HMRC VAT investigations and inspections

What a VAT check is

A VAT compliance check is HMRC examining whether a business has accounted for VAT correctly. A VAT return has no enquiry window of the kind that applies to a Self Assessment return. What limits HMRC is the time it has to raise an assessment, set out below.

If the letter refers to Code of Practice 9, HMRC suspects fraud and the position is different: see our COP9 page. If HMRC alleges that a business’s transactions are connected with supply-chain fraud, that needs specialist counsel, and we will say so at the outset.

How a VAT check starts

Most VAT checks begin in one of three ways.

• A letter. HMRC writes to say it wants to check the VAT records for one or more periods, and what it wants to see. An informal request is a request. A formal information notice is a legal requirement. Which one has arrived decides what actually has to be produced.
• A call or letter to arrange a visit. HMRC says it normally visits with the business’s agreement and usually gives at least 7 days’ notice.
• A hold on a repayment. Where a return claims money back, HMRC can check it before paying, and a hold for checks is not by itself an allegation. If the check reduces the repayment, HMRC writes to explain the adjustment, and that decision can be reviewed or appealed within 30 days.

What HMRC can ask for

HMRC’s information and inspection powers for VAT are in Schedule 36 to the Finance Act 2008, the same schedule it uses for income tax. Since April 2009 it has replaced the older information and inspection powers in Schedule 11 to the Value Added Tax Act 1994. Parts of Schedule 11 still matter: the duty to keep VAT records, the power to take samples and the power to require security.

• Information notices. HMRC can require a person, by notice in writing, to provide information or produce documents reasonably required to check their tax position. A notice can generally be appealed, but not so far as it asks for the business’s statutory records, the records the law requires it to keep, and not where the tribunal approved the notice.
• Inspections. An officer can enter business premises and inspect the premises, business assets and business documents there, where that is reasonably required to check the tax position. The power does not extend to any part used solely as a dwelling. An inspection happens at a time the occupier agrees, after at least 7 days’ notice, or with the approval of an authorised officer.
• Penalties. Failing to comply with an information notice, or deliberately obstructing an inspection the tribunal has approved, can lead to a £300 penalty and further penalties of up to £60 a day.

VAT records must generally be kept for at least six years. If an information notice arrives, the first step is to read exactly what it requires, and by when.

What a VAT check usually looks at

A check tests whether the records support the figures on the returns. An officer may look at:

• sales records, including cash takings, against the output tax declared
• purchase invoices behind the input tax claimed, since HMRC treats the VAT invoices a business receives as the primary evidence for recovering input tax
• the rate applied to what is sold: standard, reduced, zero-rated or exempt
• any special scheme used, such as the flat rate scheme, and whether the business was eligible
• bank statements, and how they reconcile to the VAT account
• whether the business should have registered for VAT earlier than it did

An officer may also ask to speak to the people who keep the records. None of this means an error has been found, but how the answers are put together matters.

VAT assessments and best judgement

If HMRC concludes that VAT has been under-declared, it raises an assessment under section 73 of the Value Added Tax Act 1994. Where returns are missing, incomplete or incorrect, or the records needed to verify them were not kept, HMRC may assess the VAT due “to the best of their judgment”. It can also assess a repayment or credit that should not have been paid.

Best judgement is a standard, not a licence to guess. HMRC’s own guidance, drawing on the High Court decision in Van Boeckel, says the officer must fairly consider the material available and reach a figure that is reasonable and not arbitrary. Assessments built on mark-ups, samples or observed takings are tested against that standard: whether the facts were gathered objectively, the arithmetic is sound and any sample is representative.

An assessment can be challenged on its amount, on whether it was made to best judgement, or on whether it was made in time. Those are separate arguments.

One limit is easy to miss. The right of appeal against an assessment under section 73(1) or (2) applies to a period for which a return has been made. If HMRC has estimated a missing return, the usual remedy is to file the correct return; if the estimate is too low, HMRC should be told within 30 days, or a penalty can follow.

How far back HMRC can assess VAT

The time limits for VAT are in section 77 of the Act. They differ from income tax in one important respect: there is no extended limit for carelessness.

The 20-year limit also covers a few other cases, including some avoidance schemes that should have been notified to HMRC. Within these outer limits there is a second test. Under section 73(6), an assessment must be made within two years of the end of the VAT period or, if later, within one year of HMRC having evidence of facts sufficient in its opinion to justify it. HMRC’s own guidance says the date it obtained that evidence can be critical, so the chronology of a check matters.

Correcting errors before HMRC finds them

An error in a past VAT return can, within limits, be corrected on the next return. HMRC calls this method 1. It is available where the net value of the errors is £10,000 or less, or is between £10,000 and £50,000 and no more than 1% of the box 6 figure on the return for the period in which the errors are found.

Errors above those limits, and any error made deliberately whatever its size, must be notified to HMRC separately (method 2). HMRC’s current notice directs this to its online service, or in writing where the online service cannot be used. Older guidance refers to form VAT652; the current notice does not.

Correcting a careless error on the next return is not a disclosure for penalty purposes. To obtain the maximum penalty reduction, HMRC must also be told separately in writing. Corrections are generally limited to the last four years.

