Why Legitimate Small Businesses Are Falling Into HMRC's Audit Trap (and How to Avoid It)

Here’s a statistic that may surprise you: small businesses accounted for over 60% of the UK’s £59.6 billion shortfall from unpaid taxes last year, mostly due to simple errors and lack of care. This makes them the largest single contributor to the annual tax gap across all customer groups.

What’s more, the shortfall is growing bigger each year. In 2024-25, the tax gap – the difference between the amount of tax expected to be paid each year and the amount collected – was 6.4%, almost 7% more than it was in 2023-24.

It’s not just the tax gap that is growing; so, too, is the share of the gap attributed to small businesses. According to HMRC, that share has increased over the past 5 years, from 44% of the overall tax gap in 2018 to 2019, to 62% in 2024 to 2025.

In the Sights of HMRC

It is perhaps no surprise, therefore, that small businesses are finding themselves in the sights of HMRC, at a time when the government is looking to beef up its tax revenues. The amount collected from tax investigations into small businesses and individuals over the past year alone has increased by 23%, according to SME Magazine.

To help close the UK’s tax gap and recover billions in lost revenues, HMRC has unveiled plans to recruit 5,000 additional tax inspectors by 2029-30. Tax inspectors are also better equipped to spot tax anomalies thanks to recent advances in data analytics, information sharing, and AI, which allow them to build a more complete picture of our tax profiles.

HMRC often compares businesses within the same sector to identify those with performance metrics that seem out of whack with industry averages. Even a small mismatch in those metrics can trigger an enquiry.

So, while there’s no surefire way for SMEs to avoid a tax enquiry, understanding what can attract HMRC’s attention puts you in a much stronger position. Below are four relatively simple tips to help keep your business compliant and thereby reduce the risk of an investigation [if all else fails and you end up falling into the audit trap, bonus tip #5 will help minimise the fallout].

1. Be punctual with your submissions. Whether it’s a Corporation Tax return, PAYE submission or VAT return, filing late on a regular basis can send the wrong kind of message to the tax authorities. While the occasional slip-up is understable, repeated missed deadlines could raise suspicions about the accuracy of your tax records.

On a positive note, this is a relatively easy trigger to avoid. Keeping track of key dates, having your financial records in order and preparing your returns well ahead of time can help you stay compliant and avoid an HMRC audit. It is also a guaranteed way of reducing stress.

2. Be wary of raising red flags. As already mentioned, even small mismatches in your metrics can attract unwanted attention. A sudden rise or sharp drop in revenues or profits doesn’t necessarily mean you’ve done anything wrong, but it can attract the intetest of HMRC.

That said, there are plenty of legitimate reasons for sharp variations in income or profits, from landing a major new contract to experiencing a subdued trading period. Seasonal businesses are particularly prone to such pronounced fluctutations.

If that is the case for your business, tip #3 is particularly relevant for you.

3. Keep your records in order. Keeping close track of financial data helps to ensure that accounts, payroll and VAT line up across all filings. That entails, among things, keeping records of expenses, director loans, and dividends to justify entries.

This is particularly important if your business handles a lot of cash, which is likely to draw greater scrutiny from HMRC. In which case, good record keeping (issuing receipts, maintaining detailed sales records, regularly reconciling cash balances...) becomes even more vital.

4. Avoid Filing Unusual Expense Claims. A common – and perfectly legitimate – way for businesses to reduce their tax bills is to file expense claims. However, if those claims seem out of kilter with your income or the industry average, HMRC may want to know why.

5. If HMRC does come calling, seek professional advice as soon as possible. It is vital that you consult an advisor before responding to HMRC...