify inconsistencies.
How do HMRC decide who to investigate?
Even something as simple a photo on Facebook can set HMRC’s alarm bells ringing and triggers an audit and investigation.
For example, let’s say someone is paying minimal tax but is constantly posting pictures of flashy cars and expensive holidays, and bragging about how well their business is doing, it strongly suggests they may be under-declaring.
Famously, several individuals seen on Channel 4’s My Big Fat Gypsy Wedding were caught out after spending thousands of pounds of undeclared income on lavish weddings on the show. It’s safe to say, HMRC has eyes everywhere.
Connect draws data from:
- Bank accounts and financial institutions (including from 60 other countries and territories)
- DVLA
- Land Registry
- Visa and Mastercard transactions
- Council tax
- VAT
- Previous tax investigations
- Previous tax returns
- Earnings (from any employer)
- Child benefit payments
- Maintenance payments
- Ebay, Amazon, Gumtree, Etsy, Airbnb
It uses all that information to look for anomalies.
“We all leave a massive electronic footprint of where we are, when we are away, what we do and what we spend,” George Bull, RSM senior tax partner told the Telegraph. Richard Morley, accountant at BDO states that “This is the tipping of the scales…Five years ago those making minor tax errors would feel fairly safe. But HMRC now has more information and more access to information.”
Handy Hint: Did you know that it’s not a legal requirement to have an accountant? But those businesses who don’t, need to be confident they are compliant with tax laws.
How your tax return can trigger an HMRC investigation
Even with all this modern technology, the first place the taxman will look at is in your yearly tax return for discrepancies. There are some key signals that help HMRC decide who to investigate .
Even if you have nothing to hide, there are 7 common mistakes or features of your tax returns that will raise red flags for the assessors at HMRC. You might be perfectly innocent, but any of these could trigger and HMRC audit.
1. Frequent late submissions
Filing your tax returns late is never a good thing. In addition to potential fines, not having an explanation can become a serious cause of concern for Revenue and Customs. Sending returns in by the deadline lets them know you are cooperative and compliant with HMRC’s rules.
2. Mistakes
We all make mistakes now and then, but if they keep regularly popping up on your tax returns, it’s likely HMRC will want to know why. Tax returns can be extremely complicated, so it always pays to use a qualified accountant to make sure everything is filled in correctly.
3. Your financial figures do not match industry norms
If you appear to be drastically over- or under-performing for a business of your kind, it may cause HMRC to do a double take at your figures and consider an audit. They’ll be comparing you to their industry averages so be aware that you may be investigated further.
4. No profit
New businesses can take a while to get off the ground, and even longstanding companies can hit hard times. But when a business has running for years but hasn’t yet turned a profit, HMRC will begin to question how you have kept it running all that time.
5. Not declaring all your income
It may sound obvious, but you must disclose every source of income you may have on your tax returns.
If you have rental properties, have recently sold any assets, or received returns on an investment, these must be included. This is something that the Connect database is likely to pull up to trigger an investigation, so it’s important that you leave nothing out.
6. Fluctuations in your profits
Many business owners have experienced the financial ebbs and flows of running a company, but drastic changes will stand out to HMRC’s assessors. If your income suddenly drops and your expenditure rises, your tax liability will reduce which will look suspicious from HMRC’s perspective.
Make sure you include details and explanations of these changes when you file your tax return.
7. Unjustified expense claims
Legitimate business expenses are easily proven. Make sure you keep accurate records and file your receipts for your tax returns, so HMRC has no reason to doubt your claims.
Any discrepancies in your tax return will almost certainly be picked out and make you a potential target for an investigation.
HMRC is known to look favourably on those who use an accountant as it is a lot less likely that they are hiding something.
What are the chances of being investigated by HMRC?
An estimated 7% of all HMRC investigations are random. This means that every business owner has a small chance of being investigated by HMRC, even if nothing has been done wrong to warrant an investigation.
Making sure you have an expert dealing with your accounting and tax responsibilities is the best way you can make sure your tax returns are accurate and to help you prepare if an investigation is triggered.
How do I know if HMRC are investigating me?
You won’t know if HMRC are investigating you until a brown envelope comes through the door telling you that they are doing so. The letter will ask for more information, possibly in a relatively passive manner asking questions about your latest tax return.
How long does an HMRC investigation take?
Most HMRC investigations will be conducted within 12 months. However, this might not be the case depending on how serious and complex the case is, and how compliant the business being investigated is.
Do HMRC always prosecute?
No, HMRC does not always prosecute. Their primary aim is to recover lost revenue for the government, so those found guilty after a tax investigation will be ordered to pay back and the money with penalties on top.
You might even end up on the public list of tax defaulters. Yes, that’s right… HMRC aren’t afraid to name and shame those who deliberately avoid paying taxes.
Prosecution is the last stage and reserved for more serious cases. Most prosecution cases involve investigations where undeclared income was more than £50,000.
The latest numbers show that nearly 20,000 businesses were hit with penalties in 2019. The Accountancy Daily website say:
HMRC imposed 19,657 of its hardest penalties on taxpayers last year for committing what it describes as ‘deliberate’ errors in their tax returns, says UHY Hacker Young, with penalties set to increase as investigations restart.
How far back will an HMRC investigation go?
An HMRC investigation can go back as far as 20 years. For example, if your business has deliberately committed tax fraud on capital gains, corporation tax, income tax, and PAYE, they will look back 20 years.
For lesser investigations involving careless behaviour, for example failure to correctly complete a self-assessment, they might go back 4 to 6 years.
The penalties you can receive after an HMRC investigation
HMRC are less willing to believe taxpayers when they claim an honest mistake on their returns. More and more tax investigations are resulting in an accusation of taxpayers making “deliberate errors” – either intentionally making a mistake or not reporting a mistake that they know of from a previous tax return.
If a taxpayer is found guilty by HMRC of making an error, HMRC will increase the level of fines imposed on them and monitor them “more closely” in the following years in the hope/expectation that they’ll be able to levy further fines later on.
In 2014/2015, just over 20,000 taxpayers were accused of making deliberate errors. In 2016/2017, this had increased to just over 34,000, a 70% increase.
Conclusion
“You better watch out, you better not cry, better not pout, I’m telling you why – the taxman’s going to take you to town”.
Apologies – after years in accountancy, I’ve always wanted to use that line, but I never found an appropriate outlet! On a much more serious note, there has been a gathering accumulation of power by HMRC over the last few years meaning more investigations than ever have been triggered.
They have always been a determined bunch when collecting taxes but now, to plug what they call “the tax gap”, they’re coming after people and companies more than ever before. The tax gap was last estimated at £34bn – it’s the difference between what HMRC expect to collect and what they collect.
They’re looking for underreporting in personal income, company income, landfill tax, PAYE, insurance premium tax, and VAT.
It’s so important to keep good records and work with a qualified and professional accountant.
Whilst that won’t protect you from a random HMRC investigation triggering, it can reduce your chances of being found guilty of errors and having penalties applied.
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Jon has been in business since 1999, and in that time worked with more than 300 small business clients. As well as being an accountant, he is also an early adopter of tech, and has helped small businesses to leverage the power of their computer systems by creating software to automate and simplify accounting tasks.
