HMRC enquiries: Complete guide for small businesses

Blogs 20 Dec 2022

Our guide to HMRC enquiries takes you through the whole process, including how long they take, what you need to do and how you can protect your business.

As a business owner, you might find your business finances and tax under enquiry. An enquiry by HMRC can feel like a time-consuming process that keeps you away from the task of working on your business, so knowing what to expect can alleviate some of the initial panic.

In this guide, you’ll learn:

What triggers a tax enquiry?

It’s possible to be selected at random for a tax enquiry, and if you have good financial and accounting records, that will go a long way to making any enquiry easier to navigate, but it does depend upon the attitude of the inspector you are dealing with.

HMRC risk assesses their compliance activity using data from a variety of sources pulled together in their Connect computer system. This ranges from the returns you submit each year to information received from banks and building societies, land registry checks, DVLA, social media information publicly available (so don’t tell the world you have 10,000 customers and return income that suggests you only have 100…) and indeed information they receive about you from members of the public with an axe to grind.

What you have to remember is that HMRC are not obliged to give a reason for starting their enquiry. Whilst the nature of the questions asked in the opening letter may help identify their concerns, the FSB Tax Investigation Protection consultants who represent FSB members in an enquiry will always seek to have that discussion with the inspector early in the enquiry. It really does help to understand the inspector’s focus in order to achieve the best result for you.

However, some of the following can be triggers:

  • Mistakes, omissions or inconsistencies in tax returns.
  • Your business results being at odds with what HMRC might expect from that trade or sector.
  • Large year-on-year changes. For example, an increase in spending from one year to another.
  • Low drawings of proprietor or capital introduced into the business.
  • Types of trade or business; e.g. cash trades, trades where HMRC can verify income against 3rd party information.
  • VAT returns leading to repayment claims.

Furlough enquiries

Since the autumn of 2020, HMRC has been undertaking compliance checks into claims made under the Coronavirus Job Retention Scheme and Self-Employed Income Support Scheme. PAYE compliance reviews may also involve an assessment of the payroll payments made to employees, including furlough payments, to ensure CJRS payments were made to employees and the correct tax and NIC was deducted.

FSB members whose furlough claims are reviewed can make a claim and receive representation for such an enquiry and should make a claim at the earliest opportunity following receipt of a letter from HMRC.

How does a tax enquiry work?

The process will start with a letter including a notice from HMRC advising you that an enquiry is being undertaken. No reason has to be given as to why the enquiry is being undertaken. A valid enquiry notice must be issued within 12 months of the date the Tax Return was submitted to HMRC, excluding late returns. It’s always worth checking the validity of the notice.

The letter will include a suggested deadline for your response, usually between 30-35 days. Your response has to be in writing.

HMRC undertake two types of enquiry. Aspect enquiries, which are concerned with only some of the entries on your tax return. They tend to be more targeted and often more technical, challenging why specific items have been claimed. A full enquiry is arguably an expression of dissatisfaction with the entire return and suggests that HMRC have real and genuine concerns about the business and will request sight of all of your business records for the year of enquiry.

What will HMRC need from me?

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

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

Communicating with HMRC

If you don’t respond on time, the inspector can issue a Schedule 36 FA 2008 information notice. This orders the production of documents and particulars to HMRC. If you don’t comply, you will be charged a monetary penalty. The inspector can revert to issuing a notice every time there’s a delay. If you feel the request is unreasonable, you can appeal.

It would not be unreasonable to expect HMRC to respond within similar timelines as those asked of you, the taxpayer, but don’t expect that always to be the case. If there are lengthy delays in the case, or you feel HMRC’s requests for information and documents are unreasonable, you can challenge this through various means including making a closure notice application to the Tribunal if this is considered appropriate.

During a meeting with HMRC

There is nothing in legislation which compels a taxpayer to meet with HMRC and certainly in more technical types of enquiry and in VAT, Employer Compliance (PAYE/P11D/NIC) and IR35 compliance visits/disputes, it’s rare that you would need to be present  (HMRC always prefer to meet to question you face to face albeit this is more likely to be virtual in the post-pandemic world).

In a full enquiry, where HMRC are likely to want to understand the complete workings of the business, verify whether the income of the business can both support business expenditure and your own personal outgoings, then a meeting is more likely. It may then be in your best interests to meet, but you should be guided by your adviser.

