HMRC has spent £100 million pound on a new supercomputer, ‘Connect’, and it’s quietly studying you and your finances.
The HMRC may call it ‘Connect’ but it’s more ‘Hunt’, as the system actively seeks out information on UK taxpayers like you. It enables HMRC to cross-check your tax returns against established financial records such as your bank records and your employer’s pay submissions, but also your social media feed and other public records.
This supercomputer is hunting for one thing: a mismatch across anything and everything it (and its AI) can look at. It uses millions of data points to spot patterns, or mis-matches. This system can then flag your name or business for a HMRC officer to investigate. It’s what HMRC call a ‘Risk Based Selection’.
The worrying aspect for many people is that you don’t have to have done anything wrong to get flagged!
Drawing on our years of experience sitting in on HMRC investigations, this blog details six usually innocent triggers that can bring HMRC to your doorstep, and how to avoid them:
- Lifestyle v declared income
- Incorrect or over-claimed expenses
- Exceptional income or expenses claims
- Cash business records
- HMRC data vs your tax return
- VAT returns and red flags
1. Lifestyle v. declared income
The whole point of your HMRC tax return is for you to answer a simple question: “How much did you earn last year?” A surprising number of people each year declare they earn just £12,570, which is the (current) personal tax allowance level. Earning under this means you pay no tax.
You can (and should) reduce your income by claiming all the legitimate expenses you can. However, if that involves manipulating your expenses in any way, HMRC and their AI will likely spot it.
For example:
- You put in your tax return that you sold £22,570 worth of sales, and have exactly £10,000 worth of expenses.
- This conveniently means you have £12,570 of taxable profit for your business.
- The HMRC could then check that against other data, and perhaps discover that your bank accounts show more income than you have declared.
- HMRC could also have a look at your social media channels and spot that new car you are driving or notice you are on your third holiday this year….
These are obvious discrepancies that HMRC can and do pick up. Our founder Dan Heelan has actually sat in on investigations where activity on social media accounts have been discussed. It’s even written in HMRC’s own manuals that they will use ‘overt, open source material’, such as social media, during an investigation.
So if you are deliberately under-declaring your income you will be caught out. That will involve investigations, repayments, fines and a whole heap of pain you really don’t want for yourself, your family and your business.
2. Incorrect or over-claimed expenses
Making a genuine mistake or claiming more than you actually can could be accidental on your part. However, HMRC have so much data on averages and expected expenses in a given sector that it’s easy to trigger an investigation if you are claiming higher than the average.
This can become a major issue when taxpayers are working with an accountant or bookkeeper who is knowingly over-claiming. Sadly, this is particularly common in the construction industry. Those working in construction hear about a mythical £2.5k ‘rebate’ and use the same “accountant” as their friends to try and claim it. However, that “accountant” may have no issues with claiming large amounts of fictitious expenses, which is often the only way to generate these repayments. (* See footnote below.)
The person or firm you choose to use to do your accounts is irrelevant to HMRC. As the taxpayer, you sign your annual tax return and declare that the content are “Correct and complete to the best of my knowledge and belief”. Basically, the buck stops with you.
So, PLEASE CHECK YOUR TAX RETURN if someone is preparing it for you. Look at the boxes for income and expenses and make sure they at least sound in the ballpark you’d expect.
If you are subject to an investigation and you can’t prove your expenses, you’ll have to pay any tax owed, plus fines and penalties on top. Under UK law, there is no come back on the person who prepared the return, particularly if they aren’t regulated.
3. Exceptional income or expenses claims
If you had a genuinely unusual year with more costs, but less income, that can be a red flag to the HMRC too. One of the key indicators for that flag can be the box on the tax return where you put in your expenses.
On a sole trader tax return for example, there are only nine expense type boxes you could fill in. It is important to choose the right one/s for your type of expense.
For some levels of income you might not have to fill in all nine boxes, you can just bundle them all together as one number. (In our experience, we have seen fewer investigations on the “bundled” one box version than the someone who has filled out the individual boxes, but that could just be down to luck.)
As always, the key is to KEEP GOOD RECORDS in case you do get questioned by HMRC. You need evidence to prove what you put in the box is true. One quick solution to track your income and expenses more easily is to:
- Set up a separate bank account for your work income if you don’t have one.
- Subscribe to an easy to learn book-keeping software like Xero.
- Link the two
(This will also be really useful for Making Tax Digital (MTD) if you’re not doing so already.)
