A tax investigation can be one of the most stressful thing you ever have to deal with whilst running a small business.
There may even be nothing wrong with your tax affairs - you can be chosen for HMRC enquiry completely at random, but any tax investigation can drag on for many months regardless of the reason for it being started.
There are more than 250,000 tax enquiries every year in the UK.
It is normal for HMRC to deal with your accountant for much of the enquiry process, but there will be occasions when they will ask you to attend meetings or answer questions directly.
If you don't have an accountant and submit your tax returns personally, you'll have to deal with the tax investigation yourself.
A tax investigation can begin at any time but in normal circumstances (unless there is serious fraud) HMRC must make their first move within 12 months of a tax return being submitted.
Getting past this deadline doesn't mean that you are completely in the clear though.
If HMRC enquire into a tax return and find errors they can re-visit earlier years.
The solution offering most peace of mind is to ensure that every tax return you ever complete is correct, at least as far as you can be aware.
Once you have been selected for a tax inspection HMRC will write to you explaining if it is a check of your entire tax return and business records or simply a specific and limited check on a particular part of the return or claim you have made.
Sometimes HMRC won't start a tax investigation but will ask to carry out a compliance check on your business instead.
It's a fine dividing line between the two, but in theory at least, a compliance check is simpler and quicker.
HMRC will usually give you at least one weeks notice of their intention to make a compliance visit to your business, although it is not unknown for them to arrive completely unannounced.
The problem with compliance checks is that if HMRC find things they believe to be incorrect or unclear they can soon escalate the visit into a full blown tax investigation.
To avoid this it is extremely important to have up to date and accurate business records available during a compliance visit.
You should also be able to demonstrate that your business has satisfactory procedures to prevent fraud or incomplete records being produced.
You should have already figured out if you are subject to a full enquiry or an aspect enquiry into a small part of your tax return.
It will be clear from the length of or details requested in HMRC's opening letter to you.
You won't know (and HMRC won't ever tell you) if you have been chosen randomly or because of information HMRC have obtained.
HMRC have many ways of obtaining information about your business and use sources such as:
So your tax investigation could be based on information HMRC already hold or on nothing at all (random).
Added to that, tax inspectors don't ever tell you what they already know.
For example, if you've missed something off your tax return such as bank interest, you won't be told this.
The question you will be asked is are there any errors or omissions on the tax return you've submitted.
This way HMRC hope that you will confess to additional omissions over and above the ones they know about!
As the tax investigation progresses you'll begin to notice that the inspector seems to live in some sort of time warp, as he or she appears to have endless time to delve into the tiniest details of your business activities, such as where you buy your lunch, when and where you go on holidays, where you carry out your weekly grocery shopping and so on.
You of course will argue that it's nothing to do with them, but the inspector is trying to prove that your declared business profits cannot support the lifestyle you live, and therefore must be understated...
See financial models further down this page...
One problem you may have is that if your accountant is answering all these questions for you then you'll be building up quite a considerable accountancy charge.
The solution is to make sure your chosen accountant offers 'fee protection insurance' to cover circumstances like this.
Consistently sending a tax return full of provisional figures or estimates will only lead to trouble in the long run.
Many small business owners are reluctant to provide anything more than the bare minimum of information to the tax office. This can sometimes result in an unnecessary tax enquiry if there is anything unusual about the entries on your tax return. Tax returns are initially processed by a computer program that looks for anything unusual or unexpected in the figures. If something odd is found your tax return will be added to an Inspector's list of potential enquiries. But your odd figures could have a perfectly innocent explanation.
All these types of situations can and should be explained in the white spaces provided on the tax return.
If you do this HMRC may be persuaded that an enquiry isn't necessary after all, and move on to someone else's return.
It's a fact that late tax returns are more likely to be looked into by HMRC as they assume, rightly or wrongly, that the business records are in a mess if a return can't be finalised in time from them.
Accounting records you will be expected to provide include:
You should only be asked to provide information that is reasonable and relevant to the tax investigation.
If you feel that requests for information are not reasonable you should tell the tax inspector of your concerns.
A particularly problematic area is a common request to see private bank statements.
The tax inspector thinks this is reasonable in order to check that business income hasn't been banked elsewhere and not recorded in the accounting records.
You probably think it's intrusive, especially if you have nothing to hide.
You will often be asked to attend a meeting with the tax inspector responsible for your tax investigation.
If this happens ask to be provided with the meeting agenda so you can prepare.
Such meetings are commonly held at your accountants offices rather than your business premises, home or tax office.
In fact, a meeting held in your accountants office can provide an opportunity to quickly put forward your case with the support of your accountant, and usually the tax inspector will only require a short time with you, perhaps up to a couple of hours.
Further discussions can then take place through your accountant, without you having to be present.
If you are asked questions that you can't immediately answer don't guess. Instead ask for time to respond later.
It is better to attend any meeting requested as it indicates your co-operation with the enquiry, something which HMRC will take into account if you subsequently receive any penalties for incorrect tax return figures.
The more co-operation you have given the less your penalty charges will be.
After the meeting you will be sent detailed notes explaining what happened during the meeting, which you need to check and confirm that they are correct.
A popular tactic employed by HMRC during a tax investigation is to present you with a financial model they have built up of your business which proves undeclared profits.
These are based on assumptions made by HMRC and are often wildly incorrect.
It is important to check these in detail.
Your accountant can help check the mathematical basis, whilst you can dispute any incorrect assumptions made by HMRC.
Each time you receive correspondence from HMRC during a tax investigation it will state the date by which the inspector expects a reply.
It is important to try your best to reply in time as it aids your score for co-operation.
If it is clear that the level of information requested will mean you cannot meet the deadline then let the inspector know this and provide a date by which you will provide the information (being reasonable - don't expect to get away with saying you'll provide the information in 12 months time!)
If you know that you have been submitting incorrect figures on your tax return and the tax investigation is inevitably going to result in an assessment for underpaid tax you can always make a payment on account to reduce interest charges arising.
Any penalties you may eventually receive are based on HMRC's potential lost revenue and are calculated as follows:
It is possible to reduce penalties by making a disclosure of your errors and this can reduce the penalty level as low as follows:
Of course it is very difficult to argue that a disclosure is unprompted once a tax investigation has begun!
The key to avoiding a tax investigation is to keep your business records up to date and accurate and submit full and complete tax returns to HMRC each year.
That is not to say you can't do any tax planning, of course you can.
But the tax planning must be within the law - deliberately concealing income is not tax planning!
Once you've submitted accurate and complete information to HMRC you need not worry about a tax investigation.
For even if your business is chosen for enquiry you have nothing to worry about.
Simply let the tax investigation take it's course.
If everything you have submitted is correct it is highly unlikely that HMRC will find any reason to issue penalty notices to you.
As soon as they realise you're an honest hard working tax payer with nothing to hide they will quickly close the tax investigation and move on to someone else.
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