If you do attend a face-to-face meeting with HMRC, this will often take place at the inspector’s office, but can be at your business premises or at a neutral venue if preferred.

The inspector will usually have questions relating to specific aspects of the business. These could include, but are not limited to:

  • Historical background of your business
  • Work undertaken, changes over recent years or who does what in the business
  • VAT issues and PAYE, if applicable
  • Record keeping and maintenance
  • 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

HMRC has the right to enquire into the personal finances and circumstances of directors where concerns arise. However, directors are a separate legal entity to the company, and the company can’t be asked to supply director’s personal financial records without due cause.

It’s not uncommon for HMRC to request the bank statements of the proprietor. This should be resisted unless HMRC can clearly demonstrate why these are needed for the purposes of checking the Return under review. It’s important therefore to keep your personal and business bank accounts separate, otherwise, you are giving HMRC easy access into your personal financial affairs.

FSB members have access to experienced professionals, including former tax inspectors, to represent you during certain HMRC enquiries into your business.

How long does an enquiry take?

The length of an enquiry depends on:

  • the extent of the enquiry
  • the amount of information HMRC has to look through
  • the area of taxation being investigated
  • the size of your business

Full enquiries will last around 18 months on average, whereas aspect enquiries usually last between three and six months, but can take much longer in cases where more complex matters are under review and also where disputed valuations arise.

Only one enquiry can be undertaken into a specific year’s return, so once a closure notice is issued there can be no further questions in that return unless HMRC make a discovery of any irregularities at a later date.  However, that doesn’t mean that an enquiry can’t be opened into a subsequent return.

What happens at the end of enquiry proceedings?

If HMRC is satisfied that your original self-assessment return was correct, then the enquiry will be concluded without any further action. If there is additional tax to pay as a result of errors or omissions made, there will be interest to pay on the tax as it was not paid at the correct time and the inspector may seek to apply a penalty – please see more detail below.

Use the end of a tax enquiry as an opportunity to learn and assess the way you report your business profits, and then take steps to ensure you avoid similar issues in future.

At the end of an enquiry where an adjustment is sought by HMRC, you have 30 days within which you can appeal their decision.

Minor adjustments

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

Larger Adjustments

In this situation, 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 basis to make adjustments in these other years.

If the adjustment arose from a careless error, HMRC can go back six years and if the error was deliberate then HMRC are able to go back 20 years, resulting in significant liabilities including interest and harsher penalties.

What penalties can be charged?

The penalty regime is based on ‘taxpayer behaviour’. There are a number of general factors which will be considered:

  • The nature of the error/omission.
  • Should you have sought advice before taking action?
  • What awareness of this particular issue existed? For example, if HMRC highlighted the issue but you took no action.
  • Whether you cooperated with the enquiry and whether you volunteered information or needed to be prompted.

The penalty regime applies equally to tax and VAT returns and considers the reasons based on the above factors to determine whether errors and omissions were due to:

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

The gravity of the failure increases the level of penalty with mistakes despite taking reasonable care not attracting a penalty and deliberate with concealment attracting a penalty of up to 100% of the tax due.

Penalties can also be charged for the submission of an incorrect return.

  • Fines for late payment of taxes
  • Fixed percentage fines for any unpaid tax
  • Repaying outstanding taxes

Other penalties can also be levied, based on:

How to stay organised during an enquiry

Being organised can help to identify any potential taxation issues before they become a problem.

Organising your paperwork

Keeping your financial information organised is important so you can find it quickly when HMRC requests it. This includes:

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

You should keep your records on a monthly basis, with everything organised by type.

How to protect your business

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

Plan, plan, plan

  • Submit your tax returns on time (don’t leave it until the last minute!)
  • Keep good records, be accurate and declare everything
  • Explain any changes before the question get asked
  • Include the possibility of an enquiry in your business continuity plan

Are you covered?

With potential payments to HMRC for backdated tax and fines, and fees for accountants and other financial specialists, tax enquiries can be very costly together with being time-consuming and stressful, irrespective of whether you have done anything wrong.

Tax enquiry insurance can help to cover the fees and lessen the financial blow, as well as acting as a buffer between you and HMRC, allowing you to focus on your business during the course of the enquiry.

Wave goodbye to tax enquiry worries

FSB Tax Investigation Protection provides comprehensive support and tax investigation insurance for most business-related HMRC enquiries, all at no extra cost. We’re on your side.

Find out more