Tax Investigation
How to Reduce the Risk of a Tax Investigation
There’s a lot that goes into running a business, especially if you’re a contractor with a limited company. But, one of the most important aspects is limited company tax planning. Operating as a contractor through a limited company offers a whole host benefits, such as tax efficiency and financial independence. But, along with these advantages come responsibilities, especially when it comes to limited company tax for contractors.
At GoLimited, we’re often speaking to contractors who are worried about the possibility of a tax investigation by HMRC, and we can see why. A tax investigation can be time consuming, costly and stressful, which is why it’s important to know how to reduce the risk of one happening.
Why Might a Limited Company Tax Investigation Happen?
In the UK, the tax authority is HMRC (His Majesty’s Revenue and Customs) and it’s responsible for making sure that businesses and self-employed individuals are complying with tax laws, and its responsibilities extend to carrying out tax investigations. There are several reasons why contractors operating as a limited company might be targeted for an investigation, such as:
Inconsistent or Incorrect Tax Returns
If your limited company tax returns show discrepancies, such as unreported income, incorrect deductions or inconsistent figures, HMRC could decide to investigation. They’re likely to view errors as an indicator that further scrutiny is required, to ensure that your tax filings are correct.
Random Selection
The majority of limited company tax investigations are based on specific concerns, and HMRC usually has a reason to want to find out more. But, HMRC does sometimes select businesses for review completely randomly, as part of their routine checks.
Excessive Tax-Deductible Expenses
Tax-deductible expenses for lunch, coffee, and professional training for limited company contractors are allowed, along with a handful of other deductibles. But, claiming a large number of tax-deductible expenses could raise suspicion. HMRC could question whether the expenses are truly related to business operations, or if you’ve been including things you shouldn’t have in your tax returns.
Unusual Payment Patterns
If your invoicing or payment practices seem unusual, such as not paying corporation tax or not submitting accurate VAT returns, HMRC might investigate further. They could view usually payment patterns as a sign that something is amiss, and they’re going to want to find out more.
Frequent Changes in Directors or Company Status
There’s nothing wrong with changing the directors of your limited company, but frequent changes in company structure, ownership or directors can be a red flag for HMRC. It could prompt them to start an investigation take a closer look at your finances.
Lack of Proper Records or Documentation
A limited company contract that fails to maintain accurate and detailed financial records might trigger a tax investigation. As a contractor in the UK, you must maintain clear records of income, expenses and transactions to avoid scrutiny. You’ll need to have this information available for a number of years after the relevant tax year has ended, in case HMRC wants to take a closer look.
There’s no way of knowing when or if a HMRC tax investigation will happen, but they’ll contact you to let you know. This could be in writing or over the phone, and they’ll tell you exactly what they need from you. They might not disclose what made them decide to investigate, but the information they ask for could tell you if it’s because of an error or due to random selection.
How to Reduce the Chances of a Tax Investigation
There’s no denying that the prospect of a limited company tax investigation is daunting, but you can minimise the risk of one occurring in the first place.
Keep Accurate Records
It’s important that you maintain detailed and accurate records of all of your business’ income, expenses and transactions. If you’re claiming tax-deductible expenses for lunch, coffee or professional training, make sure that you have receipts, invoices and appropriate justification for each expense. You’ll need to prove that they were business expenses, and that they were appropriate due to the nature of your work. Proper documentation helps prevent any disputes with HMRC.
Understand the Tax Implications for Contractors Operating as a Limited Company
It's important that you understand the tax implications for contractors operating as a limited company. Make sure that you're taking advantage of legitimate tax-saving opportunities, like tax relief on pension contributions, but avoid risky tax avoidance schemes that could raise suspicion.
Engage in Proper Tax Planning for Limited Company Freelancers and Contractors
It’s a good idea to work with an accountant or tax adviser who specialises in limited company tax. They can help you set up tax-efficient structures and ensure that you're complying with all relevant tax laws, from corporation tax to VAT. Of course, you can handle everything yourself, but doing so successfully does require a good understanding of limited company tax planning.
Stay Within the Guidelines for Business Expenses
When you’re claiming business expenses, make sure that the costs are genuinely incurred for business purposes. For example, lunches, coffee, and professional training for limited company contractors may be deductible, but only if they are directly related to your work activities. Don’t be tempted to claim expenses for costs that weren’t related to your business, as HMRC will look into this and find out in an investigation.
Submit Accurate Tax Returns on Time
It’s important to always file your tax returns on time and ensure the information you provide is correct. Mistakes can trigger a review from HMRC, and delays can result in penalties. Give yourself enough time to complete and submit your tax return without rushing, and double check everything before you send it off.
Review Your Accounts Regularly
It’s a good idea to conduct regular internal audits of your limited company’s finances, as this will help you to catch any errors before they become an issue. Catching issues early will help you avoid surprises during an investigation, and it also gives you the chance to correct them before HMRC does.
Use Professional Services
If you’re unsure about any aspects of your tax filing or deductions, don’t hesitate to hire a professional accountant. There’s a lot of accountants for limited company contractors out there, who will know a lot more than you do about the ins and outs of limited company tax planning. They can provide the necessary guidance and make sure that you're compliant with all limited company tax regulations.
There’s no way to guarantee that you won’t be investigated by HMRC at one time or another as a limited company contractor, as these things can randomly happen. Even if all of your finances are in order and your tax filing is perfect, HMRC could still randomly select you as part of its ongoing checks into compliance. But, the steps listed above can help you to reduce the risk of a tax investigation triggered by an error on your part.
What Information Do You Need to Provide During a Tax Investigation?
Whether you’ve been selected due to a discrepancy or you’re being investigated on a random basis, you’ll need to have the right documents ready. There’s a whole host of documentation that HMRC can request to see, and what they ask for will depend on the scope of the investigation. This could include:
- Bank Statements - These are used to verify your income and business expenditures.
- Invoices and Receipts - HMRC usually asks for invoices and receipts, including those for tax-deductible expenses for limited company contractors.
- Financial Statements - This includes balance sheets, profit and loss accounts, tax returns for the previous few years, and any other financial statements related to your business.
- Payroll Records - If you employ anyone, including yourself, you’ll need to be prepared to show pay slips, tax contributions and any related deductions.
- Company Structure and Ownership Information - HMRC will probably want details of shareholders, directors and any changes to the company structure.
Keeping your business records organised and up-to-date will make the tax investigation process much smoother and less stressful. Though doing so can be time consuming - and let’s face it, sometimes it’s easy to take a step back and not think twice about the administrative side of running a business - it’s worth the effort. The more organised and prepared you are, the easier you’ll find the tax investigation process.
Important:
- Please note: Any rates and thresholds mentioned in this article are correct at the time of publishing and may be subject to change.
- When choosing an accountant, look for one with proven experience and expertise in the contracting sector, particularly around areas like IR35, limited company tax matters and off-payroll working. Formal qualifications are important, but relevant hands-on knowledge matters just as much — especially in a complex and fast-changing landscape like this.
At GoLimited, we know that the thought of undergoing a tax investigation is daunting, but it’s something that comes with operating a limited company. By following the advice given above about limited company tax and staying organised, you can significantly reduce the chances of triggering an investigation. If you do trigger an investigation, or if you’re randomly selected, staying organised and accurately filing tax information will help to minimise the fallout.
