Top five VAT issues that trigger HMRC investigations

Discover the top five VAT issues that trigger HMRC investigations - and the proactive steps your business can take to stay compliant.

VAT (Value Added Tax) compliance is essential for UK businesses to avoid penalties and ensure a smooth-running operation. HMRC (Her Majesty's Revenue and Customs) conducts investigations to verify that businesses handle their VAT obligations correctly. Even unintentional errors can catch their attention, potentially leading to a full audit.

In this article, we’ll look at the top five VAT issues that commonly trigger HMRC investigations - and what businesses can do to stay compliant.

1. Inconsistent VAT returns

One of the most common red flags for HMRC is when a business’s VAT returns vary significantly from previous filings without any clear explanation. HMRC may question sharp fluctuations in VAT payments or refunds, particularly if:

  • Sales figures significantly increase or decrease without matching VAT adjustments.
  • Refund claims spike suddenly.
  • There are substantial fluctuations in costs, claims, or VAT liabilities.

How to stay compliant: Track and document all significant changes in your VAT calculations. If fluctuations are due to seasonal business cycles, large purchases, or changes in trading volume, ensure you have clear records to support these claims.

2. Inaccurate VAT invoices

Errors on VAT invoices are another common trigger for HMRC. Issues such as incorrect VAT rates, missing VAT registration numbers, or improperly labelled invoices can prompt an investigation. Specific items might be zero-rated or exempt, but if your invoices do not reflect this correctly, you could be over- or under-charging VAT, which is a compliance breach.

How to stay compliant: Ensure that every invoice follows the HMRC guidelines. Check that the correct VAT rates are applied and that all necessary information, such as business name, VAT registration number, and correct amounts, are displayed. Regularly review invoice templates and train staff to issue them correctly.

3. Misclassification of goods and services

VAT is complex, and different products and services are subject to varying VAT rates. Zero-rating, reduced rates, and exemptions make it easy for businesses to misclassify goods and services unintentionally. For example:

  • Items mistakenly classified as zero-rated when they should be standard-rated.
  • Services inaccurately marked as exempt.

Misclassifications, even if unintentional, can lead to underpayment or overpayment of VAT, which will often attract HMRC's attention.

How to stay compliant: Familiarise yourself with the VAT classification of each good or service you sell. Consult HMRC guidelines or seek advice from a VAT expert to ensure you apply the correct VAT rates, particularly if you operate in a sector with complex classifications, like food, health, or construction.

4. Large and frequent VAT repayment claims

Regularly claiming large VAT refunds can draw scrutiny, as HMRC may view frequent claims as a sign of errors or potential fraud. VAT repayment claims typically arise when:

  • Businesses have higher input VAT (VAT on purchases) than output VAT (VAT on sales).
  • Companies are exporting goods, as exports are often zero-rated, allowing businesses to reclaim VAT on purchases.

If your VAT claims appear disproportionately high, HMRC may investigate to ensure they are valid.

How to stay compliant: Keep detailed records of purchases, export documentation, and reasons for any significant VAT repayments. Document the nature of large expenses or export-related activities so you can easily explain the source of high input VAT if needed.

5. Missing VAT registration thresholds

Businesses must register for VAT if their taxable turnover exceeds £85,000 in a 12-month period. Missing the registration threshold and failing to register on time is a serious compliance issue. HMRC tracks business turnover figures and can identify when a business has failed to meet VAT registration requirements, often leading to investigations, backdated liabilities, and penalties.

How to stay compliant: Regularly monitor your turnover and stay aware of the VAT registration threshold. If you anticipate crossing the threshold, begin preparing for VAT registration immediately. Many accounting software packages can help track turnover and alert you when you’re approaching the threshold.

How to protect your business from VAT investigations

Keeping VAT records accurate and up to date is key to avoiding the scrutiny of HMRC. Here are some additional steps you can take to prevent VAT issues:

  • Use VAT-compliant software that tracks VAT liability accurately.
  • Conduct regular internal audits to catch any potential errors.
  • Stay updated on VAT regulations as HMRC updates rules periodically.
  • Consult VAT experts if you operate in complex sectors or face rapid business growth.

Staying vigilant about VAT compliance is essential for every business. By understanding these common VAT issues and taking proactive measures, you can minimise the risk of an HMRC investigation and the disruptions it can cause to your business.

Concerned about VAT compliance?
Venture Tax specialises in helping businesses navigate complex VAT issues and avoid HMRC investigations. Contact us today to discuss how we can safeguard your business.