HMRC tax inspection: what to expect and how to prepare
Published on April 14, 2023
The mere mention of a tax inspection or tax audit, is often enough to send shivers down any business owner’s spine.
In a nutshell, it involves HM Revenue & Customs (HMRC) digging around in your accounts to ensure you’re doing things by the book in terms of tax. If not, HMRC will usually give you an opportunity to rectify the problem. But sometimes that also comes with a financial penalty.
With a good accountant on your side, you’re less likely to be at risk. But sadly, nobody is immune to audit. Here's how to prepare, just in case.
This article was provided by The Accountancy Partnership – providing online accountancy services nationwide for a low, fixed monthly fee. Always consult an accountant for formal tax advice.
The different types of HMRC tax audit
HMRC has the right to rifle through your financial affairs whenever they pick or choose. It’s their way of staying on top of who is or isn’t paying the correct tax. It’s not all bad news though - if they find you’ve been overpaying tax, you’ll be issued with a tax rebate to reimburse you.
This doesn't just apply to income tax, either. This type of audit is also applicable to things like VAT, corporation tax, capital gains tax, Construction Industry Scheme (CIS), landfill tax, insurance premium tax, and IR35.
There are three different types of HMRC tax inspection.
This is where HMRC reviews all of your business records, and for limited companies, potentially the accounts and tax affairs of the directors, too. This type of inspection is typically sparked by suspicions of significant error or deliberate tax evasion.
This type of audit focuses on a specific aspect (or aspects) of your accounts. The accounts won’t be reviewed in their entirety like they would in a full enquiry - just the particular aspect(s) in question. This is generally as a result of an honest mistake, but HMRC will want to check for further inconsistencies.
This category of inspection isn’t triggered by anything in particular. HMRC is just at liberty to review your accounts randomly, regardless of the state of your tax affairs.
Reasons HMRC might want to audit your accounts
Apart from the random checks which are, as the name suggests, actioned at random, there are a few common triggers for a tax inspection. Most of these boil down to unusual activity in your financial accounts.
Reasons for inspection include:
Incorrect figures on a tax return.
Being part of what HMRC class as a high-risk industry (e.g., one which is renowned for taking ‘cash in hand’ payments to avoid paying tax).
Somebody alerting HMRC to issues with your tax affairs or accounts.
Significant discrepancies in income from one financial year to the next.
Frequently filing your tax returns late.
Your accounts appearing considerably abnormal compared to others in your industry.
Suddenly making a large claim for VAT.
Director’s pay that raises suspicion.
Omission of income.
A business with a high turnover submitting a small amount of tax.
As we mentioned above though, even if none of these apply to you and, to the best of your knowledge, your tax and accounts are squeaky clean, HMRC can still request to audit you.
What to expect during a HMRC tax inspection
You’ll almost always be told in advance that HMRC plan to inspect your finances, usually being notified with an official letter or phone call.
If you have an accountant and they’re registered as your agent, HMRC will contact them first. Depending on the services that your accountant provides, they may be able to represent you during the process.
HMRC will let you know what records they will audit, such as:
Company tax return
PAYE records (if you have employees on payroll)
VAT records if your business is VAT registered
A member of the HMRC team will be in touch to ask you some questions regarding your tax history and accounts. In some cases, they may request to visit you in person, either at your home address, registered business address, or accountant’s office.
You are legally obligated to provide HMRC with the requested information, but you’re also well within your rights to query their decision to investigate you (although HMRC will still want to look into your accounts).
How far back will HMRC look?
How far back into your records they look varies, depending on the severity of the investigation.
Random checks, with no suspected unusual activity, allow HMRC to examine records from the previous four years. This includes capital gains, corporation tax, income tax, PAYE and VAT returns.
The inspection period increases to six years for cases of careless behaviour or human error - apart from VAT which remains at four years.
HMRC can review the previous 20 years' worth of records if they suspect deliberate activity, such as tax fraud or tax evasion.
Most of the time inspections can be closed pretty quickly, but where this isn’t the case and there are additional complications, HMRC will need to investigate further.
What happens next?
If HMRC find that you have overpaid tax, you’ll be issued with a tax rebate. You’ll be given 30 days to pay (sometimes with added interest) if they find you have underpaid.
More complex audits may lead to larger penalties or ongoing investigations, which can sometimes even be raised to criminal status.
The audit process will be concluded once a decision notice is served, or a contract settlement agreed.
A contract settlement is a legally binding agreement between HMRC and the taxpayer, whereby the taxpayer agrees to pay what is owed, and HMRC agrees not to use force to collect this debt.
You’ll normally be sent a decision notice in the post, informing you of the inspection outcome and any next steps you must take.
How to minimise the risk of a HMRC tax inspection
HMRC are more likely to spend their time investigating businesses or people whose activities suggest unwanted activity. Fortunately, there are several ways that you can demonstrate your business’s finances aren’t anything to be suspicious of!
Hire a qualified accountant
Working with an accountant is invaluable when it comes to keeping your tax and accounts in order. They’ll be able to ensure your accounts stay well-organised throughout the year, and help make sure your business is running as tax-efficiently as possible.
They’ll also ensure your tax returns are filed accurately and on time, drastically minimising the risk of mistakes and inaccurate figures.
Maintain meticulous bookkeeping
Whether you choose to do this yourself or recruit the skills of a professional bookkeeper, staying on top of your bookkeeping is vital. If your bookkeeping falls by the wayside, you’ll likely end up tackling unnecessary mistakes through oversight or having to rush your returns when the deadline looms.
It’s also worth mentioning here that if you are ever called upon by HMRC for a tax audit, it pays to have your books in order, rather than having to take on the arduous task of organising them there and then.
Never miss an HMRC deadline
Regularly being late with filing your tax return is one of the most common red flags for HRMC so our advice here is simple: never miss the deadline! Always make your tax payments on time too.
Familiarise yourself with your tax obligations
A vast number of tax inspections arise due to genuine human error and often, this is because people aren’t clued up about their tax liabilities. Get to know what you’re obliged to do in terms of your taxes so that you don’t fall into this net.
Your accountant will be able to steer you in the right direction here!
More articles dealing with HMRC's rules and regulations:
e-Receipts: How to store digital receipts for your business expenses