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The thought of being targeted by HMRC for a tax investigation can be enough to cause anxiety when you’re self-employed. It goes without saying that the vast majority of taxpayers are honest, keeping accurate and comprehensive records and filing their tax returns on time with every intention of being compliant and paying the correct amount of tax.
But HMRC conducts thousands of tax investigations each year and random checks do happen so you could potentially be selected even if you’ve been compliant for all your years as a taxpayer.
The majority of tax investigations are triggered when HMRC notices something suspicious that they think warrants further investigation, so for the self-employed it’s important to keep comprehensive records and avoid raising any red flags that might put you under the spotlight. In this post we’ll explore how.
Why Might HMRC Undertake a Tax Investigation?
HMRC’s aim is to ensure that everyone pays the right amount of tax and to minimise or eradicate the tax gap. They utilise AI and sophisticated data-matching and mining software cross-checking against information from banks, employers, online platforms and even social media to look for red flags such as unusual patterns, consistently late or incorrect filings.
Even if you’ve done nothing wrong you could be selected for a random investigation which is a deterrent in terms of bad practice, with the intention of keeping taxpayers on their toes. But if something doesn’t add up or looks suspicious, it could raise a red flag and prompt an investigation. HMRC also targets particular sectors where errors or non-compliance are more common such as construction, hospitality, online retail or cash-based businesses.
For the self-employed, where income can be variable and expenses complex, this can draw HMRC’s attention to you more often than salaried employees.
Which Red Flags Could Attract HMRC’s Attention?
Not every discrepancy or issue will trigger an investigation but repeated issues or recurring patterns can raise suspicion. It’s important to understand what red flags and common triggers HMRC look for to help you avoid them.
Expense Claims
High expenses that are disproportionate to industry norms or your income, or expenses that aren’t wholly and exclusively for the purposes of running your business.
Consistently Low Profits
If your accounts show small profits over a sustained period of time HMRC may have suspicions about how you’re supporting yourself.
Big Income or expense Fluctuations
Sudden changes in your income or the expenses being claimed without explanation can raise suspicion about manipulation or under-reporting.
Cash-Focused Businesses
Businesses or sectors that deal primarily in cash, such as hospitality, taxi services or trades, are viewed as being higher risk and can come under more scrutiny.
Compliance Issues
A pattern of repeated errors, missing figures and late filings or payment of your tax bill can be an indicator of bad record-keeping or, at worst, deliberate tax evasion and increases the chances of HMRC attention.
How Does a Tax Investigation Work?
When HMRC undertakes a tax investigation, they will usually make initial contact in the form of a letter confirming that you’ve been selected and explaining what is to be checked.
The scope of investigations can vary from an aspect inquiry which would usually focus on one area of your tax return (such as allowable expenses) to a full enquiry which will review all aspects of your accounts, taxes and financial situation.
HMRC will request supporting evidence such as bank statements, invoices, receipts or contracts depending on the nature of their investigation and they may propose an in-person visit. They will analyse your tax return and the evidence supplied before deciding the next steps.
Investigations can last from weeks to years, contingent on the complexity of the case but they can be very time-consuming for the self-employed and it goes without saying that they are best avoided. Fully co-operating with the investigation is always beneficial.
HMRC will write to you with the outcome which will usually be one of the following:
- No Further Action: No issues were found
- Repayment Due: You overpaid and HMRC will issue you a refund
- Additional Tax Liability: You underpaid and may have to pay the difference plus interest
- Penalties: Can be levied depending on the nature of the issue in terms of whether it was a mistake, deliberate, or deliberate and concealed
- Alternative Dispute Resolution: A mediator could be used when there’s a disagreement or dispute
- Fraud or Criminal Proceedings: In the most serious cases such as tax evasion, HMRC may escalate for criminal investigation
Tips to Avoid Raising Red Flags With HMRC
Although random tax investigations are unavoidable, many other investigations are and not raising any red flags to HMRC helps significantly. HMRC uses AI to mine their data and spot anomalies and suspicious patterns so the best way to fly under their radar is to ensure your record keeping, accounts and tax returns are comprehensive, accurate and clear. Here are some steps to take:
Separate Business and Personal Finances
Separating business and personal finances makes managing your business finances and tax affairs much easier and more streamlined, reducing the chances of errors so use a business bank account such as Mettle by NatWest.
Be Fastidious With Your Business Records
Keep all invoices, receipts, bank statements and supporting documentation for a minimum of 6 years (6 years from the end of the tax year) and ensure nothing is missed. Comprehensive and accurate records are vital to defend your position should HMRC investigate you.
Explain Anything Unusual or Suspicious
If your income has decreased or you’ve had a significant increase in expenses, ensure that these changes are documented clearly so HMRC can understand why they have happened. This can be done in the Additional Information part of your self-assessment tax return.
Realistic Expense Claims
Ensure that your expense claims are realistic and that you only claim costs that are incurred wholly and exclusively for business purposes. Any that look suspicious or fall into the grey area could trigger questions from HMRC.
File Ahead of the Deadlines
Filing your tax returns and paying your bills ahead of the deadlines demonstrates that you’re organised, on the ball and taking your compliance obligations seriously.
Engage an Expert
Having an accountant in your corner can make a huge difference. They can spot and rectify any potential red flags before your tax returns are submitted as well as ensuring accuracy and compliance.
How an Accountant Can Help Prevent Tax Investigations
The role of an accountant is wide-ranging and a key part of their remit is to ensure compliance, helping to safeguard your business. Failure to be compliant can raise red flags with HMRC and trigger a tax investigation which can be time-consuming to resolve and also expensive if fines or penalties are levied.
When you appoint us you’ll work with your own dedicated accountant who will expertly manage all your business and personal accounting needs, ensuring transparency, accuracy and timeliness. They understand what HMRC can look for and will ensure that common pitfalls are avoided in your accounts and tax returns.
We also provide you with FreeAgent or Xero cloud accounting software inclusive at no extra cost in all our accountancy packages. Accounting software has huge benefits in terms of efficiency and accuracy as well as creating a digital audit trail that integrates with HMRC’s systems which will work in your favour should you ever be investigated as well as ensuring compliance with your future Making Tax Digital obligations.
With an accountant’s support, you can rest assured that your finances, tax affairs and compliance obligations are in expert hands, minimising the chances of being investigated and giving you the time and peace of mind to fully focus on growing your business.
To find out more about our accountancy service, request a callback today or get an instant online quote here.