Important: For any expense you are claiming, you will need to feel comfortable explaining to a HMRC officer (if you had to) why your expense is “wholly and exclusively” for use in your business. If your explanation feels false or flimsy, take this as your own internal ‘red flag’ and consider not claiming it.
4. Recording cash in your business
You may have seen on the news that HMRC are clamping down on businesses which involve large amounts of cash transactions. Raids on vape shops and barbers as part of so-called “high street interventions” may catch the headlines, but HMRC have always had an eye on cash based businesses.
Again, our founder Dan Heelan has been part of investigations where HMRC have investigated cash-heavy retail businesses. Good record keeping is key, as you will need evidence to show what cash you took in and what you do with that cash.
In one investigation Heelan Associates were part of, HMRC looked into a business’s accounts, their bank statements, tax returns and HMRC’s own data on what profits other stores make, to show a position where they thought the client was under-declaring their sales. Sadly, the shop actually wasn’t doing very well, but at least they had the records to show that to HMRC.
As this example shows, you don’t need to have done something wrong to be caught in the crossfire of HMRC investigations into certain types of businesses. If your business takes in a lot of cash, it’s really important to document where your cash is going.
If you use accounting / bookkeeping software, make sure you know how to correctly record cash transactions. Many software solutions work by connecting to your business bank account and sending you the transactions to categorise, which will not work for cash that does not necessarily go through your bank account.
If you are a cash-using business and have concerns about your records and a possible HMRC investigation, talk to your (legit) accountant. Or contact us if you feel your accountant isn’t quite up to the challenge.
5. HMRC data verses your tax return
It’s vital to put numbers in boxes on your tax return that should have a number in it. Two major triggers to getting your tax return investigated is to:
- NOT enter a number HMRC know should be there.
- Enter a number HMRC thinks is wrong.
A tax return with NO number in a box HMRC know should have a number will often trigger an instant investigation.
HMRC gets data from a wide range of sources that enables them to cross check if a number should be in a box, including:
- Your employer
- Your banks
- Payment platforms and gateways
- Crypto exchanges
- The land registry
So, yes, that small amount of interest from a foreign bank account, or the small bit of crypto you sold are required to go on your return.
In addition, if the data held by HMRC does not match these ‘external’ records, that can be a red flag. This could happen, for example, if the figure you enter for your employment income doesn’t match what your employer sent in to HMRC. Your figure can actually be correct and still cause an investigation, as employers can make mistakes in their returns too.
So, be sure to check you have all of your documents ready before completing the tax return or supplying it to your accountant, and check them all for any possible errors.
6. VAT returns and red flags
The VAT office has considerable resources and decades of experience in investigating VAT tax fraud, which is one reason that VAT is most frequent type of HMRC investigation we see at Heelan Associates. In 99% of cases, there is nothing the client has actually done wrong, but is triggered when one of your VAT returns is looking unusual.
Changes to your normal pattern of VAT return are red flags for the HMRC, including:
- Repayments
- Regular repayments
- Repayments for your first VAT return
- Large charges to sales or purchases
You normally need a VAT receipt as evidence of your claim, and it’s important that these receipts are in the r name. HMRC can be really picky about names and addresses being correct on VAT receipts. It pays to take the time to change the names and addresses on the receipts if they are wrong.
If you don’t have a valid VAT receipt, HMRC will often disallow the claim, ask for the VAT back AND give you a fine for now having an inaccurate return!
What to do if the HMRC send you a letter
First of all, don’t ignore it. HMRC’s Connect system doesn’t care if you made an innocent mistake, it just flags a mismatch. What happens after that is entirely down to you, your record keeping and how fast you reply to them.
Sometimes it is just a case of sending over some clarifying information to HMRC (or asking your accountant to do so). It is far better to eat the frog and tackle the letter soonest, as HMRC are not known for their patience. If you ignore it, they will act fast and will not hesitate to throw the book at you.
If you’d like to avoid the time, stress and financial costs of a HMRC investigation, talk to your accountant or contact us.
About the author
Dan Heelan is the Business Services Director of Heelan Associates, an accounting firm that helps small business owners across the UK start, survive, and grow.
With a background as a small business owner himself, he discovered his passion for accounting and tax early in his journey and now focuses on empowering fellow entrepreneurs with the knowledge and tools to navigate the financial side of running a business.
You can see and hear Dan in action in his regular:
FOOTNOTE:
We say “accountant” (with bunny ears) because the industry isn’t fully regulated. There are regulated, ethical and highly professional accountants (like us) but there is also the situation that literally anyone could set up in business tomorrow and say they are an “accountant”.