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How does tax investigation work?

  • Blog
  • 17 November 2016

Notification that your business is the subject of a tax investigation by HMRC need not mean disruption of your day-to-day operations. Knowing what to expect can alleviate some of the initial panic. Let’s take a look at what’s involved in a tax investigation.

Initial contact

The process will start with a notice from HMRC advising you that an investigation is being undertaken. No reason has to be given as to why the enquiry is being undertaken.

The letter will include a deadline for your response, which varies depending on the type of business, but is usually between 30-35 days. Your response has to be in writing.

How does tax investigation work?

Why am I being investigated?

Tax inspections happen for a variety of reasons, including:

  • Omission
  • You may be in an HMRC target area
  • Risk assessed selection including cash trades, low drawings of proprietor or capital introduced into business

Often, an investigation is initiated when HMRC believe something is wrong e.g. if you are always late with submitting your self-assessment or you have high expenses in relation to income.

What’s involved?

This depends on the level of enquiry.

An aspect enquiry, as implied by the name, is concerned with part of a tax return, a full enquiry will look into the entire return and will request submission of business records for the year of the enquiry.

HMRC will usually request submission of all records maintained by the business for the year of enquiry, but this may vary depending on what is being investigated. Generally HMRC will ask for:

  • Bank statements
  • Chequebooks and paying in slips
  • Credit card statements
  • Sales invoices / Till rolls
  • VAT records
  • Job quotes or estimates
  • Purchase invoices and expense receipts
  • Payroll records

In the case of computerised records, HMRC can ask for details of the software package, and a copy of the records on disk.

How long does it take?

The length of an investigation depends on the extent of the investigation. The average duration of a full investigation is circa 16 months whereas an aspect investigation can last between 3 – 6 months, but can take longer.

Progressing the enquiry

It’s in your best interest to respond within timescale given in the letter from HMRC. If you do not respond within the timescale given, the inspector can issue a Schedule 36 FA 2008 information notice, which orders the production of documents and particulars to HMRC. If you do not comply with such a notice you will be charged a monetary penalty

The inspector will usually reply within 28 days, and they will expect the same response time from you. If not, the inspector can again revert to issue issuing a Sch 36 every time a delay is encountered. If you feel the request is unreasonable, you can submit an appeal.

If, however, there are lengthy delays in a response from the inspector, or you feel there are no reasonable grounds for the documents requested to be provided, you can ask for the enquiry to be listed as a personal hearing before First Tier Tribunal to make an application for a closure notice

Meeting

If you are required to attend a meeting with an inspector, this will usually take place at the inspector’s office, but can be held at your premises or your accountant’s office by request.

You don’t have to attend the meeting and the inspector can’t force you to do so, but a meeting is often the quickest and simplest way to progress an enquiry.

If you are requested to attend a meeting with a tax inspector during a full enquiry, you should ask for an agenda and adhere to it during the meeting.

The standard format of an agenda usually proceeds as follows:

Opening

The inspector will explain HMRC’s right to enquire. They will advise you that notes will be taken and that these notes will be referred to later.

Specific questions

The inspector will usually have questions relating to specific aspects of the business, including, but not limited to:

  • Historical background of the business
  • Work undertaken
  • Changes over recent years
  • VAT issues
  • PAYE, if applicable
  • Who does what in the business
  • Record keeping
  • What records are maintained
  • Cash handling and banking policy
  • Timing of invoices
  • Payment of expenses, cash and cheque
  • Business receipts, cash and cheque
  • Personal and private expenditure
    • Loans from friends and family
    • Betting wins
    • Endowments maturing
    • Legacies

Directors

When enquiring into company, HMRC also has the right to enquire into the personal finances and circumstances of directors. However, directors are a separate legal entity to the company, and the company can’t be asked to supply director’s personal financial records.

Specific concerns

Any specific concerns arising from the examination of the business records, not covered by the above.

Summary

At the end of meeting, the inspector will summarise where the enquiry currently stands after the meeting. If the enquiry can be concluded at this point, the inspector will advise you of this. Alternatively, the inspector will detail any information required and agree a timescale for the production of documents.

Concluding the enquiry

No adjustments

If there are no adjustments, the inspector will say so and the self-assessment will be accepted as submitted.

Minor adjustments

The inspector will advise you of the reasons for the adjustment, and how the quantum has been calculated. The inspector will amend the self-assessment using these figures.

You will be given 30 days to appeal. An appeal will ultimately be heard by the First Tier Tribunal.

Larger Adjustments

Where larger adjustments are sought, the inspector will assume that similar errors or misstatements occurred in earlier and possibly later years. The inspector won’t want to review these records, but will use the presumption of continuity. The level of adjustment sought in year of enquiry will form the basis of adjustments for other years.

The number of earlier years brought into any settlement will depend on the reason for the error identified. If the adjustment arose from a careless error, HMRC can include a maximum of 6 earlier years in the settlement but if the error was deliberate then HMRC are able to go back for 20 years

Only one enquiry can be undertaken per return, so once a closure notice is issued there can be no further questions in that return, but that doesn’t mean that an investigation can’t be opened on a subsequent return.

Penalties

Where adjustments are identified, a penalty can be charged for the submission of an incorrect return.

The penalty regime tries to focus on and penalise the behaviour that led to the adjustment required. This penalty regime applies equally to tax and VAT returns and firstly considers the reason for the incorrect return, namely:

  • Mistake despite reasonable care
  • Failure to take reasonable care (careless)
  • Deliberate but not concealed
  • Deliberate with concealment

Reduce your chances

While there is no way to safeguard against tax investigation, you can take some steps to minimise your risk.

  • Submit your tax returns on time
  • Be accurate and complete
  • Explain any changes before the question get asked
  • Keep good records and declare everything

How FSB can help

FSB Legal Benefits policy protects members who are subjected to an HMRC enquiry. The policy provides cover in respect of both Full & Aspect enquiries and provides for a specialist tax consultant.

You can also read the full Tax Investigation document, including the standard HMRC stencil detailing household spending requirements, and get access to the full library of legal and tax documents, by joining FSB.

If you’re already a member, log in here to access the document library.

FSB Tax Investigation Protection from the FSB

Tax advice & investigation protection from the FSB

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