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Few things can rattle a business owner or individual more than the prospect of a tax investigation by His Majesty's Revenue and Customs (HMRC). The very thought of being under the spotlight can cause stress, worry, and sleepless nights, even when you have adhered to the rules and regulations.
At Auditox Accountancy, we are specialists in this field, and we can help you better understand the intricacies of an HMRC tax investigation, the likelihood of facing one, the triggers for investigations, and how best to navigate through them.
We offer professional advice for small business owners, self-employed persons, sole traders, and people in traditional employment.
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For the vast majority of taxpayers, HMRC investigations remain a distant possibility. The department has vast numbers of tax returns to process and review annually, and a comprehensive audit of each is impractical. Therefore, most tax investigations are instigated due to discrepancies, anomalies, or perceived risks.
Explore: 5 Stages Of Tax Investigation
However, it's worth noting that HMRC conducts random checks as well, so maintaining accurate records over the past few years is essential for sole traders, the self-employed, and traditional businesses. When HMRC contacts you, it is helpful to have as much information as you can provide, beyond your self-assessment tax return.
Before the advent of self-assessment, it was believed that 1 in 100 tax returns were studied closely. But nowadays, there is a belief that around 1 in 10 tax returns are analysed closely. This figure might be even higher with HMRC utilising new resources and improved methods of reviewing submissions and records. As of 2023, the HMRC Connect system is said to hold more than 55 billion items of taxpayers’ data.
It is also stated online that over 300,000 investigations are undertaken each year into Self-Assessment tax returns.
Check out: How Far Back Can HMRC Go
Virtually anyone who deals with financial transactions, earnings, or tax responsibilities in the UK can be the subject of an HMRC investigation. Here's a breakdown of the groups that might see a tax inspector undertake an HMRC investigation:
Individuals: Anyone submitting an income tax return can face an investigation. This includes employees, especially those with additional sources of wages or significant changes in their financial circumstances.
Self-Employed Professionals, Including Sole Trader: Freelancers, contractors, or sole traders can be investigated, particularly if there are changes in their declared tax earnings or self-assessment tax return patterns that deviate from industry norms.
Business Owners: This encompasses all forms of enterprises - from small businesses to large corporations. Any business liable for Corporation Tax, VAT, and other business-related taxes can be investigated.
Landlords: Property owners who earn rental income, either from residential or commercial properties, are under the purview of HMRC. They can be investigated regarding their rental earnings, property sales, or any other earnings.
Trustees: Those in charge of trusts have the responsibility of ensuring proper tax compliance for the trust's financial activities. They can be subject to investigations regarding the management and disbursements from the trust.
Partnerships: Whether it's a traditional partnership or a limited liability partnership, any entity that submits partnership returns can be examined closely.
Executors Of Estates: Those responsible for managing and settling an estate after someone's death can face an investigation, especially concerning Inheritance Tax and the valuation of assets.
Charities And Non-Profit Organisations: Even though these entities might have tax-exempt status or different tax obligations, they can still be investigated to ensure compliance with their specific tax rules.
Importers And Exporters: Businesses or individuals involved in importing or exporting goods might be investigated for customs and excise duties.
High Net Worth Individuals: HMRC has a unit dedicated to the tax affairs of ultra-high net-worth individuals. Their complex financial arrangements often come under scrutiny.
People With Offshore Interests: If you have bank accounts, investments, or assets outside the UK, you can be investigated, especially with HMRC's increased focus on offshore tax compliance.
Contractors And Intermediaries: Those operating under the IR35 regulations, which deal with off-payroll working, can face investigations regarding their employment status and corresponding tax liabilities.
HMRC investigates anyone who has a responsibility to report to them or pay taxes. No matter how minor the amount, people can face a tax investigation, and HMRC investigates self-employed professionals and their self-assessment tax returns as much as organisations, and many businesses.
It's worth noting that not all investigations are triggered by suspicion of wrongdoing or a tip-off. HMRC conducts random checks as a part of its process.
Yes, self-employed individuals can seek assistance when HMRC investigates self-employed workers. Given the complexities of self-assessment tax returns and the potential stress of an HMRC investigation, it's often advisable for the self-employed to consider external support. Here's a breakdown of the help available:
Explore further: Accountants For Self-Employed
An accountant is well-versed in tax matters and can provide guidance on how to respond to HMRC, prepare the right documentation, and ensure you understand the process. An accountant acts on your behalf and liaises directly with HMRC, which alleviates a lot of stress with self-assessment tax returns or inspections.
