Submitting a tax return is an an administrative headache for many small and medium-sized enterprises (SMEs), but most console themselves with the thought that once it’s done it’s out of the way for another year. However, with the number of investigations into SME tax affairs on the rise, that may not remain the case.
In theory, HM Revenue & Customs (HMRC) has up to six years after the end of the tax year to open an investigation into the return filed for that year. In practice, the tax office can go back for up to 20 years if it suspects tax has been deliberately evaded.
Analysis of the 2016-2017 tax year suggests that SME investigations yielded extra tax of £504m, 8% up on 2015-2016. This is part of a broader effort by HMRC to narrow the tax gap (the difference between the tax it estimates it should collect and what it actually receives). But some advisers believe that smaller firms are being deliberately targeted because they have fewer resources with which to defend themselves. Either way, HMRC’s increasingly sophisticated data analysis is making it far easier to spot inconsistencies by cross-referencing different sources of data on businesses’ income.
Clearly, the best approach to HMRC investigations is to avoid them. Filing complete, accurate tax returns on time certainly helps. HMRC is also more likely to investigate SMEs with big fluctuations in income and costs from year to year, so explain any significant changes when you file your return. But if you receive notice of an investigation, don’t panic.
While communications from HMRC can appear threatening – and are designed to elicit a speedy reaction – don’t rush. Take some time to marshal all the paperwork you are likely to need to answer HMRC’s questions (which you are by law required to keep for at least six years), and consider consulting an accountant with experience of handling SME investigations.
Make sure you understand exactly what type of investigation HMRC is proposing. Each year it conducts some random investigations; these aren’t based on a concern that the business has filed incorrectly, although they need to be treated just as seriously.
However, aspect enquiries, focused on one part of your return, or full enquiries into your whole return, will have been triggered by something HMRC has spotted. It doesn’t mean it thinks you’ve done anything wrong – just that your figures require further explanation. The most serious type of investigation is a Code 9 (COP9) enquiry, which HMRC only embarks on in cases where it suspects tax fraud. If you receive this notification, seek good-quality professional advice on how to respond.
Does investigation insurance pay off?
It is possible for small businesses to buy insurance that will pay out to cover the costs of an HMRC investigation. You can purchase this either on a standalone basis from many accountants, or as part of a broader legal expenses policy. Advisers are split on whether the cost of such insurance – likely to be a few hundred pounds a year – is justified, particularly as policies typically come with a number of exclusions (so read the small print).
But insurance can provide reassurance, especially for businesses in areas where there is a higher risk of investigation – those engaged in cash-based trades, for example, which is one area where HMRC has been increasing its focus in recent years.
If you are considering buying tax-investigation insurance, make sure (as with any other insurance) that you understand exactly what’s covered by the policy. In terms of what you can typically claim, you should be able to claw back the expenses that you incur in dealing with the HMRC investigation, which potentially includes professional fees (again, check the policy). However, you won’t be able to protect your business against additional tax demands or penalties, which, of course, is probably the biggest source of uncertainty arising from any such investigation.