That sinking feeling when an HMRC envelope lands on your doormat or an official email appears in your inbox – few things strike more fear into the hearts of business owners.
But just how common are tax investigations, and what makes HMRC decide to take a closer look at your affairs?
With HMRC ramping up their compliance activities and investing in new technology to detect discrepancies, understanding what triggers investigations has become essential knowledge for anyone running a business or managing their personal taxes.
In this article, we’ll explore the current landscape of tax investigations, reveal the most common triggers that put taxpayers in HMRC’s crosshairs, and provide practical guidance on how to reduce your risk of facing an unwelcome inquiry.
The Rising Tide of Tax Investigations
The political pressure on HMRC to boost revenue collection has never been greater. With a mounting national debt and increasing demands for public services, tax compliance has become a primary focus for generating additional revenue.
Recent figures show that HMRC collected £814 billion in tax revenues in 2022-23, with £34 billion directly resulting from their compliance activities targeting avoidance, evasion, and non-compliance.
While significant, this fell short of their annual target, suggesting we may see even more aggressive investigation activity in the coming years. The tax gap itself stands at 4.8% of theoretical tax liabilities (as of 2021-22), down from 7.5% in 2005-06.
This improvement represents billions in additional revenue, but HMRC continues to pour resources into further reducing this figure – meaning more investigations are likely.
How Common Are Tax Investigations?
Tax investigations are far more prevalent than many realise, and the numbers reveal a clear upward trend in HMRC’s enforcement activities. This isn’t merely about catching deliberate tax evaders; it’s also about ensuring everyone pays their fair share through proper compliance.
While HMRC doesn’t publish exact figures on the number of investigations it conducts, the data available gives us valuable insights:
- HMRC’s tax evasion hotline receives some 208 calls per day
- Around 76,000 suspected tax fraud queries were made in 2022-23, a 4% increase from the previous year
- In 2021-22, there were over 4,000 recorded tax evasion cases, reflecting a 5% increase from the previous year
- HMRC launched 625 new criminal investigations in 2022-23
- The government has pledged an additional £1 billion in funding for HMRC tax compliance efforts from 2022 to 2025
What’s clear is that both the resources dedicated to investigations and the number of cases being examined are on the rise.
HMRC’s chief executive has explicitly stated their intention to keep the tax gap in check, which translates to more investigations for taxpayers and businesses.
What Triggers a Tax Investigation?
Behind every investigation lies a trigger – something that caught HMRC’s attention.
Understanding these triggers isn’t about finding ways to avoid your tax obligations, but rather ensuring your legitimate affairs don’t unnecessarily raise red flags.
Unusual Fluctuations in Income or Expenses
Significant changes in your financial position from one year to the next raise red flags.
If your business suddenly claims much higher expenses or reports a substantial drop in profit without a clear reason, HMRC may want to understand why.
For example, if your business consistently reported profits of around £75,000 for several years and then suddenly shows only £40,000 with no apparent change in operations, this disparity might raise questions.
Industry Benchmarking
HMRC maintains detailed data on typical profit margins, expense ratios, and income levels across different industries. If your figures deviate significantly from industry norms, this could attract attention.
A restaurant reporting gross profit margins of 45% when the industry average is 65-70% might face questions about potential unreported cash sales.
Third-Party Information
HMRC receives vast amounts of data from third parties, including:
- Banks and financial institutions
- Land Registry
- Companies House
- Online marketplaces
- Payment processors
- Property rental websites
This information is cross-referenced with your tax returns. Discrepancies, such as interest received but not declared or property transactions not correctly reported, can trigger investigations.
Random Selection
Each year, HMRC randomly selects a percentage of returns for checking, regardless of whether they show any concerning patterns. This approach helps HMRC maintain compliance across the board and gather data on taxpayer behaviour.
Tip-offs
Reports from the public, disgruntled employees, or business competitors can prompt HMRC to take a closer look at your affairs. The tax evasion hotline receives thousands of calls each year, and HMRC follows up on credible information.
Previous Errors or Late Filing
A history of mistakes, late submissions, or tax disputes makes you statistically more likely to face an investigation. HMRC’s system flags taxpayers with previous compliance issues for more frequent checks.
