HMRC tax inspection: How small businesses can prepare

The thought of being investigated by HMRC leaves many business owners with a sense of dread.

But it doesn’t have to be that way.

Often, that fear comes from not understanding the process.

So in this article, we explain what you can expect from an HMRC tax inspection and share pointers on how you can minimise the risk of being investigated with the help of an accountant.

That way, you’ll feel confident in your ability to deal with an inspection if it ever does come up. After all, no business is immune from a tax inspection.

Here’s what we cover:

What is an HMRC tax inspection?

An inspection is where HMRC selects your business to review your business records and check if you are paying the right amount of tax.

HMRC has the right to review your affairs at any point, but you or your accountant will receive official correspondence from HMRC to notify you first.

If HMRC finds you have filed anything incorrectly, they will give you the opportunity to correct the problem.

But it can also come with a financial penalty.

It’s not all bad news, though. If you have overpaid tax you’ll be issued with a rebate to reimburse you.

These are the types of business records HMRC might look into:

• Corporation tax returns
• Self Assessment tax returns
• VAT returns (if your business is VAT registered)
• PAYE returns (if you’re an employer)
• Construction Industry Scheme (CIS)
• IR35
• Landfill tax
• Insurance premium tax.

HMRC tax inspections to know about

There are three different levels of tax investigation that HMRC can carry out:

1. Full enquiry

When HMRC undergoes a full enquiry, it will review your entire business records, and for limited companies, possibly the directors’ accounts and tax affairs.

This is usually because it believes there is a significant risk of tax error or deliberate tax evasion.

2. Aspect enquiry

As implied by the name, HMRC will look at a particular aspect (or aspects) of your accounts.

An aspect enquiry is usually the result of an honest mistake, and could be flagged by inconsistencies in a section of a recent tax return.

If HMRC finds you’ve made a mistake, it will want to check prior periods for additional inconsistencies.

3. Random check

Random checks can happen at any time and doesn’t mean HMRC suspects any errors in your tax.

HMRC is free to review your records regardless of the state of your accounts or whether you’ve triggered an alert.

Why HMRC may need to do an audit

Any unusual activity in your accounts or tax returns flagged by the Central Risk team can lead to further investigation.

They use sophisticated data mining tools to identify trends in industries and highlight unusual activity.

Random checks aside, there are a few common triggers for a tax inspection. The most common one is submitting incorrect figures on a tax return.

Here are some more instances that are likely to trigger an audit:

• Consistently submitting tax returns late
• Belonging to an industry deemed high-risk by HMRC (such as those known for accepting ‘cash in hand’ payments to avoid paying tax)
• Director salaries that trigger suspicion
• Noticeable variations between tax returns (such as a significant decrease in income from one year to the next)
• Your business records not aligning with industry standards
• Failure to report certain sources of income
• A one-off large VAT claim
• A business with high turnover but minimal tax payments
• Someone notifying HMRC of unusual transactions in your accounts.

What to expect of the HMRC tax inspection process

First off, HMRC will let you know in advance that it plans to inspect your business records, either via an official letter or by a phone call.

If you have an accountant who is registered as your agent, HMRC will contact them instead, and your accountant should be in touch to tell you about it.

Depending on your accountant’s services, you might find they can represent you during the inspection process.

When HMRC notifies you, it will tell you which records it wishes to audit such as your VAT returns, your company accounts or your PAYE records.

HMRC will contact you to request particular information and ask you some questions regarding your accounts and business history.

They may ask to visit you in person, either at your registered business address, accountant’s office or your home.

You’re legally obligated to provide HMRC with the requested information, and you’ll have to pay a penalty if you don’t send the relevant information or refuse a visit.

There is an exception when you can provide a ‘reasonable excuse’, for example, you’re seriously ill or someone close to you has died.

You’re well within your rights to query HMRC’s decision to investigate you, but the inspection will still go ahead.

How far HMRC will dig back into your records will depend on the level of investigation. Most of the time inspections can be closed pretty quickly.

And when no mistakes are found, HMRC can close the investigation without doing further checks.

