10 red flags that could trigger a tax enquiry

Introduction

Running a business involves making hundreds of decisions. Most of which have nothing to do with tax.

However, the records created by those decisions eventually feed into your accounts, VAT returns, payroll submissions and tax returns. When the figures do not fit together, change unexpectedly or cannot be supported, HMRC may decide to take a closer look.

That does not automatically mean anything is wrong. Some checks are routine, and others may be selected at random. A tax enquiry, which HMRC usually calls a compliance check, may simply involve asking for more information to confirm that the right amount of tax has been paid.

Here are ten potential warning signs—and what you can do about them.

#1 Figures that do not agree across different returns

Your accounts and tax submissions should tell a broadly consistent story.

For example, the sales shown in your accounts may not exactly match the sales reported on your VAT returns because the two can cover different periods or follow different rules. However, any significant difference should be understood and capable of explanation.

Similar questions may arise where:

• wages in the accounts differ from payroll records; and
• VAT returns do not appear consistent with turnover;

Differences are not necessarily errors. Unexplained differences though are more likely to create questions.

#2 Income that does not match information held elsewhere

HMRC does not rely solely on the figures entered on a tax return.

It may hold information received from employers, banks, government bodies and other third parties. It also has legal powers to request information from another person or organisation where that information is reasonably required to check someone’s tax position.

A question may arise where this information suggests that income has been omitted or reported differently.

Examples could include bank interest, investment income, property income, online sales or payments made to a contractor.

Before submitting a return, check that all sources of income have been considered—not merely the income that passed through the main business bank account.

#3 A sudden change in turnover or profit

Businesses change. A large customer may be lost. Prices may rise. A new contract may transform sales. Investment in staff or equipment may reduce profit temporarily.

Each could create a genuine and perfectly reasonable change in the figures.

However, a sharp movement from one year to the next may stand out. This is particularly true where turnover falls substantially, expenses rise quickly or profit becomes unusually low without an obvious explanation.

Do not try to make genuine figures look more “normal”. Instead, keep a short note explaining what happened on your files.

#4 Expenses that appear unusually high

Business expenses must be supported and claimed correctly.

HMRC may ask questions where a particular expense looks unusually large in relation to the size or nature of the business. It may also examine those costs that could include both business and personal use. Common examples include motor expenses, travel, accommodation, entertaining, household costs and payments to family members.

The issue is not simply the amount. It is whether the cost was genuinely incurred for the business, treated correctly and backed up by suitable records.

#5 Poor or incomplete records

You must keep sufficient records to make a correct and complete return. HMRC’s guidance confirms that this applies to both business and non-business records.

Possible areas to watch include:

• missing sales invoices or purchase expense receipts;
• bank accounts that have not been reconciled;
• large unexplained bookkeeping entries;
• figures based on unsupported estimates;
• transactions left in suspense or uncategorised accounts.

Good bookkeeping is not only about meeting a legal requirement. It gives you a clear route from the figure on the tax return back to the original transaction.

#6 A cash-heavy business with weak controls

Cash income is legitimate, but it can be harder to trace.

Where a business receives substantial amounts in cash, HMRC may want to understand how sales are recorded, checked and banked. Questions may arise where till records, appointment books, cash sheets and bank deposits do not fit together.

A simple, consistently followed process is important. Record every sale. Count cash regularly. Explain differences. Keep evidence of money taken from the business or used to pay expenses.

The aim is to show a complete trail rather than relying on memory at the end of the year.

#7 Repeated losses or very low declared income

A business can make losses for entirely genuine reasons. It may be starting up, investing for growth, experiencing a difficult trading period or operating in a sector with uneven results.

However, repeated losses or very low income may lead to questions about how the business continues to operate. HMRC may seek to understand how personal living costs have been funded and whether every source of income has been reported.

Keep evidence of the explanation. This might include savings, loans, other household income, asset sales or money introduced by the owner.

#8 Large or unusual repayment claims

A substantial tax repayment is not automatically a problem.

There may be a sound reason for a large VAT repayment, loss claim, tax refund or relief claim. However, the size or unusual nature of a claim may lead HMRC to check it before or after making payment.

