What is a tax enquiry and how can you avoid one?

Tax enquiry, Tax investigation, eek … all sounds a bit scary doesn’t it?  And, when it comes to your small business accounts and taxes, haven’t you spent enough sleepless nights worrying about whether you are doing everything legally and above board?

Facing up to a Tax Enquiry can seem like a daunting prospect. And I’ll be the first to admit that the experience won’t come stress-free. But, thankfully there are a raft of positive steps you can take to ensure you fly low under HMRC’s radar.

Let’s start by looking at it from the Taxman’s point of view.

What is a Tax Enquiry?

The Taxman is interested in two groups of tax payers – those that don’t tell the truth and those that make mistakes.

Most Enquiries are started because some suspicion has been aroused or HRMC suspect that errors have been made.

Enquiries can take the form of either an aspect enquiry which focuses on a number of specific aspects regarding your accounts or tax return or a full enquiry which might look at all of your returns and accounts in much greater depth.

Other Enquiries (only about 8%) may be started on a random basis. This is simply bad luck and there’s not much you can do about it.

HMRC have one year after the date you file your tax return to enquire into it. After that you’re safe unless they make a discovery of fraudulent or negligent behaviour. In these cases they can go back up to 20 years although 6 years is the norm.

So, if you are selected, it’s worth being prepared and understanding how you can avoid giving HMRC cause for concern.

The tools that HMRC use

HMRC uses some very powerful and sophisticated software aptly named Connect which links data from all the databases held in the public sector such as the Land Registry, Companies House, electoral roll as well as other data held in the public domain and online including social media. The system holds an enormous amount of data and is capable of a lot of cross-checking between the various sources.

An example of an anomaly the system may throw up is where you’ve filed a tax return reporting poor sales and profits whilst messaging on social media about how well your business has been doing.

HMRC collates data on all business sectors and programs their computers to automatically flag for enquiry any entries in a Return that fall outside the statistical norm.

If your stats fall outside the boundaries, such as too much expense of a certain type or too little income for the property or type of trade concerned, then you’re more at risk of having an enquiry aimed at you.

There is no getting away from the fact that small businesses today are under a lot of scrutiny from HMRC.

But, enough about Big Brother.  What can you do to reduce the chances of attracting HMRC’s attention?

Here are my top 6 tips:

1 – Review your accounts and tax return for any significant changes between this year and last year

HMRC’s systems will be looking at your figures in relation to previous years figures as well as comparing them against benchmark criteria for your business sector.  Any unusual variations will raise flags for HMRC.

Start by reviewing your accounts for any significant variations in current year figures compared to previous years and then offer an explanation in the “other information” box on your tax return. If you explain your circumstance in an honest way HMRC are far less likely to start an enquiry.

Here are some examples of what you may need to offer explanations for:

• If you introduced some money into the business, where did it come from?
• If the gross profit margin has changed significantly, why?
• If any expenses are unusually high, why?
• If sales have fallen, why?
• You may want to explain the disparity between money taken from the business and private living expenditure

2 – Avoid using estimates

There may be reasons beyond your control for why an estimate has to be disclosed on your tax return but try to avoid using them wherever possible as your return will be flagged by HMRC as one to keep under observation.

 

3 – Make sure all your income and capital gains are disclosed on your tax return

Filling in your tax return is not just about filling in the section on income and expenses for your sole trade business. You need to disclose everything from employment income, interest on your savings account to the capital gain on selling a second home.

Make sure you have a full understanding of what needs to be disclosed on your tax return. Take a look at my tax checklist here.

4 – Be organised – file your tax return and pay your tax on time

HMRC are very open about the fact that they will perceive you as a “riskier” case if you are late in filing and paying tax. HMRC suspect that you either have something to hide or are disorganised with your record keeping with the latter resulting in potential errors to your accounts and tax.

Sole traders have a deadline to submit tax returns by 31 January following the end of the tax year. Payments for tax must be made by 31 January and 31 July of each year.

Make sure these dates are in the diary and leave plenty of time to sort out queries.

5 – Keep high quality and accurate business records

To produce accurate accounts you need a good bookkeeping system – one which is easy to use, easy to retrieve information from and keeps your data safe.  I’ve got some more bookkeeping tips for you here.

Small errors and mistakes are more likely if you are using manual or spread-sheet systems so don’t rule out moving to accounting software. You can take a peep at why this might make sense here.

Accurate records will not only demonstrate that you are professional in your approach to running your business but will also help answer any queries HMRC may have regarding accounting transactions or tax issues.

Make sure that you keep copies of all your paperwork such as invoices, bank statements, cheque book stubs, paying in books, receipts and mileage records for 6 years.

6 – Use an accountant

Tax payers who are not represented by an accountant are more likely to be looked at than those who have an accountant on board.

Accountants will be able to review your accounts and tax return and recommend any additional disclosure on your tax return to pre-empt questions.

 

Summary

If we distil these helpful tips they are essentially the by-product of good habits and organisation.

If you file your returns and pay your tax on time, stay on top of your bookkeeping and are open and forthcoming about any unusual items or large variations in your numbers, then you will be sending a strong message that you understand your responsibilities and are running your business in a compliant fashion.

What next?

You may want to consider taking out insurance cover to protect the business from having to pay additional accountancy fees to deal with an HMRC enquiry. If you are a member of the FSB, you will get FREE cover.

Need some support with your small business accounts and tax? I’m here to help. You can look me up here, check out what others say about me or drop me a line here. I’d love to hear from you.

Not ready yet? feel free to sign up to more helpful tips in running your small business.

Over to you

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