If HMRC finds a mistake it believes was innocent, it will look back four years. But when it sees careless behaviour, this increases to six years.

HMRC can go back as far as 20 years when it suspects deliberate activities. Think the likes of tax evasion or tax fraud.

How to reduce the chances of being investigated by HMRC

The good news is you can take proactive steps to minimise your risk of being investigated.

Below is advice from accounting experts on how working with a qualified accountant will help you significantly in these areas.

1. Know your tax obligations

A number of tax inspections happen due to honest mistakes and often that’s because business owners don’t fully understand their changing tax obligations.

Edward Kirby, UK manager at Sleek Accounting, explains how a good accountant can help.

He says: “Tax laws are like moving targets, always changing. Accountants keep up with these shifts, so your business doesn’t get caught off guard.

“This ongoing education ensures your practices stay compliant and less likely to raise HMRC eyebrows.”

2. File your tax returns on time

Submitting tax returns late is a common red flag for HMRC, so you never want to miss a deadline (or a payment).

3. Keep your books up to date

If your bookkeeping falls behind, it’s more likely you’ll have to rush to make tax deadlines and could end up making oversights in your returns.

Ariful Islam, managing director at Sterlinx Global Ltd, explains how an accountant can ensure you stay on top of record keeping: “Dealing with receipts, invoices, and other financial records can be a nightmare.

“Accountants take the burden off your shoulders, keeping your paperwork organised and readily available for any HMRC enquiries.”

4. Avoid basic errors

Simple errors such as allocating costs incorrectly, entering the wrong VAT amount, or treating non-deductible costs as tax-deductible can alert HMRC to inspect your records.

Having your accounts reviewed by an accountant will ensure these kinds of mistakes are caught, as Ariful Islam explains: “Mistakes happen, but even minor errors on your tax return can raise red flags for HMRC.

“Accountants have the expertise to ensure your finances are meticulously organised and reported accurately, minimising the chance of triggering an investigation.”

5. Craft tax strategies

It’s possible to maximise all available tax deductions without crossing the line.

Edward Kirby explains how an accountant can help your business plan strategically: “Tax advisors aren’t just number crunchers, they’re strategists too.

“They’ll devise legit ways to trim your tax bill without stepping over any lines. By doing so, they help keep your business on HMRC’s good side.”

How an accountant can help with a tax inspection

As your agent, your accountant can usually represent you during an investigation, which means they can compile your records and handle communication on your behalf.

Edward Kirby explains how an accountant can reduce the burden on your business: “If the worst happens and HMRC comes knocking, having an accountant in your corner is a game-changer.

“They’ll handle the nitty-gritty, deal with HMRC inspectors, and ensure all paperwork is in order, making the process less stressful.”

What happens after the tax inspection

HMRC will write to you to tell you the results of the inspection and any next steps you must take.

You’ll be repaid if you overpaid your tax. You may also receive interest on the amount you’re owed.

If you owe tax, you’ll be asked to pay the additional tax within 30 days. It’s likely you’ll also have to pay interest from the date the tax was due.

You may also have to pay a penalty, and HMRC will take into consideration the reasons for your underpaid or over-claimed tax, whether you informed HMRC as soon as you could, and how helpful you’ve been during the investigation.

More complex audits may result in heftier penalties or prolonged investigations, occasionally escalating to criminal charges.

You can always apply for alternative dispute resolution (ADR) if you don’t agree with HMRC’s decision.

Final thoughts on HMRC tax inspections

It’s impossible to avoid an HMRC tax inspection altogether. But you can take steps right now to minimise that possibility.

And remember, filing accurate tax returns isn’t just important for compliance, it’s also about maintaining a healthy business.

Ariful Islam explains why working with a good accountant is invaluable: “An accountant offers far more than just a shield against HMRC investigations. They can help you optimise your tax strategy, identify areas for cost savings, and plan for future growth.

“Consider it an investment in the overall financial health of your business.”

If you are selected for an HMRC tax inspection, don’t panic. If you are co-operative and provide all requested information in a timely manner, you can make it a smooth and painless process..