Small Businesses and the Tax Gap, How to Prepare for HMRC Checks
Overview
HMRC's latest provisional estimate puts the UK tax gap at £59.2 billion for 2024/25, equivalent to 6.4% of the tax theoretically due. Small businesses account for 62% of that estimated gap.
This does not mean 62% of small businesses are evading tax. It is a share of the total estimated shortfall, which has several causes, including errors, failure to take reasonable care, non-payment and deliberate non-compliance.
HMRC uses data analysis to support its compliance work. Accurate records, appropriate tax treatment and timely responses to correspondence help businesses explain their position and reduce avoidable errors. They do not guarantee that a business will never be checked.
Detailed Content
What Is the Tax Gap?
The tax gap is the difference between the tax theoretically due under the law and the tax actually paid. It is not simply the difference between a government revenue forecast and receipts.
HMRC's estimates are subject to uncertainty and revision. In its latest customer-group series, the small-business share was 58% in 2020/21 and 62% in 2024/25. Comparisons should use consistent published figures and take account of methodological changes.
What Does This Mean for Small Businesses?
Small-business compliance is an important part of HMRC's work to reduce the tax gap. Sole traders, partnerships and limited companies can receive requests to review information, formal compliance checks or investigations where concerns warrant further action.
A nudge letter encouraging you to review a return is not necessarily a formal enquiry. Nor does receiving a letter prove that tax has been underpaid. Read what HMRC is asking, identify any deadline and obtain advice where needed.
How Can HMRC Identify Discrepancies?
HMRC uses AI, advanced analytics and data matching to support compliance. It can compare tax returns and submissions with information it holds or lawfully obtains, including relevant third-party information.
Bank transactions, payment-provider information, marketplace reports, VAT returns and payroll records can help explain a business's activities. Do not assume that HMRC has unrestricted live access to every account, or that every difference automatically opens an investigation.
Differences may have legitimate explanations, such as transfers, loans, refunds or accounting timing. Keep evidence that reconciles the figures rather than assuming every bank receipt is taxable turnover.
Areas Worth Reviewing
Sales: Record all taxable business income, including cash and online trading. Reconcile gross platform sales, refunds, fees and net payments received. Selling personal possessions is not automatically a trade.
Expenses: Apply the relevant tax rules, distinguish business from private spending and make appropriate private-use adjustments. Ask about uncertain claims rather than relying on a single generic list.
VAT: For most UK-established businesses, check whether taxable turnover has exceeded £90,000 in a rolling 12-month period, or is expected to exceed £90,000 in the next 30 days alone. Different circumstances can bring additional rules.
Payroll: Check PAYE deductions, reporting deadlines and employment-status treatment. Contractor labels alone do not establish the correct tax treatment.
What Penalties Can Apply?
For standard domestic penalties for inaccurate returns or documents, the outcome depends on behaviour and disclosure. The percentages below apply to potential lost revenue, which is not always simply the unpaid tax.
The quality and timing of disclosure affect reductions. Some offshore cases and other penalty regimes have different rules. Additional tax and interest may remain payable even where no inaccuracy penalty is charged.
An unprompted disclosure generally means telling HMRC before you have reason to believe it has discovered, or is about to discover, the error. A relevant nudge letter can affect that assessment, even before a formal enquiry starts. Seek advice promptly and use the correct amendment or disclosure route.
What Does Good Record-Keeping Look Like?
Keep sales, expense, payroll and VAT records complete and current. Retain supporting invoices, receipts and claim calculations, reconcile bank and payment accounts, and explain unusual transactions or changes in results.
Good records provide evidence, but they do not automatically settle a disagreement about tax treatment. Use suitable software and meet digital-record obligations where they apply. The business or taxpayer remains responsible, even when an adviser assists.
For most people filing a 2025/26 online Self Assessment return, the deadline is 31st January 2027. The usual paper deadline is 31st October 2026. Company accounts and Company Tax Returns have separate deadlines, and individual notice-based exceptions can apply.
Professional Support and Investigation Insurance
An accountant or bookkeeper can help identify errors, reconcile figures, review compliance and prepare an accurate response to HMRC. The scope of support should be agreed, and no adviser can promise a quick resolution or immunity from a check.
Tax investigation insurance or fee-protection arrangements can help meet eligible professional costs for covered enquiries. Cover depends on the policy, limits, exclusions, notification requirements and insurer approval. Do not assume an existing enquiry or nudge-letter response will be covered. These arrangements generally do not pay the underlying tax, interest or penalties.
Step by Step Procedure
Bring bookkeeping up to date and resolve missing documents and unreconciled transactions.
Reconcile business income across bank accounts, cash records, cards and online platforms, separating transfers and other non-sales receipts.
Review expense claims and private use under the relevant tax rules, seeking advice where treatment is uncertain.
Check VAT registration tests, payroll obligations and filing deadlines.
If HMRC contacts you, verify the correspondence, read the request and deadline, preserve records and seek appropriate advice. Request additional time promptly if genuinely needed.
Correct identified errors through the relevant amendment or disclosure process. Do not assume a disclosure is unprompted merely because no formal enquiry has opened.
Review any investigation-fee cover and its conditions before assuming costs are insured.
Frequently Asked Questions and Answers
How Much of the Tax Gap Comes from Small Businesses?
HMRC attributes 62% of its provisional £59.2 billion tax-gap estimate for 2024/25 to small businesses. This measures their share of the estimated gap, not the percentage of small businesses doing something wrong.
Does a Data Mismatch Prove I Have Underpaid Tax?
No. Timing differences, transfers, loans and refunds can explain differences. Reconcile the figures and keep evidence supporting your tax treatment.
What Should I Do with a Nudge Letter?
Check that it is genuine, read the specific request and review the records for the period concerned. Obtain advice before making admissions, changing returns or signing declarations you do not understand. Respond where requested within the stated deadline, or seek more time promptly if necessary.
Will an Honest Mistake Automatically Lead to a Penalty?
No. HMRC does not charge an inaccuracy penalty where reasonable care was taken. Careless or deliberate inaccuracies have different ranges. Tax and interest can still be due.
Can Insurance Cover an Investigation Already Under Way?
Do not assume so. Cover depends on the actual policy and the circumstances. Check existing cover, notification requirements and approval before incurring costs or purchasing new cover.
How Can 360 Accounts Help?
360 Accounts & Bookkeeping can help review your records, tax returns, VAT and payroll position, and provide support with HMRC correspondence and compliance checks within an agreed engagement. We also offer HMRC investigation insurance, subject to the applicable terms and eligibility. Contact our Guildford team to discuss the support your business needs.