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Under What Circumstances Would HMRC Investigate A Self-Employed Person?

when does HMRC investigate self-employed

Filing your tax return can be a nerve racking process. No matter how thoroughly you’ve checked it before submitting, there’s always that little bit of lingering doubt that something might have slipped through the net. This might leave you concerned that you may be investigated by HMRC.

So, when does HMRC investigate self-employed workers, and should you be concerned if you receive notification of an investigation?

The most common reason for a HMRC investigation is if they receive a tip off that you might not be declaring all of your earnings. However, they may also choose to investigate sole traders who declare that they haven’t been making a profit for several years, or if there are large fluctuations in your annual figures.

In this article, we’ll explain how HMRC decides which sole traders to investigate and how you can minimise your chances of being chosen for a HMRC investigation.

Reasons For HMRC Investigation

There are a few reasons why HMRC might decide to investigate a sole trader. These range from a tip off to dramatically fluctuating self assessment figures.

Let’s take a look at some of the reasons why HMRC might decide to investigate you as a sole trader.

They’ve Received A Tip Off

If someone contacts HMRC with concerns that a business might not be trading fully above board, HMRC might decide to launch an investigation. This may be the case if someone thinks that you might not be declaring all of your income.

HMRC will investigate your business to ensure that all income is being declared on your self assessment tax return, to make sure you’re paying the right amount of tax on your earnings.

Mistakes Have Been Made

If HMRC believe that you have made a mistake with your self assessment tax return, they may investigate your business. This could be as simple as forgetting to tick a box, missing out a section of your tax return or forgetting to income supplementary information.

Remember, HMRC is not trying to punish people that make genuine mistakes, so providing you have the right documentation to hand, the matter will be cleared up quickly.

You Haven’t Made A Profit For Several Years

Not all businesses are profitable every year. However, if your business does not make a profit for several years running, HMRC may become suspicious that you are under reporting your income or over reporting your expenses.

In this case, HMRC will launch an investigation to ensure that your reported income and expenditure are genuine. If you have reported your figures correctly on your self assessment tax return, there should be no need for concern, as HMRC will quickly realise that your tax return is accurate.

Fluctuating Profits

Not every business turns over the same amount of profit each year, as many different factors can affect business turnover.

If there are dramatic fluctuations in your profits each year, HMRC may become suspicious of your business. This could lead to an aspect or full enquiry to investigate your business and ensure that your reported profits are correct.

You Don’t Use An Accountant

Whilst there’s no legal requirement to use an accountant to file your self assessment tax return, there is evidence to suggest that sole traders that don’t use an accountant are investigated more often. This is because HMRC believes that it is more likely that you will make a mistake when completing your self assessment tax return yourself.

Types Of HMRC Investigation

Types Of HMRC Investigation

You might be surprised that there are different types of HMRC investigation. This means that you might not be subjected to a full investigation if you are selected by HMRC.

There are two different types of investigation that HMRC can undertake: a full enquiry and an aspect enquiry. Let’s take a look at these two types of HMRC investigation in more detail.

Full Enquiry

If HMRC suspects that there may be a problem with your tax return, they may launch a full enquiry into your business. This is often done when HMRC believes that you may be under-reporting your profits to reduce your tax bill.

During a full enquiry, HMRC will ask for your full business records to be provided. They may also request access to your personal financial records if they suspect that income is not being declared by the business.

Aspect Enquiry

If HMRC believes that you may have made a mistake with your self assessment tax return, they may launch an aspect enquiry. This means that they will only be investigating one part of your finances. This type of enquiry will usually be done if HMRC believes that you have made a genuine mistake with your self assessment tax return.

How Often Do HMRC Investigate Sole Traders?

If you’re self employed, you might be wondering how likely it is that you will be investigated by HMRC. The likelihood that you will be investigated will depend on how accurately your tax returns are completed and whether your income has dramatically fluctuated year-to-year.

HMRC only investigates a small handful of sole traders each year, and most of these are selected due to suspicions that they may be concealing income or have entered incorrect figures during their self assessment.

However, there are instances where HMRC will decide to randomly investigate a business to ensure compliance.

It’s impossible to provide an exact probability that your business will be the subject of a HMRC investigation, as it is dependent on many different factors. For this reason, it’s essential that you ensure that your self assessment tax return is completed accurately and on time, to avoid any penalties should your business be selected for a HMRC investigation.

What Happens In A HMRC Investigation?

If HMRC decide to investigate your business, you might be wondering exactly what they’ll be checking.

Generally speaking, this will depend on the type of investigation that is being done. If your business is subject to a full investigation, they’re likely to want to examine your full financial records. However, if it’s just an aspect enquiry, it may be limited to just one area of your finances.