VAT penalties

An inaccuracy in a VAT return carries no penalty if the business took reasonable care. If it was careless or deliberate, the penalty under Schedule 24 to the Finance Act 2007 is a percentage of the potential lost revenue, broadly the VAT under-declared. The range depends on the behaviour and on whether the disclosure was prompted.

A disclosure is unprompted only if it is made when the person has no reason to believe HMRC has discovered, or is about to discover, the inaccuracy. HMRC’s VAT guidance says its enquiries normally begin when it makes an appointment to inspect the records. Within each range, the reduction depends on the quality of the disclosure: telling HMRC, helping it quantify the inaccuracy, and giving access to records. A penalty for a careless inaccuracy can sometimes be suspended. The higher offshore percentages that can apply to income tax do not apply to VAT.

Late filing and late payment have their own regime. For VAT periods starting on or after 1 January 2023, each late return earns a penalty point, and a £200 penalty is charged at the threshold (2 points for annual returns, 4 for quarterly, 5 for monthly) and for each late return after that. VAT paid within 15 days of the due date carries no late payment penalty. After that, at current rates, there is a first penalty of 3% of the VAT unpaid at day 15, a further 3% of what is unpaid at day 30, and a second penalty at 10% a year from day 31. Late payment interest, at Bank of England base rate plus 4%, is charged as well.

A business that should have registered for VAT and did not faces a separate penalty for failure to notify, under Schedule 41 to the Finance Act 2008. Our page on penalty appeals explains how the behaviour category, the disclosure reduction and suspension can each be argued.

How to challenge a VAT assessment

VAT appeals do not follow the income tax route, where an appeal goes to HMRC first. For VAT, HMRC must offer a statutory review when it notifies the decision, and the appeal itself goes to the First-tier Tribunal.

1. Check that the decision can be appealed. Section 83 lists the decisions that can, including an assessment and its amount, the input tax that can be credited and a requirement to give security. Penalties carry their own appeal rights.
2. Within 30 days, choose a review or the tribunal. To take the review, accept HMRC’s offer within 30 days of the date of the letter containing it. The alternative is to appeal direct to the tribunal within 30 days of the date of the decision letter. Once an appeal is with the tribunal, HMRC will not review the decision.
3. The review. HMRC can uphold, vary or cancel the decision. It has 45 days to give its conclusions, unless a different period is agreed; if it misses that deadline, the review is treated as upholding the decision. After a review, there are 30 days from the date of the conclusion letter to appeal to the tribunal.
4. Paying the disputed VAT. For an appeal against an assessment, the tribunal will not hear it unless the VAT HMRC has determined has been paid or deposited with HMRC. The exception is hardship: if HMRC accepts, or the tribunal decides, that paying or depositing it would cause the appellant hardship, the appeal goes ahead without it. The tribunal’s decision on hardship is final. An inaccuracy penalty, by contrast, does not have to be paid before an appeal against it is decided.
5. Late reviews and appeals. HMRC must carry out a late review if it is satisfied there was a reasonable excuse and the request was made without unreasonable delay once the excuse ended. A late appeal needs the tribunal’s permission.

HMRC may charge interest on VAT that turns out to be due, so whether to pay, deposit or apply for hardship is a decision to take early. If paying is the difficulty, our guide to HMRC Time to Pay arrangements explains how HMRC handles instalments.

Security notices

If HMRC thinks it necessary to protect the revenue, it can require a business to give security for VAT as a condition of continuing to make taxable supplies. The requirement comes in a Notice of Requirement to give security, which takes effect immediately and states the amount and how it can be given. Making taxable supplies without providing it is a criminal offence. The requirement can be reviewed or appealed within the same 30-day limits, so the notice needs attention the day it arrives.

When a VAT check reaches other taxes

A VAT check that finds a problem does not always stay about VAT. Sales under-declared for VAT are usually income missing from the accounts as well. HMRC’s guidance tells VAT officers to keep their assessments consistent with any corresponding direct tax assessment, and to liaise formally with direct tax colleagues where needed.

Schedule 36 restricts information notices about a Self Assessment or company return that has been filed, but not where the information is also needed to check another tax, such as VAT. Questions about cash wages or money drawn from the business can lead on to PAYE and income tax. Our page on compliance checks and formal enquiries covers the direct tax side.

What we do

• Establish what the letter or notice is, and which power it relies on
• Confirm the real deadline, including the 30-day limit on any decision
• Take over the correspondence, and prepare for any visit, so nothing reaches HMRC undrafted
• Establish what the records actually show before responding substantively
• Test any assessment against best judgement and the statutory time limits
• Put the behaviour and disclosure case on any penalty deliberately
• Take the matter through review, a hardship application or the tribunal where that is right

Further reading

• HMRC tax investigations: an overview
• How to appeal an HMRC decision: review, ADR and the tribunal
• HMRC penalties for careless and deliberate errors
• HMRC penalty points, late filing fines and how to appeal
• HMRC Time to Pay arrangements
• Is HMRC looking at your tax affairs?