A Contractor’s Guide to Staying on the Right Side of the Taxman

A Contractor’s Guide to Staying on the Right Side of the Taxman

Nobody wants to get on the wrong side of the taxman. Like Icarus, when he flew too close to the sun, it’s not a pleasant place to be. We show you how to keep your financial house in order so you can stay off the taxman’s inspection radar (and avoid crashing and burning).

As a contractor, you’re at constant risk of being the subject of an HMRC tax investigation – now more than ever.
Fortunately, there’s some simple steps you can take to lower the risk of a tax inspection and avoid the stress and expense of a potentially protracted investigation.

What is involved in a tax inspection?

HMRC carry out three categories of tax investigations:

  • Aspect enquiries: at least one area of tax is reassessed.
  • Full enquiries: an entire tax return is inspected.
  • Random enquiries: it’s estimated that seven to eight per cent of tax inspections are conducted on a random basis. HMRC use random enquiries to assess tax returns across ‘high risk’ areas. They especially keep an eye on entrepreneurs and SMEs and use random tax inspections as a means of keeping them guessing.

In the worst-case scenario, an unfavourable tax inspection result could see you looking at a criminal record and prison time. So, regardless of the type of investigation you’re under, you should always take it very seriously.

What prompts HMRC to carry out a tax inspection?

Sometimes, HMRC believes there’s something wrong with your numbers, your back story or both. Maybe you’ve been a touch creative with your figures and they don’t quite add up?

At other times, HMRC doesn’t necessarily have grounds to believe that there’s anything wrong at all (as is the case in random inspections). Some contractors get more unwanted attention from HMRC purely because, for example, they work in certain sectors such as the construction industry or they operate cash-based businesses, both of which are prone to non-compliance.

How can you lower the chances of a tax inspection?

It’s impossible to rule out an HMRC tax inspection, but it is possible to reduce the chances of being inspected. Here’s six ways you can do this.

1. File your tax returns on time

In the eyes of HMRC, timing is everything.

Many tax investigations are triggered by taxpayers who miss the initial filing deadline. If you file your tax returns and other documentation on time (or, better still, ahead of time), HMRC will assume – rightly or wrongly – that you’re a solid operator who will probably pay the right amount of tax. But if you’re overdue, it sends out all the wrong signals – mainly that you’re unlikely to make the right tax payment.

2. Ensure your tax returns are accurate (and complete!)

There’s no point turning in your tax returns early if they’re wrong or incomplete.
Your job is to ensure that you’ve dotted all the i’s, crossed all the t’s and left out no information that could raise eyebrows.

3. Pay your tax on time

You must always be timely in completing two tax activities – submitting your tax returns and making tax payments. If you do one without the other, you’ll face a penalty.

4. Explain any changes in your tax return

HMRC run two types of analysis:

  • Ratio analysis: they look at any change in your figures from year to year.
  • Sector analysis: they use software to compare your tax returns to your industry average.

If either analysis throws up any unusual fluctuations, this will get the attention of the tax inspectors who may open an aspect enquiry.

So, if you’ve experienced a change in your circumstances, your tax return should reflect this. If it doesn’t, alarm bells will likely sound especially if, for instance, there are significant changes in turnover or gross profit. There’s extra space on your tax return for a reason – use it!

5. Keep accurate records

Good record-keeping is a sure-fire way of keeping even the most hard-to-please taxman at bay.
If your records are accurate and up-to-date, what is there to question?

6. Hire a reputable accountant

A good accountant is best-positioned to give you advice on highlighting changes from one year to the next that are likely to prompt a tax inspection.

A great accountant will go one step further. They will keep on top of the latest developments that affect your business and keep you informed every step of the way. HMRC even recommends that micro-business owners under tax investigation seek independent legal advice to put a cap on potential damages.

If you’d like to get your contractor finances in shape or you want more information about minimising the risk of a tax inspection, give us a call today. We’ll talk you through the basics, so you can focus your efforts on building an honest, profitable business.

With the right know-how, you can stay on the right side of the taxman – year in, year out.

About the Author:

Nik Patel , A specialist accountant and tax adviser for freelancers, contractors and small businesses. Expert in business growth and development strategies. A renowned tax expert for owner managed businesses and contractors.