How to Survive an Investigation by HMRC

Very little will strike more fear into the heart of any small business owner than the words' HMRC investigation'. The phrase immediately conjures up the image of time-consuming processes with the potential of a hefty fine at the end of it. But what should you expect if it does happen, and how can you make it as painless as possible?

What is an HMRC tax investigation? 

A tax investigation is when HMRC decides to take a more detailed look at your business's finances to ensure you're paying the correct tax. This can happen at any time and can involve both your current and your historical tax affairs. An investigation doesn't necessarily mean you've done anything wrong, but you must comply with it by law. You'll be advised by letter when an investigation has been launched and why. HMRC will also state whether it is investigating a particular aspect of your tax return or taking a more comprehensive look at your wider tax affairs. Either way, now is the time to let your accountant know the situation and check that your records are in order. This should include gathering your accounts for at least the last few years – the more information you have, the better. If you don't have an accountant, it may be time to think about bringing in some professional help. Accountants will be used to handling such investigations and will help to make sure you're in the best possible shape for when it begins. It is also a good idea to check if you'll need to bring in additional support for your day-to-day business activities – investigations can be time consuming, and you don't want your wider business to suffer while it's going on.

The three types of tax investigation 

HMRC will inform you what type of investigation is being carried out. There are three types, and you may need to prepare differently for each.

Full enquiry 

The most extensive investigation will be a full enquiry. Here HMRC will look at all your business records, often because they believe there is an error in your reporting. When investigating limited companies, expect HMRC to delve into the tax affairs of company directors and those of the business itself.

Aspect enquiry 

If HMRC has concerns about a particular part of your accounts, they'll launch an aspect inquiry. This may well be due to a mistake or misunderstanding, but it's still a serious matter and should be treated as such.

Random check

Finally, the random check is just that, random. Any business can be selected at random for HMRC to investigate, even if there is no hint of mistakes or wrongdoing.

What triggers a tax investigation?

While a random check will happen by chance, several other factors could lead to a full or aspect enquiry. For example, HMRC may receive a tip-off that your tax affairs are not entirely in order, they may see that there are large fluctuations in your reported figures or believe they look significantly different to those of other companies in your sector. Indeed, it may be that HMRC is conducting more checks into a specific industry that you fall into. HMRC will also investigate if they suspect you're not recording all of your income, your returns regularly include mistakes, or they show you haven't been making a profit for multiple years.

What can HMRC check? 

If any of these situations arise, HMRC can request to see a range of records and documents. If you have an accountant, HMRC will contact them directly with details of what they'd like to see. This is likely to include information on the taxes you've paid, your financial records and detail of the tax calculations you've made, annual returns if you operate as a limited company, as well as self-assessment returns and PAYE records if applicable. Other files such as job quotes and pricing formats, sales invoices and expense receipts may also be of interest.

What happens during an HMRC visit? 

HMRC must follow strict procedures when it comes to carrying out an investigation – they will be able to supply a copy of these rules in advance if you request it.

A tax inspector will lead the investigation, and they may visit or ask you to visit them. You aren't legally required to attend this meeting, but it's a good idea to show willingness and co-operate as much as possible. You may have an advisor such as your accountant present at any meetings should you wish.

The tax inspector must tell you what they want to discuss in advance of a visit, and you may ask for the agenda in writing before the appointment if you'd prefer. This will detail any questions you'll be expected to answer, and the inspector must stick to these. Of course, the more comprehensive and accurate your answers, the better, and the more likely the situation will be resolved promptly.

How far back can HMRC investigate your taxes? 

Generally, HMRC will investigate your accounts and tax submissions up to four years before the investigation date, and it can claim any unpaid tax it believes is due from this period. However, if issues are found, such as regular mistakes on your returns, it can delve deeper and go back up to six years. However, even this is not the final limit, and if HMRC suspects deliberate tax avoidance, it can investigate the past 20 years of accounts if available. For this reason, it's always a good idea to make sure you can easily access accounts from as far back as possible.

What happens after an HMRC investigation? 

Once HMRC has assessed the situation and reached a decision, they will write to you detailing the outcome of their investigation. If no issues were found, it's simply a case of business as usual. If HMRC finds mistakes on your returns but believe the errors weren't made fraudulently or negligently, they'll tell you how they think the return needs to be corrected. You then have 30 days to make the correction. If you fail to do so, HMRC can correct the return itself. If you have underpaid tax, you'll have to pay the amount owed, possibly with interest, within 30 days. If you're found to have overpaid, you'll receive a rebate.

If HMRC believes that you've acted with negligence or fraudulently and deliberately omitted information or supplied incorrect information, you'll be made to pay penalties, extra tax and interest. The amount will vary depending on why you under paid or over-claimed, whether you told HMRC once you realised and if you co-operated with the investigation. You'll usually be required to sign a contract pledging to pay any penalties in exchange for HMRC waiving its right to prosecute. It's important to get legal advice if this happens. Criminal convictions in this situation are relatively rare. If you are found to be at fault, you have 30 days to appeal the decision.

It's also worth remembering that if you are found to have been at fault, it's likely that HMRC will keep a closer eye on you in the future, so take extra care to make sure your records are accurate, and you're paying the correct tax. Having the right accounting software will help here, as your records will be easily accessible and accurate, and you'll benefit from the simple submission of tax and VAT reporting it offers. If you don't already have an accountant, seriously consider employing one as if you've accidentally made mistakes in the past, they will help ensure this doesn't happen again.

How does an investigation end?

A tax investigation will end when you receive a decision notice or agree to a contract settlement. A decision notice letter will detail the final decision and can include a penalty notice or an assessment. If you sign a contract settlement, you agree to pay any money due, and HMRC agrees not to use its powers to recover the money. This is a legally binding document. Once a return has been investigated, it cannot be investigated again.