What does an HMRC Investigation mean for you?

The words ‘tax investigation’ may fill you with dread, it should. But, in reality, having your business checked out by HMRC shouldn’t be too bad. Although it’s rarely a walk in the park, if you have done everything right and not tried to hide anything, you should be fine. But this can still be a laborious and time consuming effort to deal with the enquiry.

How will I know if HMRC is investigating me or my business?

HMRC will tell you with a dreaded brown, recycled, envelope. You or your company records will be scrutinised. The initial letter doesn’t normally tell you the reason for the investigation or why it has been launched. The letter will tell you what particular aspect of your tax return it intends to explore. For a more comprehensive investigation into your wider tax affairs the letter will layout the areas.

What is a tax investigation or also known as an enquiry?

A tax investigation is when Her Majesty's Revenue & Customs (HMRC) decides to take a closer look at the finances and record keeping of you and/or your business. It aims to ensure that the tax payer or company is paying the right amount of tax. The scope can cover both now and historical filings. You must, by law, cooperate fully and the penalty regime takes notice of the diligence and effort undertaken by the tax payer during the enquiry. An enquiry does not imply that you have done anything wrong. Often it can be a random choice you have been chosen.

As a minimum, HMRC will be looking to clarify a specific aspect of your tax return. However, if they want to conduct a full investigation you’ll need to submit your financial records. Normally these include:

Bank and credit card statements
PayPal or other online statements
Sales invoices or records
VAT records (Making tax digital compliance)
Chequebooks and paying in slips
Job quotes or pricing estimates
Payroll records
Purchase invoices and expense receipts
Diary entries
Mileage records
Contractor quotes

If you use an accounting package or file digitally using spreadsheets for VAT, HMRC may request access to the digital software. It isn’t obligatory to provide, as long as you are providing the requested information in another format.

The reasons for tax investigations

The Connect system compares thousands of data sets to look for anomalies. Tax is not from straightforward, and HMRC are not looking to punish companies that make honest mistakes. But they are focussed on retrieving unpaid tax revenues, no matter what the cause of the shortfall.

Here are some of the most common reasons for a tax investigation.

No 1 Reason in my book: Omissions and/or mistakes

Something as simple as forgetting to tick a box perhaps you paid too much (or too little). Missing out a section of revenue or expenses, omitting a supplementary information section or page on your latest return. HMRC will launch a letter to advise an opening of an investigation to get to the bottom of the inconsistency. If you had the information and made a genuine mistake, it is normally quickly
resolved. Or, it is an oversight in a certain area that has been highlighted by Connect as part of its continuous cross referencing, and you are able to clarify the omission and lay your hands on the required information for submission.

HMRC have targeted your business sector

HMRC may be taking a more proactive look at certain sectors where there might be tax shortfalls, or you may tick a box that they are particularly interested in now. Construction is a favourite, but we have seen sectors like home tutors and peripatetic teachers being targeted.
Online traders, Airbnb, eBay and Facebook marketplace traders have all come under scrutiny as part of sector reviews.

You have been deemed a risk

Certain things can trigger the HMRC risk-based selection process. Cash traders is a given or high levels of capital going into and out of the owner’s personal bank account and the business account. Commercial relationships with other high risk companies or individuals is a common link.

HMRC is suspicious of you or your business

HMRC will seek to investigate if there is evidence of fraud or criminal wrongdoing. But a range of innocent behaviours may also look suspect until they are properly explained. For example, perhaps you have high expenses compared to your income. HMRC suspicion may also be a factor in how far back they look into your accounts (see below).

The HMRC tax investigation time limits

A question often asked is how far back HMRC can look into your accounts. Normally HMRC will investigate your accounts and tax submissions up to four years prior to the date of the investigation, and claim any unpaid tax it believes is due from this period. However, if it finds that you have been careless (e.g. regularly making mistakes on your tax returns) then it can go back up to six years. Even
this is not the limit: if HMRC suspects deliberate tax avoidance, it may investigate the past 20 years of accounts if available. Therefore it is always best to retain access to as many years of accounts as possible.

Potential outcomes of a tax investigation?

The outcome of the tax investigation depends on a number of factors. Critically the most important factor is whether you are found to be at fault. By accident or design it doesn’t matter, but the penalties will be representative of the cause. Criminal convictions are relatively rare, except for cases of proven fraud. Most of the time people or companies will be fined for a misdemeanour or asked to pay what you owe.

If you are told that you are in the wrong and you need to pay, do so quickly. If you don’t agree with the decision, you have 30 days to appeal it.

If there are large discrepancies or errors in your records, HMRC will assume that these kinds of errors are present in your earlier statement, you have to prove otherwise. This presumption of continuity will affect the outcome of the investigation.

You are likely to face a penalty if you are found to have:

Made a mistake (despite taking reasonable care)
Failed to take reasonable care and this has led to a mistake
Deliberate omissions that have not been concealed
Deliberate omissions that you have tried to hide

If you are found to be in the wrong, it’s likely that HMRC will check back in to see if you have changed your ways. So the morale here is, “..learn from your mistakes.” Otherwise, you may find you are going to do another round with HMRC.

How to prepare for an HMRC tax investigation

It is quite possible you will never meet an Inspector nowadays. But the investigation will require a significant amount of your attention, so set aside suitable time and resources. Think of the investigation as a business project. You will need to dedicate time and energy towards it and most likely pay for professional advice.

If you try to deal with the matter on your own, you need to budget for the fact that you may not be able to dedicate as much time to your business as you usually do. This could mean getting someone to take on your responsibilities or taking on fewer clients. You may even want to bring in extra accounting help instead of giving up your work and delegate the investigation to a professional.

Make sure you have all of your records in order, and not just for the last year. The more information you have, the better. Take time to gather all the relevant information at the start and you’ll prevent the need for a lot of stressful searches later on.

How long the tax investigation process takes will depend largely on how much information HMRC wants to look at. Smaller tax investigations usually take between three and six months, while a full- scale investigation can sometimes take up to 16 months to complete.