Dig deeper: Chartered Accountant Qualifications
In cases where there's potential for a tax bill with severe penalties or legal action, it might be prudent to engage a tax lawyer or a legal firm that specialises in tax disputes.
Many professions have associated unions or bodies that offer resources, advice, or even representation for their members in matters like tax inspections.
There are many reasons you might face a tax investigation, including:
Omissions And Mistakes In Tax Returns: One of the primary triggers for an HMRC investigation is errors in a tax return. Such errors can arise from genuine mistakes, misunderstandings of the tax regulations, or lack of proper documentation.
You Are In A HMRC Target Area: At times, HMRC can target specific sectors or businesses they perceive to be a high-risk industry for tax evasion. For instance, HMRC investigates sectors that predominantly deal with cash payments to a closer degree.
You Have Been Deemed A Risk: If your tax returns consistently show significant variance compared to industry norms, it can flag you as a risk, and lead to a case where the HMRC investigates you.
HMRC Is Suspicious Of You: Activities like large one-off transactions, a large fall in earnings, consistent late filings, or regular amendments to past returns often mean HMRC suspects you are hiding something.
It might be that HMRC receives a tip-off and decides to investigate with further action, but generally speaking, the above reasons are more common.
Typically, HMRC can look back up to 4 years if they believe an innocent error was made. However, if they suspect deliberate inaccuracy, they can investigate as far back as 6 years. In cases where they believe tax evasion has taken place, they can delve into tax records dating back 20 years.
HMRC will notify you in writing if you are under investigation. This letter will outline the reasons for the investigation, the specific details they require, and the period under review.
HMRC takes its role of ensuring accurate tax payments very seriously. To maintain this level of scrutiny, they employ various types of investigations depending on the situation or the suspicion at hand. Here’s a more detailed overview of these investigation types:
These are audits carried out without a specific reason. HMRC occasionally selects individuals or businesses at random to scrutinise their tax returns and financial affairs. The idea is to maintain an element of unpredictability and keep all taxpayers diligent in their reporting.
An aspect enquiry is more focused than a random check but less extensive than a full enquiry. It targets a specific part or aspect of your tax return where HMRC believes there may be an error or requires further clarification. This could be due to inconsistencies in the data provided in assessment tax returns or due to patterns observed in similar cases.
As the most comprehensive type of investigation, a full enquiry delves into all areas of your financial affairs to ensure the complete tax return is accurate. This often happens if HMRC believes there is a significant risk of errors or intentional misreporting in the tax documents. It can be a time-consuming process, and it's essential for the taxpayer to provide all the requested documents.
Regardless of the type of investigation, it's crucial for taxpayers to remain cooperative and provide the necessary information promptly. While the idea of an investigation might sound intimidating, maintaining thorough records and seeking expert advice can significantly simplify the process and provide peace of mind.
Whether subjected to a random check or a full enquiry, transparency and adherence to tax regulations are key to navigating any HMRC investigation.
Upon deciding to investigate, HMRC will issue a notice of their intention. This notice will demand certain documents, which could range from receipts and invoices to comprehensive financial statements.
The length of the investigation can vary widely. Simple enquiries can be settled in a few months, whereas investigations in more detail take a significant time.
During an inspection, HMRC reviews the documents provided, and there may be interviews or site visits. It's a thorough review to ensure that the tax returns and financial records are accurate and to identify any discrepancies.
Uncover more: Tax Investigation Cover
HMRC expects honesty, transparency, and prompt communication. They want taxpayers to report their tax affairs accurately, maintain clear records, and respond to their queries timely.
Tax investigations by Her Majesty's Revenue and Customs (HMRC) can be thorough, as they seek to understand the complete financial picture of an individual or business. When HMRC requests supplementary information during a tax investigation, it typically revolves around verifying the figures declared in your tax returns and ensuring the completeness of the information you've provided.
Below are some of the common pieces of additional information HMRC might ask for:
Bank Statements: This is one of the most commonly requested items. HMRC will want to see all bank accounts related to the individual or the business, including current accounts, savings accounts, tax bills, and even foreign bank accounts.
Invoices And Receipts: For businesses, HMRC may ask for a breakdown of all sales and purchases, supported by the original invoices and receipts.
Payslips And Payroll Records: For those employed, payslips can validate the income declared. For employers, payroll records ensure that employees' tax and National Insurance contributions are correctly handled.
Business Expense Claims: If you've claimed expenses, be ready to provide evidence. This can include receipts, travel logs, or even explanations for more unusual or one-off expenses.
