Updated 24 March 2022
The words ‘tax investigation’ may fill you with dread. In reality, having your business checked out by HMRC shouldn’t be too onerous if you’ve been keeping efficient accounts. Although it’s rarely a walk in the park, this guide can help you turn what might be scary experience into one that is merely time-consuming.
A tax investigation is when Her Majesty's Revenue & Customs (HMRC) decides to take a closer look at the finances of your business, to ensure that the company is paying the right amount of tax, both now and historically. It is a process with which you must cooperate by law, but it does not imply that you have done anything wrong. If you have rigorous accounting procedures in place and a good accountant, then a tax investigation should not be too onerous or time-consuming.
Every tax investigation starts with a brown envelope marked ‘HMRC’ falling through your letterbox. Your company records will face varying degrees of scrutiny, depending on the reason the investigation has been launched. The letter will tell you whether the investigation is into a particular aspect of your tax return, or a more comprehensive investigation into your wider tax affairs. Ask your accountant to give you their view on why the investigation is being launched.
At 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. These will probably include:
If your records are stored digitally, HMRC can request access to the software system you use as well as copy of your records.
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.
There are a number of reasons why HMRC may want to take a closer look at your finances, so you shouldn’t assume that they are accusing you of wrongdoing. Tax is often far from straightforward, and HMRC are not looking to punish companies that make honest mistakes.
Here are some of the most common reasons for a tax investigation.
You may have forgotten to tick a box, paid too much (or too little), missed out a section or failed to include the right supplementary information on your latest return. HMRC will launch an investigation to get to the bottom of the inconsistency. If you have the right documentation to hand, you should be able to resolve the problem quickly and get on with running your business.
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 (for instance if you have multiple sources of income).
There are certain things that trigger the HMRC risk-based selection process, such as cash trades or high levels of capital going into and out of the owner’s personal bank account and the business account.
Obviously, HMRC will look 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, or you are always late submitting your tax return. HMRC suspicion may also be a factor in how far back they look into your accounts (see below).
You may be wondering 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.
The outcome of the tax investigation depends on a number of factors – the most important one of course being whether you are found to be at fault. Criminal convictions are relatively rare, except for cases of proven fraud. Most of the time you 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 statements. This presumption of continuity will affect the outcome of the investigation.
You are likely to face a penalty if you are found to have:
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 if you don’t want to keep hearing from them, it’s advisable to do so.
A tax investigation will require a significant amount of your attention, so set aside suitable time and resources. Think of the investigation in the same way that you would any other business project, as a process that you need to work through step by step.
Budget for the fact that you will not 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.
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.