Under What Circ*mstances Would HMRC Investigate A Self-Employed Person? (2024)

When filing tax returns, the chances of overlooking some important details or making a typo on figures submitted can be high due to the human error involved.

Even the most experienced business owners with accountants submitting information on their behalf can make mistakes that could trigger an investigation from HMRC.

HMRC may start an investigation if they see:

• Mistakes on the self-assessment tax return
• Consistent report of no profit for several years
• Unexplained fluctuations in reported profits
• No professional help when filing tax returns
• a tip-off about undeclared income
• Or to make random compliance checks (rare)

As a self-employed worker, can the HMRC investigate you? The simple answer is Yes. Should you be concerned if you receive notification of an investigation? The most logical answer is to think of where you could have made a mistake and work with HMRC to correct the errors. If you have deliberately tried to hide earnings or submit false information for self assessment purposes and are found out, then you could face hefty penalties.

This article will discuss the circ*mstances under which the HMRC can investigate a self-employed person and how you can minimise the possibilities of such investigations as a self-employed business owner.

Reasons For HMRC Investigation

The following are different scenarios that can make HMRC decide to investigate a sole trader. They can act based on intelligent tip-offs, errors seen during self-assessment returns, non-disclosure of profits, fluctuating account details or calculated possibilities for those without an accountant.

They’ve Received A Tip Off

HMRC can decide to investigate you as a self-employed business person if they have intelligent reports with substantial information against you. Although the words of a third party cannot be completely believed, they can choose to launch an investigation if they perceive you might be hiding important income details based on the strength of the information in their possession.

The basis of any HMRC investigation is to ensure that all business income is exactly as declared on the self-assessment tax return and that the correct tax amount is paid on every taxable income.

Mistakes Have Been Made

While HMRC understands that business individuals are not above mistakes, they can choose to investigate if they observe errors on your submitted self-assessment return. The mistake could be as little as forgetting to tick a box or skipping a section of the tax return form.

Another possible mistake is forgetting to answer questions requiring supplementary information about the business. Upon investigation and provision of the right documents, the HMRC can determine if the mistake was genuine or not.

You Haven’t Made A Profit For Several Years

A business might experience a tough financial year without tangible profits and this would be common in new businesses, particularly in the first few years of trading. HMRC understands such situations but can become suspicious if the problem lingers or it appears that you might be under-reporting or over-reporting your expenses to reduce your profits and therefore taxable income.

In such a situation, HMRC will investigate if the reported income and expenditure values are genuine over the observed period. There is no need to panic if you did nothing wrong and your submitted values tally with your self-assessment return. You can expect HMRC to follow the right procedures and round up investigations if they find no discrepancies in the account.

Fluctuating Profits

Normally, businesses do not turn over the same amount of profits each year. Economic factors, changes in management, market demands, and political factors can affect business turnover.

These are all factors that the government is aware of, but dramatic fluctuations in business accounts that seem untraceable would make HMRC suspicious. That can lead to a full investigation or enquiry into the business process and account books to confirm the accuracy of recorded profits.

You Don’t Use An Accountant

While it is not mandatory for every business owner or self-employed person to hire an accountant, the absence of one can subject your reports to more scrutiny. The general belief is that sole traders or self-employed persons can struggle to properly record details of every transaction which affects the accuracy of their self-assessment tax returns.

That explains why HMRC can decide to investigate if they suspect the likelihood of accounting error and are bringing in the ‘making tax digital’ scheme to help streamline the declaration process to be digital only. This reduces the likelihood of receipts being lost or underreported income.

Types Of HMRC Investigation

There are two different types of HMRC investigation depending on the initial reason for suspecting your business account. We have the Full Enquiry and the Aspect Enquiry.

Full Enquiry

The Full Enquiry investigation by HMRC occurs when they have substantial reasons to believe there are problems with your tax returns. An example is when the HMRC thinks you are under-reporting your profits to intentionally reduce the tax bill.

As the name implies, the full enquiry digs deeper into your business records and HMRC can ask for documents to prove previously submitted returns. They can also request access to check your personal financial records if they have evidence that might not have declared some business income.

Aspect Enquiry

An aspect enquiry is an investigation by the HMRC for only a part of your finances. It is usually done when the HMRC believes you have made a mistake with your self-assessment return. Compared to the full enquiry, an aspect enquiry only attempts to correct mistakes on the part of the business owner or self-employed.

How Often Do HMRC Investigate Sole Traders?

HMRC only investigates a few sole traders every year and most of them are based on suspicions with their financial returns. They do not investigate unless they suspect that a business does not accurately file its returns or notice significant discrepancies in the account reports.

Hence, the likelihood that the HMRC will investigate your business is dependent on how you file your tax returns. Do you have an accountant to ensure there are no errors? Do you also keep records of every business transaction or wait until the self-assessment deadline is close before rushing things?

Taking note of your tax returns process is important to avoid issues with HMRC, although there are a few instances where they randomly investigate businesses to ensure compliance. Taking steps to keep proper records of transactions, file self-assessment returns before the deadline and your business will likely remain penalty free and without investigation.

What Happens In A HMRC Investigation?