Make sure the claim can be supported by clear calculations and the relevant invoices, contracts or other documents. This is particularly important where a claim depends on detailed conditions. The supporting work should explain not just how much has been claimed, but why the business qualifies.

#9 Problems with dividends, directors’ loans or payroll

Money taken from a company must be recorded and treated correctly.

Potential concerns include dividends paid without sufficient profits, a director’s loan account that becomes overdrawn, personal expenses paid by the company or benefits that have not been reported through the correct process. Calling a payment a dividend does not, by itself, make it one.

Company owners should review how they take money from the business during the year. If unsure if it’s been handled correctly, talk to your accountant. Leaving everything until after your accounts year end can limit the options available to you.

#10 Overseas income or assets that have not been clearly reported

Overseas income can be easy to overlook.

Examples include foreign bank interest, overseas property income, investment returns and gains arising when overseas assets are sold.

The reporting position depends on the individual’s circumstances and the type of income or gain involved. Offshore inaccuracies can also carry higher penalties in some cases.

Do not assume that income is outside the UK tax system simply because it arose overseas or tax was paid in another country. Raise the matter early with your accountant so that the correct position can be checked.

Clear records help explain unusual figures

Clear records do more than support the figures on a tax return. They also help explain why this year looks different from the last.

A sudden fall in profit, an unusually large expense or a one-off transaction may be entirely genuine. But if HMRC asks about it months or years later, it can be difficult to remember exactly what happened.

Make sure you keep the invoices, agreements, calculations and brief file notes that explain unusual figures. This gives you a clear trail back to the original transaction and makes it easier to answer questions quickly and confidently, should it ever be needed.

What should you do if you discover a mistake?

Do not ignore it. Start by establishing what went wrong, which returns or periods are affected and how much tax may be involved. Then take advice on the correct way to put matters right.

Telling HMRC before it begins a check may be treated as an unprompted disclosure. The timing and quality of a disclosure can reduce the level of any penalty. HMRC considers whether the inaccuracy was careless, deliberate or deliberately concealed, as well as whether the disclosure was prompted or unprompted.

Correcting a mistake voluntarily will not always remove the tax, interest or penalties due. It can, however, place you in a much better position with HMRC than if you wait (hope..) to see if they find it.

What happens during a tax enquiry?

HMRC will normally explain what it wants to check and request relevant information or documents. The enquiry could be limited to one figure or cover wider areas of the return. The information requested might include bookkeeping records, invoices, contracts, bank statements or explanations of particular transactions.

Respond carefully and within the agreed timescale. Provide what has been requested, but make sure you understand the purpose of the questions and that the response is complete and accurate. HMRC publishes guidance explaining the compliance-check process and the support available.

Professional advice can help you understand the request, prepare the information and avoid creating further confusion through an incomplete or unclear response.

Key takeaways

No single red flag automatically triggers a tax enquiry, and an unusual figure does not necessarily mean that anything is wrong.

The best protection is straightforward, including:

1. Keep complete and accurate records.
2. Make sure different returns and reports fit together.
3. Retain explanations for significant or unusual transactions.
4. Review uncertain tax treatments before submitting the return and better early.
5. Correct mistakes promptly rather than hoping they will go unnoticed.

The objective is not to make every year look the same. It is to ensure that the genuine figures can be clearly explained and properly supported.

How Sanders Partnership can help reduce tax enquiry risk

At Sanders Partnership, we help business owners keep their accounts, tax records and submissions organised and up to date.

We can review unusual transactions, identify gaps in the supporting records and help ensure that the treatment adopted reflects what actually happened. Where an error is discovered, we can help establish the position and advise on the appropriate next steps.

Good compliance should give you more than completed returns. It should provide confidence that the figures are reliable, deadlines are managed and potential problems are addressed before they become more difficult. This reflects our wider approach of creating a dependable foundation for clearer decisions and greater peace of mind.

This article provides general information only and should not be treated as advice for a particular person or business. Tax treatment depends on the individual facts and the rules applying at the time.