Small business leaders all too often think they are immune from HMRC tax investigations, believing that the government’s tax collectors only go after the big fish. Actually, it’s not the case. HMRC are much more thorough than you might think, and while lots of SMEs escape the tax investigation radar, they are definitely not off limits and should be prepared.
In recent years HMRC have cracked down on tax avoidance in an attempt to close the UK’s tax gap. In fact HMRC’s latest figures reveal there has been a significant increase in the number of tax investigations into the tax affairs of SMEs.
One report estimates that as many as one in ten small businesses are under investigation by the taxman. The truth is, no business should think they are immune to a tax audit.
Why HMRC might investigate your SME
There are many reasons HMRC may decide to investigate your business, no matter what its size. Common reasons HMRC investigate SMEs include:
- A tip off – ex-partners, disgruntled employees or a competitor may suspect or have knowledge of tax-dodging activities, or be jealous of your extravagant lifestyle!
- Widely fluctuating margins – when profits take a big hit without a reasonable explanation, HMRC will want to understand why
- Tax return mistakes – a one-off mistake is unlikely to be investigated, but regular errors will flag up suspicions
- Years without profit – if your SME operates for a prolonged period at a loss, HMRC will be curious as to why your business is still running
- Consistently filing late returns
- Your tax returns are wildly different to other businesses in your industry sector
- Your business happens to be in a sector that HMRC are targeting
If you are notified by HMRC that your tax affairs are under investigation, it is a good idea to seek the advice of a specialist tax accountant. Robin John, who runs the tax team at Wellden Turnbull, says tax reporting is complicated, so it’s no wonder so many small businesses fall foul, especially when they try to do their tax reporting and returns themselves.
Are there different types of tax investigation?
Yes. HMRC differentiate tax investigations into full, aspect and random. Let’s take a look at what each one means.
A full tax investigation is undertaken when HMRC believes there is significant chance of error in the return. All records are reviewed under a full enquiry, and can include the personal financial records of business owners and directors. A full investigation can take up to 16 months to complete.
The most serious type of investigation is a Code of Practice 9 (commonly known as COP 9) which is opened when HMRC suspect fraudulent behaviour.
An aspect investigation happens when HMRC spot something they think doesn’t look right in your return. The investigation usually focuses on the specific area in question. This type of investigation is usually associated with genuine mistakes. Small investigations on a single aspect of your tax return usually take between 3 and 6 months to complete.
Random tax investigations
Random inspections are simply down to fate. HMRC sometimes target specific sectors or types of business.
What to do if you find your business under tax investigation
Finding out your business is about to be investigated by HMRC is a daunting situation to be in. However, the first thing to do is NOT to panic. HMRC carry out many random investigations, so it’s not necessarily an indication that the taxman thinks you have done something wrong.
Here are some tips to help you should you find your SME under investigation:
- Contact your accountant for advice
- Let your accountant or specialist tax adviser deal with any correspondence
- DO NOT ignore the enquiry
- Respond within the designated time-frame (usually within 30 days)
- Answer all questions asked in the letter from HMRC fully and provide any information requested
- Refer to the Tax Payers’ Charter to know your rights
- If you are asked to meet with an inspector, always ask to see the agenda before you meet
- If the investigation leads to you having to pay further taxes, get a specialist tax accountant to negotiate penalties on your behalf
Importantly, take a breath, comply, establish the level of enquiry and get a good accountant or tax specialist to fight your corner. It could save you a lot in penalties if you are found to be owing tax.
How to avoid a tax investigation
Ultimately, the best position is to keep your business off the HMRC tax investigation radar. You are much less likely to be investigated by HMRC if you:
- File tax returns on time
- Use an accountant
- Pay tax bills on time
- Explain any significant fluctuations
- Don’t run a cash-only business