What to do in the event of an HMRC tax investigation

If you receive a letter from HMRC alerting you that they intend to investigate your tax position, your initial reaction may be to fear, especially if you don't know what it means or what to do in the event of an HMRC tax inquiry.

What exactly is a tax investigation?

A tax inquiry entails HMRC investigating your tax reporting and payment history in the past. They do this to ensure that the correct amount of taxes has been paid. They are unavoidable since one of HMRC's primary priorities is to close the tax gap, This is the sum that is not collected by HMRC notwithstanding their reasonable expectation of receiving that sum in tax revenue.

HMRC has obtained increasing powers throughout the years in order to successfully combat tax fraud, avoidance, and underpayments. HMRC asserts in one of their most recent reports that the tax gap has been declining for a long time and that for the tax year 2018/19, the tax deficit dropped to a record low of 4.7%. While HMRC's introduction of new digital methods for people to declare and submit tax, which reduces the potential for inconsistencies, it is also due to their efforts and developing strategies when it comes to picking who to examine.

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How does HMRC determine who to look into?

HMRC often initiates an investigation as a result of one or more of the following potential triggers:

Consistently submitting tax forms with errors - these errors might include forgetting to check the correct box, leaving out portions, or include inaccurate computations, and they are easily detected by HMRC. Genuine errors are unlikely to result in criminal prosecution, but sanctions may be imposed.

Continually filing tax returns late - Similar to making mistakes on a regular basis, if you are frequently late with filing tax returns (whether for self-assessment, business tax return, or VAT return), HMRC will want to know why. It may raise suspicions that you are not keeping accurate records, leading to an investigation.

Your costs or expenses are uncommon and may be above the industry standard - while HMRC realises that every business is unique, they will nonetheless check for anomalies. A family-run takeaway in a small town, for example, will have quite different costs than a Michelin-starred restaurant in a big city. It may appear peculiar if the takeout claims foreign business travel, and HMRC will want to know the reasons for any unusual expenditure to decide whether it was genuine or not.

You declare a significant gain or fall in income; a single dip or climb may not be enough to warrant a tax investigation. HMRC, on the other hand, may compare recent tax returns to prior tax returns to see whether there have been any significant changes or recurring swings that should raise a red signal. HMRC may also investigate you if they believe your income is in keeping with your level of life.

You work in a high-risk industry - HMRC will frequently focus on industries deemed high-risk. This has included, among others, the construction industry and private health care providers over the years. HMRC's focus has now switched to those associated with cryptocurrency. Those working in industries where 'cash-in-hand' is widespread, on the other hand, are more likely to be scrutinised.

Someone complains you to HMRC; sadly, this is not unusual, and claims are taken seriously by HMRC. Before proceeding, they will consider how much evidence has been supplied to support the claim as well as how much potential tax can be recovered from the investigation.

In addition to the foregoing, HMRC has made significant investments in technology to more accurately identify cases to investigate. Their sophisticated software, dubbed 'Connect,' has the ability to collect data from a wide range of sources, including the Land Registry, DVLA, credit card information from issuers, and data from companies such as eBay, PayPal, and Airbnb. Not only does it collect data, but it also analyses it and flags prospective instances for investigation, which is another another reason why HMRC is getting better at closing the tax gap.

What does HMRC look into?

If you receive notice that HMRC is conducting an inquiry into your tax affairs, they may ask to check into:

• History of tax payments
• Accounting, bookkeeping, and tax computations
• Tax return for self-assessment
• Return of Corporation Tax
• If you are an employer, you must keep PAYE records and submit PAYE returns.

If you are VAT-registered, you must file VAT returns.

The letter will also tell you more about the type of investigation HMRC is conducting:

A random check can include any part of your tax history and present status. If HMRC conducts a random check, it does not necessarily mean that they believe you have done something wrong, but rather that they are merely following routine processes as part of their wider fight on tax evasion.

An aspect enquiry is when HMRC is only interested in one area of your tax situation. For example, they may only be interested in your PAYE data and not your company tax returns. The most common conclusion of these inquiries is the revelation of honest mistakes rather than purposeful tax evasion.

A complete enquiry entails HMRC investigating all areas of your tax affairs. This can include both personal taxes and, if relevant, company taxes. A thorough investigation should be conducted because HMRC is likely to suspect there are significant problems in your tax filings.