HMRC investigations: the costly tax return mistakes you can't afford to make

Accurate reporting on tax returns is both a legal obligation and vital for maintaining trust between taxpayers and authorities.

HM Revenue & Customs enforces tax compliance, ensuring fairness in contributions to public funds since its establishment in 2005. Mistakes in tax returns can lead to investigations and possible penalties. This article explains common issues that catch HMRC's attention, shares real examples of inquiries caused by errors, and offers practical tips to help taxpayers avoid mistakes.

HMRC's role in enforcing tax compliance

HMRC strives to ensure taxpayers fulfil their responsibilities, primarily using its power to investigate suspicions of incorrect or misleading tax returns. By using advanced data analysis and sharing information with other government bodies, HMRC can identify unusual figures and link them to bigger patterns of possible tax problems. These investigations can vary in size and intensity and may start due to simple mistakes or signs of serious tax fraud. If HMRC suspects that someone has deliberately done something wrong, they may begin a Code of Practice 9 (COP9) investigation. This gives taxpayers a chance to disclose any mistakes or omissions they have made knowingly.

How tax return inconsistencies trigger investigations

While there are numerous reasons HMRC might open an inquiry, certain inconsistencies consistently raise red flags and prompt deeper scrutiny. Among the most common issues are:

Income discrepancies: A mismatch between a taxpayer's declared income and information sourced from employers, banks, or other entities can lead to suspicion. For example, if a self-employed individual reports substantially lower earnings than those reflected in bank deposits, an HMRC investigation may be initiated to determine whether any income has been omitted. Similarly, an employed person with a lifestyle that far exceeds their declared salary may attract additional attention.

Inflated or inconsistent expense claims: Overstating expenses or misclassifying personal costs as business-related can artificially reduce the tax bill. HMRC looks closely for unusually high expenses or expenses that do not match industry norms. If a business owner's annual accounts show implausibly large meal or entertainment costs that overshadow actual turnover, the anomaly may prompt further analysis.

VAT return discrepancies: Businesses registered for Value Added Tax (VAT) face more detailed reporting requirements. Any significant differences between VAT submissions and year-end financial statements or recurring patterns of large VAT reclaim amounts may lead to an investigation. If a business persistently claims high input VAT without a corresponding increase in revenue, HMRC will likely request evidence to justify those figures.

Unreported income: Failing to declare any source of revenue—whether freelance work, rental income, or overseas earnings—can have serious consequences. HMRC routinely cross-checks data from multiple sources, and undisclosed revenue could become apparent when comparing reported figures to bank statements or property ownership records. Even inadvertent errors can trigger investigations, although deliberate omissions carry heftier penalties.

Incorrect tax codes: Tax codes assigned to employees may sometimes be wrong, resulting in overpayment or underpayment of tax. If a taxpayer's self-assessment return conflicts with information submitted through the Pay As You Earn (PAYE) system, HMRC may investigate to reconcile these discrepancies. Employers who apply incorrect codes or fail to update them when circumstances change also risk drawing attention to their payroll processes.

Unusual patterns in income or expenses: Sudden fluctuations in reported income or expenses can lead HMRC to question whether such changes are justified. A once-small enterprise suddenly claiming exceptionally high expenses or an individual experiencing a dramatic spike in income without any clear business explanation could attract an inquiry. Abnormalities that defy typical industry trends are especially concerning.

Understanding HMRC Investigations

HMRC investigations can vary in intensity. Some cases are resolved quickly if taxpayers provide adequate documentation or correct errors, while others may escalate to tribunals or courts. There have been instances where HMRC was defeated, showing that mistakes do not always imply wrongdoing.

In some FTT cases, a taxpayer was penalised for allegedly misfiling details but was found to have made an honest mistake with no intent to deceive, leading to a ruling in their favour. This underscores that not all discrepancies indicate fraud.

Conversely, individuals or companies found guilty of deliberately concealing income face severe penalties, including repayment of underpaid taxes and significant fines. Serious tax evasion can potentially result in criminal charges.

A word from an expert

"Any inconsistency in a tax return, no matter how minor, can act as a red flag to HMRC," warns Aatif Malik, a seasoned tax advisor and founder of Tax Accountant – a specialist tax consultancy. "We always urge taxpayers to double-check their figures and documentation before submitting returns. In my experience, most HMRC investigations start from avoidable mistakes—a missed income entry or an over-claimed expense—that could have been caught with a bit of extra care. Having comprehensive records and professional advice is key. It's far better to get it right the first time than to face the stress of an inquiry later."

Practical tips for accurate tax reporting

Keep comprehensive records: Organised documentation is the bedrock of compliance. Retain receipts, invoices, bank statements, and other proofs of your business transactions or sources of income. Being able to substantiate every figure in your tax return strengthens your position if questions arise.

Seek professional guidance: If you are unsure about how to categorise particular expenses or whether specific income sources need to be declared, consult a tax professional. Their expertise can help avoid unintentional mistakes and ensure you fulfil your legal obligations.

Review before submission: Always double-check your numbers before filing. Look for logical inconsistencies, such as dramatic changes in income or outgoings. Comparing the previous year's figures can help flag potential oversights or erroneous entries.

Consider VAT and PAYE alignment: If you run a business, confirm that your VAT returns align with your annual accounts. Likewise, ensure that employee PAYE codes are correct and updated regularly if circumstances (like benefits or allowances) change.

Disclose fully: If you discover an error after you have submitted your return, correct it voluntarily by contacting HMRC. Prompt disclosure often results in reduced penalties, particularly when compared to the consequences of waiting for HMRC to unearth the issue.

HMRC investigates to make sure everyone pays the right amount of tax. They often find issues like unreported income, incorrect figures, big expense claims, and VAT errors. Although HMRC can make mistakes, it's the taxpayer's job to keep accurate records and support their reported numbers. Good record-keeping and professional advice can help you avoid a tax investigation. If you do face an investigation, it's important to be open and cooperative. Properly managing your taxes is better than dealing with the stress and financial problems of a serious HMRC inquiry. Filing honest and accurate tax returns is a legal responsibility and is important for good financial management.