HMRC has at its disposal some rather clever software which analyses relationships and seeks out anomalies in company tax and VAT returns. Businesses are benchmarked against other companies in the same industry and against the performance of the economy as a whole. A company's returns can also be compared with previous years. Any anomalies or fluctuations which are discovered are likely to put a company directly under the tax spotlight, especially if these are not explained.
On VAT forms the software might looks at things such as the relationship between the value of a company's sales and purchases, which is then compared with all other companies in the same trade class. If you're significantly different, you're likely to get targeted for an inquiry. You can also be targeted if there's a sudden change in VAT on sales. On tax returns, HMRC is interested in how a company is performing against what would be expected in their industry-for example, percentages for gross profit, turnover growth and net profit. The software will also be checking for any year-on-year fluctuations in turnover, profits, debtors or stock. Therefore if this is happening in your business you should always use the space on the return to explain why.
Companies are more at risk from an investigation in industries where fraud is common or where complex legislation makes compliance mistakes more likely. Insiders suggest that companies at highest risk from a VAT inquiry are in construction, mobile phones and computers, retail and other cash businesses and export. Businesses which are partially VAT exempt are also at high risk. Mistakes in meeting payroll requirements set off many HMRC inquiries, especially for smaller companies.
Sadly, you are also at higher risk of an HMRC inquiry if you are a fast growing, entrepreneurial business. This is because the business might be growing rapidly but accounting systems haven't kept pace with that growth and aren't robust enough to capture data properly. HMRC is believed to be very aware of this and also that entrepreneurial companies are more likely to try and reduce their tax liabilities.
According to business lobbies such as the Federation of Small Businesses (FSB), HMRC is less likely to carry out a full investigation on large businesses due to the resources required. Most full investigations are on cash businesses with turnovers up to £250,000, the FSB claim. Large companies have a multitude of tax accountants and internal advisors, at their disposal and are deemed to be less likely to make a mistake. However, in smaller companies it's the proprietor who's expected to keep pristine records and mistakes can easily happen.