HMRC Tax Audit Readiness: A 6 Step Guide for UK SMEs

The thought of a tax audit can make any business owner’s stomach drop, but for small and medium-sized enterprises (SMEs), the prospect of a tax audit from HMRC can feel particularly daunting. 

And at Ellis & Co, we’ve been there, and we get it! 

Which is why we believe that with the right preparation and understanding, an audit doesn’t have to be a nightmare. In fact, it can be a real opportunity to strengthen your financial foundations!

But what exactly do SMEs in the UK need to know about preparing for a potential tax audit from HMRC? Well, don’t worry, let’s dive into it:

First… What is a HMRC Tax Audit (or Compliance Check)?

His Majesty’s Revenue & Customs (HMRC) conducts tax audits, A.K.A “compliance checks,” to ensure that businesses and individuals are paying the correct amount of tax and on time. 

These checks can range from a specific “aspect enquiry” focusing on a particular area of your tax return (for example: VAT or PAYE) to a “full enquiry” where HMRC reviews your entire business records. And in the case of limited companies, potentially even the directors’ personal tax affairs.

So while some audits are random, many are triggered by discrepancies or “red flags” in your tax returns.

Common Triggers for a HMRC Tax Audit

Now that you’ve got an understanding of tax audits, you might be wondering… how would I know if I’ve got a discrepancy, and how do I avoid it? 

Well, don’t fret, as understanding what might catch HMRC’s eye is the first step in proactive preparation. So here are some common triggers:

1. Inconsistent or unusual figures: Significant fluctuations in income or expenses, or figures that don’t align with industry averages, would definitely raise questions. Especially in line with potential money laundering activities.
2. Consistently reporting losses: Even though it may be genuine, multiple years of losses might prompt HMRC to investigate how the business remains viable.
3. Late or incorrect filings: Missed deadlines or recurring errors in your tax returns are immediate red flags that would spur HMRC to take action.

To find out more about possible triggers, read our educational piece here: “The Common Triggers That Lead to HMRC Audits”.

The Power of Preparation: Your Tax Audit Readiness Checklist

You’ve got the understanding, you know the triggers, so now, the key to a smooth audit process lies in meticulous record-keeping and proactive financial management!

Hence, here’s what SMEs should focus on:

1. Maintain Impeccable Records: This is the cornerstone of audit readiness. HMRC requires businesses to keep detailed and accurate records of all income and expenses.

• What to keep: Sales and purchase invoices, bank and credit card statements, payroll records, VAT returns and records, PAYE records, CIS documents (if applicable), and any other relevant correspondence or digital records.
• How long to keep them: Generally, records should be kept for at least 5 years after the 31st January following the tax year for self-employed or partnerships, and 6 years after the end of the accounting period for limited companies.
• Digital v Physical: Cloud-based accounting software can be invaluable for maintaining organised and accessible digital records, reducing the risk of errors and making information retrieval much easier.

Read more about “How To Choose The Right Accounting Software for You” to find out if cloud-based accounting is for you!

2. Timely and Accurate Filings: Always submit your tax returns and payments on time! Late filings incur penalties and draw unwanted attention. So make sure you double-check all figures before submission to minimise the chance of errors.

3. Understand Allowable Expenses and Tax Reliefs: Familiarise yourself with what you can legitimately claim as business expenses and any applicable tax reliefs. If you’ve claimed personal expenses incorrectly or missed out on legitimate deductions, issues may occur.

4. Regularly Review Your Financial Statements: Don’t just look at your accounts once a year. Make sure you do them regularly (monthly or quarterly) so that you can identify and correct errors promptly. This would ensure your financial position is accurately reflected, thus reducing discrepancies that could trigger an audit.

5. Separate Business and Personal Finances: This might seem obvious, but it’s a common pitfall for many small business owners. Mixing personal and business transactions can make it incredibly difficult to track expenses and prove their business’s legitimacy during an audit.

6. Conduct Internal Checks: Consider performing a “self-audit” of your records periodically, so let’s say reconcile bank statements, review your profit and loss, and ensure all transactions are properly categorised. This proactive approach can help you spot and rectify issues before HMRC does.

We know how much information is being thrown around, and things can get overwhelming. Which is why we want to make it easy for you!

Just download our FREE CHECKLIST to ensure your documents are audit-ready!

But… What Happens If You’re Audited?

Now if HMRC decides to conduct an audit, they will typically notify you (or your accountant) in writing. The letter will usually specify the period and type of tax they are interested in, so here’s what to do if you’re audited (and you don’t have a professional with you):

1. Cooperate fully: While it can be stressful, cooperating with HMRC and providing requested information promptly can help resolve the audit more efficiently.
2. Seek professional advice immediately: This is where Ellis & Co can make a significant difference! Trying to navigate a tax audit alone can be overwhelming, so rest assured we can:
   
   1. Help you understand the scope of the enquiry and what exactly HMRC is requesting.
   2. Assist in gathering and organising the necessary documentation.
   3. Communicate with HMRC on your behalf, ensuring all responses are accurate and timely.
   4. Represent you in meetings or interviews with HMRC, protecting your interests.
   5. Negotiate with HMRC if discrepancies are found, aiming for the best possible outcome and minimising potential penalties.

While a tax audit can feel intimidating, it’s basically a routine part of the tax system. By being prepared, maintaining excellent records and having expert support like our team by your side, you can face any HMRC enquiry with confidence.

So don’t leave your business vulnerable.  Get in touch with our team at Ellis & Co for a no-obligation consultation and let us help you achieve ultimate peace of mind when it comes to your tax affairs.

About Ellis & Co

Ellis & Co is a leading accountancy firm specialising in accountancy & audit, bookkeeping, payroll, tax planning and business advisory services. We work with a diverse range of businesses, from start-ups to established companies, ensuring they have the financial clarity and support they need to succeed. With our team of experienced accountants based in Chester and Wrexham, we are proud to offer personalised solutions that help businesses succeed.