What triggers an HMRC investigation?

Nobody expects a letter from HMRC to land on their doormat, which is why for most taxpayers, an investigation feels like it comes out of nowhere.

In reality, HMRC rarely opens an enquiry at random. Behind almost every investigation is a trigger, which could be something in a return, a pattern of behaviour or a piece of data that has caught the attention of HMRC’s systems or officers.

Understanding what those triggers are will not guarantee you avoid an enquiry, but it can help you spot risk areas in your own affairs.

This may prompt you to keep better records and reduce the chances of a routine check turning into something more serious.

HMRC’s risk-based approach

HMRC does not have the resources to investigate every taxpayer every year, so it targets its efforts by profiling the risk of each person or business.

Most enquiries begin as follows:

• Initially via “Connect”, which is HMRC’s data-matching system, which uses a wide range of sources, including the DVLA, social media and e-commerce sites and which identifies potential issues.
• Then through a decision by a caseworker that the identified issue is one that is not easily explained and is worthy of questions.

Connect works by comparing the data it gathers against what has been declared on a tax return. Where the figures do not add up, a flag is raised and a human review usually follows. Sometimes Connect might be tasked on a specific ‘project’, often where HMRC has received a data set about certain transactions or income.

A small number of cases are also selected entirely at random, simply to maintain a general deterrent effect and to test whether HMRC’s risk models are working as intended. Another reasons is does so is to estimate the ‘tax gap’, i.e. the estimate of the amount of tax that is not paid because of misunderstanding, mistake or deliberate errors or failures. HMRC extrapolates its findings from the random enquiries to the whole population to make this estimate.

Remember, nobody is immune from an enquiry, even those with a spotless compliance history, but receiving a compliance check is not any indication of wrongdoing.

Common triggers for an HMRC investigation

There are a number of common triggers that HMRC looks for when profiling a taxpayer’s risk.

Inconsistencies and errors on a return

The most straightforward trigger is a return that does not stack up. This might be figures that do not match previous years without explanation, expenses that look unusually high for the size of the business or numbers that fail to reconcile with VAT returns, payroll submissions or Companies House accounts.

Simple mistakes happen and HMRC understands that. However, repeated errors or errors that consistently favour the taxpayer tend to draw more scrutiny than one-off slips.

Income that does not match lifestyle

HMRC increasingly uses third-party data to build a picture of a taxpayer’s financial life, including reviewing social media accounts.

If declared income looks low compared to property purchases, foreign holidays, car finance or other visible spending, this mismatch can prompt questions.

This is particularly common with directors of small companies, landlords and self-employed individuals, where income can be more easily understated than for someone on PAYE.

Operating in a high-risk sector

Certain industries attract closer attention because of a history of non-compliance.

Cash-based businesses such as takeaways, hairdressers, taxi firms and market traders are frequently reviewed, simply because cash transactions are harder to trace and easier to under-record.

Property and construction also feature heavily in the number of investigations launched, partly because of the scale of transactions involved and partly because of known issues around the Construction Industry Scheme.

Filing late or paying late

A pattern of missed deadlines, whether for filing returns or making payments, can mark a taxpayer out as higher risk as well.

It suggests to HMRC that record keeping may not be robust, which in turn increases the likelihood that the figures being reported are unreliable.

This may prompt a manual check by an officer to ensure that the information presented is accurate.

While many people focus on the fines for late reporting, this issue is lesser-known but just as important.

A tip-off or whistleblower report

HMRC operates a fraud hotline and receives a significant number of reports each year from members of the public, disgruntled employees, ex-partners and business rivals.

Not every report leads to an investigation, but where the information provided is specific and credible, it can prompt HMRC to open a case.

Involvement in a known avoidance scheme

Taxpayers who have used a tax avoidance scheme, particularly one that HMRC has already identified and challenged, are likely to face enquiries.

HMRC publishes details of schemes it considers to be avoidance and actively pursues users of these arrangements, sometimes going back several years.

It is worth discussing the potential for disclosure to be part of this scheme with a professional before HMRC launches its own enquiry into your affairs.

In many cases, early disclosure may lead to a reduced penalty and prevent further investigation into your affairs.

Sudden changes in a business

A sharp fall in turnover, an unusually large jump in expenses or a business that consistently declares a loss year after year while continuing to trade can all raise questions.

HMRC will want to understand why the figures have moved in a way that does not fit the wider pattern for that sector.

Being connected to another enquiry

An investigation into one taxpayer can lead directly to another. Business partners, connected companies, family members involved in the same enterprise and even customers or suppliers can find themselves drawn into a wider review once HMRC starts looking at the wider picture around an existing case.

If you are aware of someone close to you being investigated by HMRC in relation to you or a business you operate, it may be worth seeking advice.

Offshore income or assets

Under the Common Reporting Standard, HMRC receives financial account information from tax authorities in over 100 countries.

Undeclared offshore income or gains are increasingly easy for HMRC to identify and offshore matters carry extended time limits and higher penalties, which makes them a particular area of focus.

Property transactions

Buying, selling or letting property generates a paper trail through the Land Registry, mortgage lenders and letting agents.

Capital gains on property sales, undeclared rental income and stamp duty land tax positions are all closely monitored. Any discrepancies here are relatively easy for HMRC to spot.

What happens once a trigger is identified

Not every trigger leads to a full enquiry. In many cases, HMRC will first write to ask for clarification or supporting evidence on a specific point.

How this initial contact is handled matters and a prompt, clear and well-evidenced response can often resolve a query before it develops further.

If you are contacted by HMRC, it is advised that you seek immediate professional advice, as it may be possible to resolve matters sooner if your chosen agent is able to address HMRC’s concerns.

Where HMRC decides to proceed, it will open either a full enquiry, covering the whole of a tax return or an aspect enquiry, focused on one particular area.

In more serious cases involving suspected fraud, HMRC may use its Code of Practice 9 (COP9) procedure, which carries the possibility of criminal prosecution if not handled correctly.

Reducing your risk

There is no way to guarantee HMRC will never come knocking, but good habits make a real difference:

• Keep records that are accurate, complete and easy to retrieve, even years after the event
• File returns and make payments on time, every time
• Make sure figures are consistent across tax returns, VAT returns and company accounts, since HMRC will compare all three
• Take advice before entering into any arrangement that seems designed primarily to reduce tax, rather than to serve a genuine commercial purpose
• Disclose or amend any errors as soon as they are identified, rather than waiting for HMRC to find them first

As mentioned, a voluntary disclosure, made before HMRC opens a formal enquiry, is treated far more favourably than information that only comes to light once an investigation is already underway.

If you are already under enquiry

If HMRC has already been in touch, the way the first few weeks are handled can shape the entire outcome of the case.

Early advice helps to establish what HMRC is actually looking for, what needs to be provided and, just as importantly, what does not need to be volunteered.

If you are worried about a tax investigation being launched against you, please speak to our experts.

You can get in touch with our friendly and experienced team on 0203 675 8122 or email joe.mcdermott@intaxltd.com

inTAX is a specialist tax disputes firm. We deal with disclosures, investigations, and tax enquiries of all descriptions, including COP9, fraud investigations, VAT fraud, tax avoidance, let property disclosures and tribunal appeals. However, we don’t just deal with the serious end of tax investigations; we are also happy to handle smaller enquiries, disputes and problems that can be equally as worrying for our clients.