Many books have been written about how to improve your chances of winning in the National Lottery or how to improve your chances of backing a certain winner in the 2.30 at Chepstow. This article is about how to avoid winning the HMRC lottery and therefore avoid the prize of having a Tax Inspector crawling all over your business.
HMRC investigations of any kind are costly in time and even more costly in the emotions they engender and the distraction they cause in the running of your business. So is it possible to avoid them?
The honest answer is that no one has absolute immunity from investigation. There is always a small random element in the choice of cases for enquiry but there are a number of basic things that you can do to help improve your position.
The number one priority is to have an impeccable record of submitting all tax returns on time. This applies not just to the personal self assessment or the corporation tax return but also covers your employer returns such as the P35, the P11Ds and any regular VAT returns that you have to make. Regular delays in submission signal to HMRC that there may be control issues and put the accuracy of basic business records under scrutiny.
Number two is to always ensure that your returns are accurate and complete. HMRC have a wide range of information gathering powers and receive large amounts of information from third parties about amounts that might be paid to you. The omission of interest credited to bank accounts from returns is common and is a regular reason for HMRC to start an enquiry. Information is also obtained about commission payments and a wide range of other matters.
Number three would be to look at your business accounts when they have been prepared and try to explain any significant changes from the previous year. HMRC will look at trends in accounts and also compare them to results from other traders in your line of business. Marked differences will cause alarm bells to ring. Consider providing explanations when the return is submitted that might prevent questions being asked. Look for the reasons for significant changes in turnover and gross profit rates - they are real favourites of HMRC. There may be a very good reason why things have changed - make sure the Inspector knows. Only a few years ago your Tax Inspector would have been in an office probably no more than 20 miles away from you. Today it is more likely that your Tax Inspector will be many hundreds of miles away from you and he will have absolutely no knowledge of the trading conditions you are facing - so tell him!
Cash businesses are always high on HMRC's suspect list and extra vigilance is needed here but HMRC know that people being paid by direct bank transfer can arrange for money to disappear as well.
Dramatic changes in turnover / gross profit rates will really ring alarm bells when drawings taken from the business or remuneration paid seem to be insufficient to meet perceived living expenses. Remember that the Inspector has only the return on which to make a judgement and some background information may help make the difference.
If you are a sole trader or in a partnership, perceived inadequate adjustment for private matters such as motor expenses, or goods taken for own use, may prompt an enquiry.
Major changes in any other significant expenses may also need to be explained and you should always ensure that your stock or work-in-progress at the year end has been given some careful thought.
HMRC have new powers from April 2009 which will alter the way in which they carry out investigations. They also have a new penalty regime that will inevitably mean that the level of penalties charged where tax has been lost due to negligence or deliberate action on the part of the taxpayer will increase. You don’t want to be involved in helping an Inspector get practical experience of how the new powers work! Various tax returns will be prepared over the coming months so give some careful thought to what goes in them.