Most people in business worry about the taxman looking into their affairs. But how does HMRC make the decision to investigate the self-employed?
Investigating sole traders may appear to be a random act – but they tend to use mechanisms that alert them to any discrepancies. If your financial house is in order, you really don’t need to worry. But knowing some of the issues that alert HMRC should help you avoid an investigation.
How they decide to investigate the self-employed
There are a number of reasons that will ring alarm bells with HMRC. As a result, they are more likely to choose you for scrutiny.
Before self-assessment forms were introduced, 1 in 100 tax returns were investigated. Since then, it’s closer to 1 in 10! With reports stating that HMRC is taking more money from investigations, it’s clear they are keen to keep on probing tax affairs.
A number of events can help HMRC decide whether to investigate the self-employed.
There’s a tip off
Anyone can contact HMRC if they have concerns that your business isn’t fully above board. If you’re suspected of not declaring all your income, HMRC can start investigations. They will ensure all income is being declared on your self assessment tax return to ensure you’re paying the right tax on your earnings.
Failing to declare all your income could result in penalties or even prison. One millionaire trader who sold goods on eBay was jailed for two years for failing to correctly report his income.
You haven’t made a profit for years
With so many ups and downs over the past couple of years, making a profit might be more difficult. But if you’ve reported that you haven’t made any profits for many years, HMRC might become suspicious. They will want to find out if you’re under reporting your income or over reporting your expenses!
If your figures have been correctly reported, there’s nothing to worry about.
It’s not always easy to keep your turnover consistent, especially in economically challenging times. One year you could make a healthy profit, but the following you may struggle to make anything. But if HMRC monitors your profits and they seem to spike and fall dramatically over time, this could result in an investigation.
Of course, if the figures are accurate, then there’s no need to worry. But be aware that massive fluctuations will make you more likely to be investigated.
You make mistakes
Filing a self assessment tax return should be straight forward. It can be easy to make mistakes, however! Not ticking a box or forgetting to fill out a section increases your chances of being investigated.
HMRC wants to ensure that the information you’re giving is correct. They’re not out to punish you! A genuine mistake can be quickly cleared up, so make sure you always have the right documentation to hand.
You don’t use an accountant
Business owners and the self-employed do not need to use accountants legally. But not using an accountant can increase the chances of you being investigated.
Us accountants deal with tax every day, and we’re used to seeing the phrases, documents and forms that need filling in. That gives HMRC confidence as accountants will check your documents and figures before filing returns.
The tax office assumes you are more likely to make mistakes if you file your own returns. So, not using an accountant will increase the chance of you being scrutinised.
What if I’m investigated?
As we’ve already said, if you affairs in order, there’s no need to worry. Even mistakes can be cleared up without any problems if they’re genuine.
But if you’re hiding income sources or putting lots of personal expenditure through as expenses, this will increase the chances of investigation.
Types of enquiries
There are two types of ‘enquiries’:
- Full enquiry
- Aspect enquiry
If HMRC believes you have made a genuine mistake when filing your return, they may launch an aspect enquiry. This means they only investigate a part of your finances.
If they believe that you’re not reporting profits correctly to reduce your tax bill, then they’re likely to launch a full enquiry. In these investigations, they can ask to see your full business records. HMRC’s website tells you what happens during an enquiry.
How do I know if I’m being investigated?
Although many people worry about MI5-style covert investigations, HMRC are usually upfront when they investigate the self-employed! They will write to you if they decide to investigate you. The letter explains whether you will be investigated for a single aspect of your return or it will be a full enquiry.
If you use an accountant, HMRC also writes to inform them and requests any information required.
Be aware, they will write to you via post and will not text you or email you to provide personal details! Any email or texts are suspicious if they request anything personal, such as your bank account information or payments.
If you’re worried about a tax investigation or want help filing future tax returns, you can contact us today.