Company Accounts: For businesses, especially limited companies, HMRC might request a full set of accounts, including profit and loss statements and balance sheets.
VAT Records: If you're VAT registered, HMRC may want to review your VAT accounts, including your VAT returns, sales and purchase daybooks, and associated documentation.
Property And Asset Details: This might include details of property owned, both in the UK and abroad, as well as other assets that could generate income or capital gains.
Loan Agreements: HMRC may request details of loans to ensure that the borrowing and any related interest payments are legitimate.
Contract Agreements: Details of business contracts, especially if you have substantial contracts with specific clients or suppliers, could be scrutinised to understand the nature and legitimacy of transactions.
Cash Books And Petty Cash Records: If you keep a cash book for your business or maintain a petty cash system, HMRC may want to review these to ensure that cash transactions align with declared figures.
Foreign Income and Gains: For those with overseas interests, HMRC may request details of foreign earnings, gains, and any associated foreign tax paid.
Private Expenditure: In some cases, they may also delve into personal financial records and expenditure, especially if there's suspicion that business expenses are being masked as personal or vice versa.
Dividend Vouchers: For limited company directors or shareholders, HMRC might ask to see dividend vouchers or board meeting minutes confirming dividend declarations.
Digital Records: With the increased digitalisation of financial transactions, HMRC might also request access to online accounting or bookkeeping software.
Previous Years' Tax Returns: While the investigation might be for a specific year if discrepancies are found, HMRC might ask for a previous tax return or returns from for context.
If you find yourself the subject of a tax investigation, it's essential to cooperate fully with HMRC's requests. It's always a good idea to maintain well-organised and comprehensive records, as this not only simplifies compliance but can also expedite the investigation process.
Tax inspections can be a daunting process for many. Given the intricate nature of income tax laws and individual circumstances, the outcomes of these investigations can vary considerably, and here are the most common outcomes:
This occurs when HMRC finds that you've paid more tax than you were required to. It could be due to miscalculations on your end, changes in tax codes, or overestimation of earnings on your assessment tax return.
Example: Jane, a freelance graphic designer, mistakenly classified a non-taxable grant she received as taxable income on her Self-Assessment tax return. After an inspection, HMRC recognises the error, and Jane received a refund for the excess tax she paid.
This is when the inspection determines that you've paid less tax than you owe. This can arise from unintentional mistakes, misunderstanding tax obligations, or omitting sources of income from your assessment tax return.
Example: Robert, a landlord, forgot to declare the rental income from one of his properties for a year. HMRC's investigation highlights the oversight of his self-assessment tax return. As a result, Robert has to pay the additional tax owed. Depending on the time elapsed, he might also be charged interest on the overdue amount, increasing the total he owes.
This is a serious outcome where HMRC decides that unpaid tax is due because the taxpayer has intentionally tried to evade tax, as opposed to making a genuine mistake. It's not merely about a mistake but rather a deliberate effort to misreport, under-declare income, or claim unjustified reliefs or expenses to avoid paying tax. Consequences can be severe, even for self-employed professionals, ranging from hefty fines to potential legal proceedings.
Example: A boutique owner, Sarah, reports consistently low sales figures over several years, despite visibly expanding her business and lifestyle. Upon inspection of bank statements and business records, HMRC discovers she has been hiding a significant portion of her cash sales to reduce tax calculations to avoid paying tax.
This intentional underreporting could lead to Sarah facing severe penalties, which might be a percentage of the evaded tax or potential legal action.
Delve further: How To Avoid VAT When Buying A Van
There are severe punishments for cases of tax evasion in the United Kingdom, with a prison sentence of up to 7 years, or an unlimited fine possible as punishment. When it comes to VAT evasion, a case in a magistrate court could lead to a fine of up to £20,000 or 6 months in prison. When it comes to Crown Court cases, those in the wrong can face unlimited fines or a maximum of 7 years in prison.
Post-investigation, HMRC will send a letter outlining their findings, and the decision notice. If discrepancies were found, they would detail the amounts owed or refunded and any penalties imposed.
If you suspect errors in your tax returns, it's imperative to act proactively. Consider seeking advice from a tax professional, like us at Auditox Accountancy. We can review your income tax, and tax returns, advise on corrections, and guide you on the best course of action. You can also be proactive in gaining help in managing assessment tax returns.
While an HMRC investigation can be a daunting prospect, understanding the process and having professionals guide you through can make it manageable. Stay diligent, maintain transparent records, and always ensure you comply with the tax regulations. If you require any assistance with assessment tax returns, please contact us, and we will be happy to assist you.