It seems with every passing year the taxman gets more powerful. Given the precarious state of the UK government’s finances, this should perhaps come as no surprise. UK national debt currently stands at £2.6tr and we run an annual deficit of £328bn.
In light of this, the Treasury needs every penny of tax revenue it can muster, and the responsibility falls on HMRC to collect it. One of the ways they do this is by identifying areas where they perceive tax collection is not as high as it could be, or where it’s being lost.
They then use internal teams to conduct in-depth investigations, into individuals and businesses, in order to recover any tax that may have been avoided or evaded.
The pandemic has only heightened this tax gap problem, with HMRC looking to extract as much as possible from investigations to make up for all the lost revenue due to Covid-19 disruption.
‘Tax investigations cost small businesses an average of £18,400 each’
Tax revenue generated from investigations into individuals and small businesses has increased to an average of £18,400 per investigation, up from £17,500 last year.
Furthermore, small businesses can be targeted because they lack the specialist resources in-house to deal with an investigation effectively.
>See also: How to tackle PAYE in your small business
One of the areas SMEs need to be alert to is a potential review of their payroll to ascertain if it’s being run in line with the rules and regulations of the Employer’s Further Guide to PAYE and NICs published by HMRC.
In this article I’ll cover what is likely to be checked in a PAYE compliance audit and how best to protect yourself from the taxman.
Why payroll is likely to fall under the taxman’s gaze
PAYE (pay-as-you-earn) is the system in the UK that HMRC uses to collect income tax and national insurance contributions from organisation’s employees as they earn their wages. You, the employer, deduct all this from your employees’ salaries and then send it to HMRC on a monthly or quarterly basis.
Operating a payroll has, over the years, become increasingly complex with the addition of legislative requirements such as RTI reporting and pension auto enrolment. This increased intricacy means unless you know exactly what you’re doing, you may not be sure if you’re compliant with all your PAYE obligations.
HMRC is very aware of this amongst SMEs and so carries out a PAYE audit to gauge the level of payroll compliance. In instances where it discovers issues, HMRC will calculate the tax and NI lost from the last six years. However, that is not a hard and fast rule, it can be extended with penalties then applied at HMRC’s discretion.
What will HMRC check?
Representatives from HMRC will conduct checks in the following main areas:
- Correct use of employee tax codes
- Working sheets for PAYE deductions
- Where PAYE has not been used, evidence of cash payments
- Correct administration for new employees and leavers
- Reconciliation of the records with the Final Full Payment Submission (FPS) and/or Employer Payment Summary (EPS) for the tax year
- Compliance with all NIC regulations
- National Minimum Wage compliance
- Right to work and identity checks being maintained
- Benefits provided to employees, in line with trivial benefits rules
- Expense payments and their disclosure
- Use of freelancers and sub-contractors in relation to IR35 tax rules
PAYE areas where inconsistencies are likely to arise
With PAYE audits being fairly structured as to what agents from HMRC will be looking for, it’s possible to pre-empt what could cause issues. Not only does this help to identify areas for concern in the short term, but also ensures you can plan and mitigate any problems occurring in the first place by being aware of the processes required to ensure that everything remains above board.
Areas where issues are likely to arise include:
- Payments to suspected ‘self-employed’ people
- Lump sum expenses
- Purchasing of petrol for private use
- Payments to spouses for travel and subsistence
- Gross payments to casual employees
- Staff rewards
- Travel to work from home and home to work
- Trips unrelated to business activities such as social outings and trade fairs
- The use of a home as an office for the purpose of expenses
- The trivial benefits system
- Medical expenses
- Home telephone
- Club subscriptions
- Lunch related expenses
- Where goods and services have been provided free/below market value
- Work undertaken at an employee’s home
What should you do if you are selected for a PAYE audit?
Given all the different things HMRC is reviewing and looking for, it’s not uncommon for inconsistencies to be uncovered. To guard against this, it may be wise to get your advisors to conduct a review of the wage and salary data of your employees. They can then identify any potential PAYE and NI discrepancies prior to a visit.
In the event that the taxman has already conducted their checks, then it would be wise to seek professional advice to help you in negotiating any potential settlement with HMRC.
What to remember in a PAYE audit?
On the whole, a PAYE audit shouldn’t induce sleepless night. Often, the inconsistencies uncovered by HMRC are simple accounting mistakes which can happen in smaller businesses which don’t have large finance departments.
This is why it’s important to work with a trusted professional advisor to prevent anomalies and inconsistencies in your financial reporting. This not only takes the pressure off the possibility of a PAYE audit, but also makes end of year tax payments and budget forecasting easier too.
Ercan Demiralay is a partner at accountancy firm Wellers