Lifestyle Inconsistent with Reported Income
If you’re reporting modest income but displaying signs of significant wealth (expensive cars, property, frequent luxury holidays), HMRC may question whether all income is being properly declared.
Types of Tax Investigations
The nature and scope of tax investigations vary widely based on what triggered them and HMRC’s assessment of risk. The three main ones are:
1. Aspect Enquiry
These focus on specific parts of your tax return that HMRC wants to verify. Perhaps they’re questioning a particular expense claim or income source. Aspect enquiries are generally shorter and less intrusive than full investigations, but shouldn’t be taken lightly.
2. Full Enquiry
These comprehensive reviews examine all elements of your tax return, business accounts, and sometimes personal financial records, too. HMRC may look at multiple years and can expand the investigation if initial findings raise concerns.
3. Random Check
Sometimes there’s no specific trigger – your return is simply selected as part of HMRC’s random sampling programme. These checks help HMRC ensure compliance across the taxpayer population and gather data on common errors or avoidance strategies.
The Financial and Emotional Cost of Investigations
When you’re facing a tax investigation, it’s not just about the potential additional tax bill at the end. The process itself can be draining.
First, there’s the financial burden. Accountancy fees alone can quickly mount up, often reaching thousands of pounds for complex cases. The longer an investigation drags on, the higher these costs climb.
Then there’s the time factor. Most aspect enquiries might conclude within a few months, but full investigations frequently stretch beyond a year. Throughout this period, you’ll need to allocate precious time to gathering evidence, attending meetings, and responding to queries – time that could otherwise be spent running your business.
The mental toll shouldn’t be underestimated either. Many business owners report significant stress and anxiety during tax investigations. The uncertainty, the feeling of being under scrutiny, and the potential consequences can weigh heavily on your well-being.
And finally, if HMRC does find issues, you’re looking at not just the tax you originally owed, but also interest calculated from when the tax should have been paid.
Add potential penalties on top (which can reach 100% of the tax in cases of deliberate errors), and the financial consequences become serious indeed.
Learn more about potential penalties in our article here.
Protecting Yourself from Investigations
While you can’t entirely eliminate the risk of an investigation, you can take practical steps to reduce the likelihood and minimise the impact if one does occur.
1. Maintain Accurate Records
Good bookkeeping is your first line of defence. Keep organised, detailed records of all income and expenses, and retain supporting documents for at least six years.
2. Ensure Returns Are Complete and Accurate
Take time to review your returns before submission. Many investigations start simply because of careless errors or omissions that could have been avoided.
3. Explain Unusual Items
If your tax return contains anything unusual – a one-off large expense, a significant drop in profit, or an exceptional gain – include explanatory notes. Being proactive helps address potential questions before they trigger a formal investigation.
4. Consider Fee Protection Insurance
This insurance covers the professional costs of dealing with an HMRC investigation. It won’t prevent an investigation, but it can make the experience much less financially painful.
5. Work with Qualified Professionals
HMRC looks more favourably on taxpayers who employ qualified accountants to handle their compliance. Professional guidance reduces the risk of errors that might trigger investigations.
What to Do If You’re Investigated
If that dreaded notification arrives, your immediate response can significantly influence how smoothly the investigation proceeds and its ultimate outcome.
- Don’t panic – many investigations are routine and don’t mean HMRC suspects serious wrongdoing.
- Contact your accountant immediately – professional guidance is vital throughout the process.
- Gather relevant records – but don’t send anything to HMRC until you’ve discussed it with your advisor.
- Respond promptly to HMRC requests – delays can create a poor impression and potentially increase penalties.
- Be cooperative but cautious – answer the questions asked, but don’t volunteer additional information unnecessarily.
How Double Point Can Help
At Double Point, we understand the stress and complexity of tax investigations. Our team of chartered accountants has extensive experience helping clients through the investigation process, from initial response to final resolution.
We provide:
- Expert guidance on responding to HMRC inquiries
- Thorough review of your financial records before submission to HMRC
- Professional representation in meetings and correspondence
- Fee protection insurance to cover the costs of an investigation
- Proactive tax planning and compliance reviews to minimise investigation risks
Don’t face HMRC alone. Book a consultation with Double Point today to discuss how we can help protect your business from the disruption and expense of a tax investigation.