Information that HMRC may request includes:

  • Your business’ full accounts, including details of your tax calculations
  • Sales invoices
  • Bank statements
  • Details of all taxes you’ve paid
  • Your self assessment tax returns
  • Details of your expenses, including receipts
  • PAYE records if applicable

When HMRC contacts you to inform you of the investigation, they will explain what information they require to complete their enquiries. If you use an accountant, they may contact your accountant directly for the information.

How Do I Know If HMRC Are Investigating Me_

How Do I Know If HMRC Are Investigating Me?

Many sole traders are concerned about becoming the subject of a HMRC investigation. But how will you know if HMRC decide to investigate your business?

If HMRC decides to investigate you as a sole trader, you will receive a letter informing you of the investigation. This letter will explain whether they plan to investigate a single aspect of your tax return, or if they are conducting a full enquiry into your business.

At this stage, HMRC will inform you of the information that they require to complete their enquiry. This could include bank statements, sales invoices and receipts for any expenses.

If you have an accountant, HMRC will also write to them to inform them of the investigation and request any required information.

If you use online accounting software, HMRC may request access to the software. This will enable them to view your records digitally, minimising effort on your part.

How Long Does A HMRC Investigation Take?

How long the HMRC investigation will take will depend on the number of enquiries that are required. A simple investigation into a single aspect of your taxes may be resolved in just a few weeks, whilst a full investigation into your business can go on for several months.

How Far Back Can HMRC Investigate Self Employed?

If you’ve been notified about an impending HMRC investigation into your finances, you might be wondering how far back they can investigate your accounts.

How far back HMRC will look in your accounts will depend on the reason they are investigating. If they are completing an aspect enquiry, they may only look at one year of your accounts. However, if they find in these accounts that you have been concealing income or making regular mistakes, they may go back further.

In the majority of cases, HMRC will go back up to four years in your accounts. If it notices any considerable concerns, it may go back six years. However, this is not the legal limit. In fact, HMRC can go back up to 20 years if it has a significant cause for concern, so it’s important that you maintain accurate records of your business finances, in case of a HMRC investigation.

Outcomes Of HMRC Investigation

HMRC will write to you following the investigation to inform you of the outcome.

If your accounts are found to be in order, they will inform you that their investigation is complete and no further action is required. In this case, you can simply continue to file your annual self assessment tax return each year.

On the other hand, if errors have been found in your accounts, it’s likely that you will be fined and asked to pay any outstanding tax. This is likely to be the case if:

  • Errors are found within your accounts (even if they were unintentional)
  • You have deliberately omitted information from your tax return
  • You have attempted to conceal income, for example by not declaring cash in hand work

In more extreme cases, you could find yourself facing a fraud charge. However, this is rare and reserved for the most severe of cases.

If you disagree with the outcome of the HMRC investigation, you can appeal the decision. This must be done within 30 days of being notified of the outcome.

It’s important to note that once HMRC become aware that there have been errors in your tax returns, they’re likely to keep checking up on you in the future to ensure that future tax returns are accurate. So, it’s essential that you maintain accurate and complete records going forward.

Do HMRC Always Investigate Tip Offs

Do HMRC Always Investigate Tip Offs?

When HMRC receives a tip off regarding a sole trader, it will do some preliminary checks, including looking at their annual self assessment tax returns. If HMRC has any concerns that the sole trader might be concealing income or that there may be errors in the tax returns, it will launch an investigation into the sole trader.

If HMRC decides to investigate your business as a result of a tip off, you will receive a letter informing you of the upcoming investigation. However, HMRC won’t usually tell you that you are being investigated as a result of a tip off.

Do HMRC Do Random Checks?

Whilst the majority of investigations by HMRC are triggered by inconsistencies in self assessment tax returns or tip offs, they do also complete random checks on sole traders in some circumstances. However, these checks are rare, as HMRC prefers to focus its resources where it believes that tax returns may not have been completed accurately.

In Summary

Filing your annual self assessment tax return can feel daunting, especially if you’re worried about becoming the subject of a HMRC investigation. Whilst HMRC investigations of sole traders do happen, they’re usually the result of inconsistencies with your tax returns or tip offs from other people.

If you’re unsure when it comes to completing your tax return, or if you want to future-proof your business against future HMRC investigations, we’d always recommend using a qualified accountant. They will be able to ensure that your accounts are in order and your tax return is completed accurately, so there shouldn’t be any problems if HMRC decide to investigate your business later down the line.

In this article, we’ve answered the question ‘when does HMRC investigate self-employed individuals?’, as well as exploring some of the most commonly asked questions about HMRC investigations.

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