How to Avoid a Tax Audit in 2023

HMRC is nothing if not thorough, and when tax audits are involved they go over every detail with a fine tooth comb.

They are expensive and time consuming to endure. And they also detract your attention away from your business and towards the ongoing efforts of the investigation. Even if you’ve done nothing wrong, they can still cause many sleepless nights for business owners.

For startups, having a high tax audit risk is only going to affect your immediate future. At a time when your efforts should be better spent towards growing your business and scaling up, undergoing a tax audit can set you back.

So let’s take a look at how you can reduce the chances of getting audited in 2023.

What does a tax audit involve?

HMRC standard operating regulations usually notify you of any audits or investigations ongoing about your business.

Firstly, you’ll receive a letter from HMRC directly to your place of work informing you of their intention to perform a tax audit on your business. This includes a full assessment of your business including property, equipment, staff and taxes. Although it is not uncommon for HMRC to launch an audit specifically relating to just one of these particular items.

You’ll face one of three types of HMRC tax inspection:

Full inquiry

HMRC will perform an in-depth review of every single record of the business and the directors.

Aspect inquiry

HMRC believes that a mistake has been made in a specific area of your taxes, and will analyse only that aspect of your account.

Random check

As your business has been randomly selected for a tax audit, they’re free to examine and review as much or as little as they would like from across all of your tax records.

Following that, a tax officer will visit your place of business and begin their investigation. This will include a review of your tax records, financial records and any other documents or systems that relate to the management of your business.

They do this to ensure that what you state on your tax returns is, in fact, thoroughly corrected down to every dotted “i” and crossed”t”.

That’s the basic story of an HMRC tax audit, but what about the real cost?

How much does a tax audit cost?

Every tax audit has a cost that is measured in money, time and work.

Each tax audit lasts an average of 16 months, and can often continue longer if HMRC is feeling particularly investigative. That’s almost a year and a half of sleepless nights and worrying about an investigation when you should be focusing on your business.

In terms of cost, a tax audit on your business can usually cost around £5,000 in accountancy fees. This will not be because you have performed any illegalities, but simply because you are forced to defend your side of the investigation.

Of course, if you've done something wrong, then the cost of a tax audit will be much, much steeper…

How often does HMRC perform tax audits?

Three factors determine how often HMRC perform their tax audits. Either:

• Your business appeared on their random business generator and scheduled you for an audit

• You haven’t been audited for 5 years and are due a bog standard check up

• They have been alerted to trigger reasons and schedule a tax audit to ensure that any mismanagement of taxes is caught immediately
  
  

This means that if you reduce your tax audit risk, and ensure that everything is above board, you can expect an audit every 5 years or so!

Of course, if you haven’t reduced the chances of getting audited, then that time is significantly lowered.

Why would I be audited by HMRC?

While the exacting standards of HMRC are kept relatively hush hush, multiple reasons will trigger a tax audit. Although by far the most common is that there are startling inconsistencies in your latest tax returns.

The other most common reasons to trigger an HMRC audit include:

• Your tax return is not consistent with other businesses within your industry

• Your tax return is not consistent with your lifestyle

• The industry that your business is in is considered a “high-risk” by HMRC

• HMRC received a tip off about your business in particular

• You were “mystery shopped by HMRC...

  • This trick is performed by an undercover HMRC officer. They order from your business and monitor how that transaction was recorded to check if it matches up.

These are just the primary reasons why you may be at risk of a tax audit in 2023.

Ways to avoid a tax audit

While you can’t avoid a tax audit, what you can do is significantly lower your chances of HMRC launching an investigation against your business. You may still face a regular tax audit every 5 years, or be selected randomly by their business generator, but you can give them no real cause to perform a tax audit of their own accord.

Let’s have a look at how you can keep 2023 tax audit free!

1. Accurate tax returns

It should go without saying, but make sure to double check your tax returns!

HMRC tax audits are often triggered by large discrepancies within tax forms. So if you have a decimal point out of place, then they immediately know that something is wrong.

This is especially relevant to businesses and limited companies as well. For a sole trader to make a small error is one thing. The possible variances in sole trader taxes are so small that they’ll likely fail to raise alarm bells. However, for Limited Companies, any deviation from the norm is likely to trigger a tax audit.

If you are attempting to do DIY taxes, then it is always best to enlist professional accounting services, even if it is just to double check your work.

An experienced accountant can not only find the flaws in your tax return but more than likely can figure out legal ways in which to reduce your tax!

Healthy work environment

A healthy work environment can do more than create a productive team, it can also reduce your risk of being audited by HMRC.

As you know, HMRC will investigate serious allegations of mismanaged taxes. The most common individuals who set off this chain of events are disgruntled ex employees.