What type of questions do HMRC ask in a typical interrogatory session? The type of investigation and questions depend on what aroused their suspicion. We already mentioned how the HMRC could commence a Full Enquiry or Aspect Enquiry investigation.

For the full investigation, they will want to examine your complete financial records, but only an area of your finances under the aspect enquiry. Some of the common information that the HMRC may request includes:

Information that HMRC may request includes:

• Your complete business account records including details of tax calculations
• Sales invoices
• Bank statements
• Documentation of paid taxes
• Your self-assessment tax returns
• Full details of expenses incurred with attached receipts
• PAYE records (if applicable)

The normal process is for HMRC to contact a business when they have good reasons to suspect the possibility of errors or manipulation of financial return documents. They provide the business with a list of information they require and may prefer to directly contact the accountant if the business has one.

How Do I Know If HMRC Are Investigating Me?

Most sole traders often try their best to avoid circ*mstances that warrant investigation from HMRC. Following the best accounting and tax practices could help, but how do you eventually know if the HMRC decides to investigate your business?

Firstly, you are going to receive a notification letter of the planned investigation from them. The content of the letter would state the type of investigation either a full enquiry into your business accounts or an aspect enquiry for a specific part of your tax return documents.

The letter or an additional notification from HMRC will also contain the necessary information required from you to complete the investigation process. Examples include your bank statements, sales invoices and receipts of any transaction or business expenses.

For self-employed business owners with an accountant, HMRC will also write to them about their planned investigation and request any required information from them. That could include permission to access online accounting software or other integrated business accounting tools.

The objective of these software and document access requests is to view the records digitally without involving you too much in the investigation process.

How Long Does A HMRC Investigation Take?

The duration of the HMRC investigation depends on the type of investigation. A full enquiry is expected to take longer than an aspect enquiry and could run for months. The total number of required documents for evaluation or investigation also determines the length of the process.

How Far Back Can HMRC Investigate Self Employed?

How much of your past records can the HMRC request during the investigation of your business finances? It depends on the reason for investigating your business and the type of suspicion or tip-off that led to the formal enquiries.

For an aspect enquiry, HMRC might only review details of the accounts within the last year. They could also decide to dig deeper if they notice additional evidence that you might have been concealing income or made significant mistakes in the past. Most long investigations were due to new findings made when reviewing the business account.

The account vetting process for a full enquiry is usually longer and HMRC can go back four years on the account sheets. Further discrepancies might even make them check as far as the last six years’ record.

There is no legal limit to how far the HMRC can dig up your financial information provided they have substantial reasons. Hence, you must maintain an accurate and clean financial record in case the HMRC requests to investigate your business accounts.

Outcomes Of HMRC Investigation

Following the completion of their investigation, HMRC is going to write to the business owner on the outcome of their findings. If the business records are perceived to be in order, HMRC would conclude the investigation and no further action is required. The business is then allowed to proceed with its normal filing of self-assessment returns annually.

However, if HMRC discovers errors in the account details or evidence of manipulating finance documents, the business is charged a fine and will have to pay every outstanding tax.

Examples of scenarios that attract penalties from HMRC are:

• Errors in the account sheets (even if it was unintentional)
• Proof of deliberate omission of important information on tax return documents
• Confirmed attempt to conceal income and not completely declaring business income

In extreme cases, HMRC takes up the case and charges the sole trader or business management to court for fraud. It rarely happens but is a possibility depending on the severity of the investigations.

There is a chance to appeal the outcome of the investigation or disagree with the decision of HMRC. Any appeal must be done within 30 days of receiving the outcome of the investigation.

If HMRC concludes that a business is guilty of the accusations concerning tax returns, it could decide to place the business on periodic checks. The objective is to ensure that the business starts filing accurate tax returns and maintains accurate and complete financial records.

Do HMRC Always Investigate Tip Offs?

HMRC is open to tip-offs concerning sole traders who might be violating tax return policies but will never act without conducting preliminary checks. That involves checking their annual self-assessment tax returns and observing possibilities that the sole trader is concealing income or has errors in their tax returns.

Upon deciding to investigate further, HMRC will send an official letter notifying the business owner of a planned investigation. The letter will not disclose that the business is investigated based on information from a tip-off but can contain necessary documents to provide ahead of the investigation.

Do HMRC Do Random Checks?

HMRC can decide to carry out a random check although that rarely happens and most of its investigations are from tip-offs or observed inconsistencies in self-assessment returns. Investigations involve a lot of planning and the HMRC would usually prefer to focus on cases where they substantially believe there could be possibilities of inaccurate tax returns.

In Summary

Filing your annual self-assessment returns without making errors is a great start for any self-employed person who wants to avoid the possibility of an HMRC investigation. The most common circ*mstances that can warrant such investigations are inconsistencies with tax returns or reliable tip-offs.

We also recommend getting a qualified accountant to check your submissions before sending them to HMRC as this significantly reduces the possibility of tax return errors. Hiring an accountant provides room to focus on other essential business matters while they monitor that every transaction is properly recorded. The accountant also ensures accurate tax returns and offers advice in case the HMRC decides to investigate from a tip-off.

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