‘Anybody running a business needs to be concerned about the possibility of facing a tax inspection,’ says Nicholas Parkes, an ex-tax inspector turned tax information provider. ‘In the Revenue, we always believed you could pick up any file and find something.’
What triggers a tax inspection?
According to Parkes, some 7% of tax inspections are triggered at random – ‘so HMRC can check that they are targeting their inspections properly and also so that nobody feels safe’. The vast majority, though, happen when HMRC believes there’s something wrong.
So, in theory, small businesses that keep good records and declare everything should have nothing to fear. However, when it comes to mistakes, ignorance is no defence, so firms have to take every care when completing their returns and ensure that they are on time – in other words, don’t give HMRC any cause for concern.
What HMRC is doing increasingly is looking at ratio analysis – where a company’s figures change a lot from one year to the next.’
Any unusual fluctuations can raise alarm bells for HMRC. Specific queries like these can trigger what’s called an aspect enquiry – as opposed to a full-blown investigation.
A couple of common examples – a landlord running a buy-to-let business and his repairs expenses were very high one year, HMRC could investigate to find out why that was.
Another example could be if a business owner forgets to declare the interest income from savings account, there is a chance that the bank may send the details of the interest to HMRC directly.
Good records, tidy accounts and clear tax returns
New powers such as getting information from third parties and tighter penalty regulations, as well as increased powers to search premises, all mean that businesses are under more scrutiny than ever from HMRC.
What’s more, all businesses are now required to file returns online. That means HMRC can use its own software to analyse returns and compare them to sector averages.
So, what else can trigger an investigation? Some types of business get more attention, such as cash-based businesses and industries like building. It also depends on your accountant’s credibility rating. If your accountant is diligent and identifies problem areas clearly, it helps.
But you can’t rely on a good accountant, says Nicholas Parkes. ‘Business owners, sole traders and the self-employed are making decisions on a daily basis about how to keep their accounts. And an accountant can only do as good a job as the records they are presented with.’
What every business should do is to use the extra space on their tax return form to explain any unusual fluctuations in turnover or profit.
What happens in a tax inspection?
So, what will happen if your business is inspected? In a full inspection, they will take all the records away and come back with questions. They can raise penalties of up to 100% of the tax that should have been paid. However, if it’s an honest mistake, there’s scope for a reduction. They tend to investigate one year’s accounts, but if they find you have been deceitful, they can then go back five more years or even further. Having said that, often an inspection finds nothing and there’s nothing to pay, so it’s just about the inconvenience.
How to reduce your chances of being inspected
- Always submit your tax returns on time.
- Make sure your returns are accurate and complete.
- Explain any changes from one year to the next. Big changes in turnover or gross profit rates will ring alarm bells, especially when drawings taken from the business or remuneration paid seem to be insufficient.