Could your business survive a tax investigation? Do you know how these operate and what’s involved? If the answer is ‘no’, you need to be aware of the consequences of an HMRC enquiry, particularly if you are a smaller business with limited funds. It could happen to you.
Tax investigations can be time consuming, expensive and very stressful. Leading small business support organisation and networking opportunities provider, the Federation of Small Businesses (FSB), has in-depth knowledge of them, as it provides all of its members with comprehensive and free tax advice and tax investigation insurance, to protect them, should they be chosen by HMRC.
27% of all tax enquiries handled on behalf of FSB members in the 11 years to 30 September 2014 were for businesses with turnover below the VAT threshold and half were for businesses declaring profits of £15,000 or less. It is not just larger businesses that are targeted.
Here FSB helps you understand how HMRC tax investigations operate.
Each year, one in 1000 businesses is subjected to a tax investigation and traditionally around seven per cent of targeted businesses have been random selections from HMRC’s database. The rest have been targeted because of their business sector, their ways of transacting business, their annual accounts, or errors in tax information submitted to HMRC.
In recent years, HMRC has acquired a lot of knowledge from databases held by bodies such as the Land Registry, banks, local councils, hospitals and the DVLA. This is fed into HMRC’s powerful computer system and cross-referenced, to identify discrepancies between the amount of tax paid and the picture the computer creates. For example, the number of cars registered to the business, might be higher than HMRC would expect, looking at the business’s declared profit and turnover.
Some would now argue that no tax investigation is truly random these days.
How a tax investigation works
A tax investigation is emotional and extremely in-depth. As with jury service, there is no escape and you must comply. It is worth noting that HMRC believes it can pick up any file and find some sort of tax discrepancy. Bear in mind that, under a tax investigation, you are guilty until proven innocent.
HMRC has the right to open an enquiry into any tax return and does not have to provide a reason. The investigation can start with a Self Assessment Tax enquiry and then simultaneously examine business VAT and PAYE returns. Cross-discipline reviews are increasingly common.
You will be subjected to either an ‘Aspect’ enquiry, looking at specific aspects of the tax return, or a ‘Full’ enquiry, which reviews everything. If put under a Code 9 (COP9) investigation, this is extremely serious and full and complete disclosure is required.
Once you receive that most feared of brown envelopes from HMRC, notifying you of a tax investigation, you will usually have around 30 days to supply documentation such as business bank statements, sales and purchase invoices, business credit card statements, VAT records, petty cash book, job quotes and estimates and your job booking or appointments diary. Under a Code 9 investigation, you must reply to HMRC within 60 days.
You will be required to attend face-to-face meetings with the tax inspector, accompanied by your consultant or adviser. It is worth taking the time to prepare carefully, presenting not just figures but the background to your business, explanations for unusually low salary drawings, or high expenses, and many other things.
It is advisable to appoint a tax consultant straight away and also wise to immediately disclose anything you know was not accurate. If you are an FSB member, you simply need to activate your insurance and right to tax consultancy as part of your membership.
If you try to cover things up, you will face increased penalties. On average, tax inspections last a very long 16 months and cost, on average, £5000, even before any penalties are levied. Records stretching back five years, or more, can be scrutinised.
Certain types of business are more at risk than others. Businesses handling mainly cash payments are regularly under scrutiny, with this covering a wide variety of trades-based businesses. HMRC often focuses on certain sectors and professions, this including construction, solicitors, buy-to-let property owners, driving instructors, pharmacists and taxi firms.
You could also trigger an investigation if you send in your tax return late, so it certainly pays to meet the deadline. Unusual fluctuations in your turnover or profit, loans to directors, large balance sheet adjustments, large benefits in kind to employees or directors and low drawings by the business owner, can all make your business susceptible. HMRC also benchmarks businesses against each other. If your profile doesn’t stack up, you could be selected.
HMRC may have been monitoring your business and could even have studied your social media posts. It is not unknown for HMRC to question why someone drawing such a small salary from their company can afford so many luxury holidays and such expensive cars and possessions. Additionally, don’t forget that you could end up on HMRC’s radar because of tip-offs.
There is no set cost for a tax investigation. An FSB member from the licensed trade claimed £9500 on his policy and paid an added liability of £3084 after a 28-month enquiry. An antique dealer faced a 30-month enquiry and claimed £4800, having to pay an additional £3820 to HMRC.
HMRC penalties fall within a range of up to 100 per cent on the amount of unpaid tax. HMRC fixes the penalty according to whether the error was a genuine mistake, due to carelessness, deliberate but not concealed, or deliberate with concealment. Importantly, reductions apply to those who tell, help and give ready responses to HMRC’s inspectors.
A tax investigation can decimate any business, but particularly a smaller one. If the taxman cometh, the best possible scenario is having protection in place to cover expert advice and the fees of the specialist you will need to lean on. Visit http://www.fsb.org.uk/benefits/advice/fsb-tax-investigation-protection to find out more.