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Seven reasons why HMRC might investigate your business and how to avoid being audited

If HMRC chooses to investigate your tax returns, you could be in for a costly and lengthy process. So what can you do to make it less likely while also keeping your finances in check?

Being audited, or, as it’s officially termed, being under HM Revenue & Customs tax investigation, is not something you would ever want to go through. Not only is it a frightening experience, it is also expensive and time consuming.

When you submit your self-assessment to HMRC, that submission stays ‘live’ for six years, meaning it could be investigated by HMRC at any time in that period after submission is made (an investigation can occur after this period, but generally only in exceptional circumstances). If you are selected for attention, it is difficult to say how detailed the investigation will be or how long it will continue. It all depends on what HMRC believes to be the issue that will determine the level of scrutiny. What is important is that you will need to be able to provide proof and documentation of any income, expenses or financial activity that you are asked about.

Unfortunately you can’t eliminate the possibility of being investigated – indeed, a small number of unlucky sole traders are picked entirely at random every year. However, there are ways to minimise this.

Here are seven common causes for HMRC to investigate and how you can operate correctly to avoid unwanted attention:

1. HMRC gets a tip-off

Why would somebody tip off HMRC for a potential investigation? The most common reasons are:

• Unhappy acquaintances who may suspect dodgy activity.

• The existence of a cash-only policy at your business.

• Living a lifestyle beyond your supposed means.

Make sure you don’t get your business involved in any dodgy deals, or anything suspicious. The risks are not worth it. It would seem unjust to spend money to fit the idea of your income if you receive money from elsewhere, such as inheritance, investments or trust funds. As for the existence of a cash-only policy, being able to accept card payments is not an expensive practice today. It also removes that concern from suspicious clients.

2. Regular mistakes on returns

Making a single mistake on your tax return is not something you should worry about. They happen and HMRC understands not everyone is a tax expert. So it makes allowances and forgives these one-off sins.

However, if you regularly make mistakes on your returns, submitting inaccurate figures or information year after year will make HMRC suspicious. It will cause investigators to start digging. If you’re making mistakes two years in a row, you should get help from an accountant to make sure things will go smoothly from then on – or fire your existing accountant!

3. Numbers fluctuate by large margins

It’s uncommon for businesses to have large fluctuations year on year. Say you’ve had a profitable year in 2015 making £10,000, but the next year the profit dropped to £3,000. There could have been a sound explanation for this, but HMRC is going to notice.

To avoid an investigation, inform HMRC of the reason. While you’re writing your self-assessment you can write notes about any of the information you are submitting. So tell HMRC what happened. You were sick and had to cut down on your working hours, there was a lot less work, etc.

4. Years of unprofitability

So you’ve been in business for years, and still haven’t turned a profit. If you’ve had a lot of investment carrying you through, this isn’t impossible. Years of unprofitability will certainly ring the loud bell at HMRC’s door. Again, our advice is to inform it of the reasons behind your unprofitability.

5. Your figures are inconsistent with industry standards

For most industries, HMRC generally has a good idea of what you should be earning.

Example: It knows a local gardener is unlikely to be earning £500,000 a year. It compares the latest trends and patterns in particular businesses or professions and evaluates it against other available information.

If your figures vary from the industry standard wildly, eyebrows will be raised and HMRC tax investigations are unlikely to be far behind. So if you’ve recently signed a five-year deal with a famous record company and have become an overnight singing sensation, you should mention this on the note section of your next self-assessment.

6. Omission of income

If your business involves working and engaging in transactions with other businesses, your fingerprints are all over their finances. This applies to banks and lenders on interest as well. It’s important to declare all payments received.

Let’s say you failed to declare you were paid interest, and it comes up during an investigation from the company that paid you that interest – HMRC will not be happy about it and there will be an investigation.

7. You do not have representation

It’s always a good idea to have an accountant to double-check your books. As stated earlier, HMRC doesn’t expect you to be an expert on tax, but you need to be responsible enough to provide accurate books.

Having an accountant represent your business boosts your trustworthiness in the eyes of HMRC and reduces your chances of being investigated.

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