There are few things in life more stressful than a tax audit. Just when you think you’re on top of things that little brown envelope comes through the post and inside is an ominous looking letter. Not printer on the usual white paper but instead on a scary looking grey paper. At the top of the letter is says “Check of Self Assessment tax return for the year ended 5 April 2013” (in my case) and it’s accompanied by a leaflet “General information about compliance checks”. You’re being audited by HMRC and it’s time to put your record keeping to the test.
In this article I’m going to tell you exactly what I went through in a compliance check, the questions asked, how I responded, how long it took and what the outcome was. Did I get fined or locked up for tax evasion? You can watch the full video here:
What was my self employed business?
At the time, as has often been the case in my life, I had several self employed businesses. To complicate matters, in that particular tax year I had also been employed paying tax through PAYE. The business under investigation was my drum teaching business. Long story but for several years I tried and tried and tried to make money from playing the drums, one of my passions in life. I taught the drums privately, played in several professional bands and also had a fledgling online business via YouTube. For simplicity just assume I was a drum teacher.
Tax audit timescales
In my example HMRC wanted to check the tax return for the tax year 6th April 2012 to 5th April 2013. Here’s a few key dates so that you can understand how long this all took:
- 6 April 2012 -- start of tax year under investigation
- 5 April 2013 -- end of tax year under investigation
- 7 October 2013 -- tax return submitted by my accountant
- 31 January 2014 -- tax return deadline
- 1 August 2014 -- notification received of audit, phase 1 questions
- 21 August 2014 -- phase 1 responses sent to HMRC
- 8 September 2014 -- deadline for initial responses to HMRC
- 24 September 2014 -- phase 2 investigation started
- 29 September 2014 -- phase 2 responses sent to HMRC
I’ll let you know what happened after that later on! To complicate matters slightly, I had some ‘accountant issues’. My accountant at the time completed and submitted the tax return on my behalf without giving me the opportunity to check it. They also didn’t give me a copy of the completed return, so I was somewhat blind to proceedings. In hindsight this was a big mistake.
Initial questions from HMRC (phase 1)
HMRC’s initial letter was directed to my accountant and they sent a copy to me. My accountant simply forwarded the letter to me and had no involvement in the audit after that. Both myself and HMRC had difficulty getting hold of them -- there’s a story for another day!
TOP TIP: Always get a copy of all information submitted to HMRC from your accountant. Make sure they explain anything you don’t understand including calculations. They should have given you the opportunity to check over the tax return before submitting it. In my case this didn’t happen.
So I spoke to HMRC and we agreed it would be best if I just muddled through the audit myself even though I had no clue what had been submitted to them from my accountant. From this point onwards HMRC were happy to deal with me electronically (by e-mail). Here are the initial questions they asked:
- Level of income as a sole trader
- Expenses claimed against income
- Capital allowances claimed
- Why was there a lack of bank interest
- Description of this business and the reason for low turnover
- Reasons why losses should be considered as allowable expenses
- Explanation of business expenses
- Copies of receipts and invoices for the amounts claimed
- Reason for no bank interest in this tax year
- Source of funds for bank interest in the following tax year
Questions 9 & 10 were a telltale red flag for both me and I suspect HMRC. I had told my accountant about bank interest (on which I’d already paid tax) but he hadn’t bothered to include this on my tax return.
So we had a ‘hole’ in our interest declarations. Bank interest was declared for the previous and next tax years but not for the 2012/13 tax year. As soon as anything like this happens HMRC immediately want to know “Where did the money come from that you received interest on in the following tax year?”. The answer was of course “Nowhere”. Since there was no ‘extra’ money. My accountant had just dropped the ball and missed it off my return. I submitted my responses and waited patiently.
Detailed tax audit questions from HMRC (phase 2)
Around a month later HMRC got back in touch with a much more detailed set of questions. They’d completed their initial investigation and were now digging deeper. Here’s what they asked:
- Where did business income originate from?
- How many drum lessons did I give?
- How many times did I play drums professionally in a band?
- How much money have I made from my online drumming website?
- Why do I think this is a ‘real’ business?
- Which parts of the business generated income in the earlier years?
- When did the business actually start trading?
- How much time did I spend running the business per week?
- Provide a copy of the mileage log for all business travel
- Why did I claim for business travel when the turnover was low?
- Provide specific details about an individual trip
- Why did a drum teacher need to pay for drum lessons?
- Why did I claim for costs of rehearsals with very low income?
- Provide full details or rehearsals, band names and how costs were split
- Provide details of costs relating to using your home as an office
- What area of your home is used for business purposes?
- How much electricity, gas and water were used?
- Proportion of time the home office is used for business purposes?
- Provide copies of all receipts over the value of £250
And that was that! In part 2 I’ll explain the answers I gave to HMRC, how long the audit lasted and what the outcome was. Did I get fined or was I sent straight to jail? Come back soon to find out!