It doesn’t matter whether or not there has been any tax fraud. A bitter employee or ex employee can still sow the seeds of a tax audit by reporting or fabricating a story. If you create a healthy work environment and maintain professional and courteous relations with employees leaving, you can help remove this risk entirely.

Make sure employees feel valued while they are within your company, and missed once they leave. You’ll not only boost your productivity, but keep HMRC off your back!

Avoid cash only policies

Once upon a time, the implementation and running of card transactions for businesses were deemed expensive and not extremely convenient for profits.

However, nowadays it is cheap to introduce, helps you keep your accounts cleanly regulated and monitored and helps you prove every single transaction that your company makes. Not only that, but by restricting customers to cash only you can actually lose out on business!

Due to these reasons, card payment for businesses absolutely is the norm. If you’re implementing a cash only policy, you’re making your business dealings look conspicuous.

By itself, this may not be enough to draw the eyes of HMRC to your business dealings. But when combined with other signs, this appears to be an obvious sign of a guilty party.

Explain large fluctuations

You’ll never report the same profits in consecutive years, that’s a given. But, it’s equally unlikely that your profits will fluctuate to a massive degree, without good reason.

If your business brought in £700,000 in 2020, but only scraped in £150,000 in 2021, then alarm bells will be raised.

There are a number of legitimate reasons why this might be:

• Market collapse

• Cut down working hours

• Started a family

• Severe illness for long periods
  

Whatever the cause, be up front when you submit your tax return. In each return, you’re allowed to write notes about the information being filed. So get ahead and explain your changes in profit.

They may never read them, and there won’t be a problem. But it’s worth 5 minutes of your time to provide an explanation and avoid months of HMRC tax audits on your business!

2. Be explicit on expenses

It is absolutely your prerogative to have a section labelled “other expenses” as long as you have the receipts, however, it’s not okay to be lazy with your categorisation.

Define your expenses. Are they travel expenses? Was it a one off marketing attempt? Did you hire a freelancer to work on your website?

Categorise your expenses as much as you can. If you repeatedly lump expenses under your miscellaneous category, then the numbers will begin to look suspicious. You’ll increase your tax audit risk by appearing as though you are falsely lowering your profit margins to pay less tax.

3. The integrity of financial hierarchy

You may have heard of Dan Price, the CEO who cut his own salary to almost double his employees’ wages. Publicity stunt or not, it made front page news around the globe because of one important reason - it broke the financial hierarchy.

“In the UK, the top 100 FTSE chiefs earn 183 times that of the average worker.” - The Guardian

As a business owner, you earn more than your employees, it is the standard setup. Every once in a while there is an outlier like Dan Price.

However, if you regularly earn less than your employees (especially in a field that respects managerial skills more than technical skills) it can look like you are skimming money off the top illegally.

This type of tax avoidance is all too common, yet it is easily detected and noticeable by HMRC tax audits. If you want to reward your employees in a way that doesn’t trigger alarm bells with HMRC, maintain financial hierarchy but look to reward your employees in alternative ways! There are many different forms of equity compensation that give employees massive bonuses without increasing their chances of a tax audit.

4. Be on time

Be on time with your tax return. Don’t request extensions unless absolutely necessary and avoid amending tax returns at all costs.

If you’re efficient and on time with your tax returns year after year with zero errors, then your business becomes respectable, at least in the eyes of HMRC. If you build up a history of compliance, then you’re far less likely to be put under scrutiny.

A pattern of late tax returns, extensions and numerous amendments can increase your chances of a tax audit. They may not believe that any purposeful wrongdoing is going on, but they’ll definitely initiate an audit to check that you aren’t making any mistakes.

5. Answer everything

Even if you don’t have an answer, make sure that you answer!

Answering every single question and form on your tax return is essential. Otherwise, it could trigger errors and lead to a tax audit. If you didn’t have any Expenses X for that year, then don’t leave it empty! Make sure that you answer everything with a value, even if that value happens to be zero.

6. Use a professional accounting service

Tax audits may be ultimately unavoidable, but you can reduce your chances of getting audited in 2023. By enlisting our professional accounting services you can achieve a level of financial health that keeps tax audits to a minimum.

With our professional accounting service, you’ll also be uniquely positioned to reduce the costs of an audit when it eventually does come. With a dedicated team of experienced accountants handling your books alongside AI powered bookkeeping software, you can rest assured knowing that everything is how it should be; fully HMRC compliant.

You’ll also receive fully scalable accounting services that help you grow your business. Your accounting representative will work alongside you to give in depth financial advice to prepare your business for growth.

So, contact a financial specialist today and learn about how our CFO Services can secure you funding for growth. Or, learn about our R&D Tax Specialists that have claimed startups £30 million+ in successful Tax Credits and counting!

With our School of Startups providing comprehensive guides for Startups from professionals in the field, we are the best and last financial partner you’ll ever need.