How to Handle a VAT Inspection Without Panicking
What triggers HMRC VAT inspections, what they actually check, how to prepare your records, and what to do if they find discrepancies.
You open a letter from HMRC. "Notice of Inspection: VAT Records." Your stomach drops.
Here's what triggers VAT inspections, what HMRC actually checks, how to prepare your records, and what to do if they find problems.
What Triggers a VAT Inspection
VAT inspections aren't random. HMRC's system flags businesses based on patterns:
Common VAT Inspection Triggers
1. Consistent VAT refunds
If you're claiming back more VAT than you're charging (net refund position) for 3+ consecutive quarters, HMRC wants to verify you're not overclaiming input VAT.
2. Sudden changes in VAT pattern
Your VAT bill drops from £8K/quarter to £2K/quarter with no corresponding drop in turnover. HMRC assumes either: (a) you're miscalculating, or (b) you're hiding sales.
3. Industry benchmarking anomalies
HMRC knows what typical plumbers/electricians/builders claim. If your input VAT is 40% higher than industry average, they'll investigate.
4. Late or amended returns
Filing late, amending returns repeatedly, or submitting corrections after HMRC queries = red flag for poor record-keeping.
5. Whistleblower reports
Former employee, disgruntled customer, or competitor reports you for cash jobs or VAT fraud. HMRC investigates all reports.
6. Random compliance checks
HMRC selects a percentage of businesses randomly each year. Just because you're audited doesn't mean you did anything wrong.
Key insight: Most VAT inspections are triggered by inconsistent patterns, not specific fraud suspicions. Good record-keeping = nothing to fear.
What HMRC Actually Checks
During a VAT inspection, HMRC reviews three main areas:
| What They Check | What They're Looking For | Documentation Required |
|---|---|---|
| Output VAT (sales) | Have you charged VAT on all taxable supplies? Are you hiding cash sales? | Sales invoices, bank statements, card payment records, job sheets |
| Input VAT (purchases) | Are you claiming VAT on legitimate business expenses? Or personal stuff? | Purchase invoices, receipts, supplier statements, mileage logs |
| Record accuracy | Do your records match your VAT returns? Can you evidence every claim? | Accounting software exports, bank reconciliations, VAT return workings |
| Exempt vs standard rate | Are you correctly applying 20% VAT vs 0% vs exempt supplies? | Job descriptions, service classifications, mixed supply breakdowns |
| Subcontractor payments | Are you treating labour-only subbies correctly (no VAT if not registered)? | Subcontractor invoices, CIS deduction statements, payment records |
| Cash sales | Are cash payments properly recorded and banked? Or disappearing? | Cash book, deposit slips, till receipts, customer invoices |
The test: If you claimed £5,000 input VAT on materials, can you show £5,000 of receipts with VAT numbers? If you charged £12,000 output VAT, can you show invoices totaling £72,000 (£60K + £12K VAT)?
If yes: inspection takes 2 hours, inspector leaves happy.
If no: expect follow-up meetings, assessments, and potential penalties.
How to Prepare Your Records (Before They Arrive)
HMRC will give you 7-14 days' notice before the inspection. Here's your prep checklist:
Pro tip: If you discover errors during your prep (missed sales, incorrect VAT claims), voluntarily disclose them to HMRC before the inspection. Penalties are significantly reduced for unprompted corrections vs discovered fraud.
During the Inspection: What to Say (and Not Say)
The inspection usually lasts 2-4 hours. Here's how to handle it:
Do's and Don'ts During VAT Inspection
DO:
- Be polite and cooperative – HMRC inspectors are just doing their job; hostility makes them dig deeper
- Answer questions directly – "Yes," "No," "I'll need to check that" are perfectly fine answers
- Provide requested documents promptly – Don't make them ask twice
- Explain your process – "I issue invoices via Toolfy, reconcile weekly, and file VAT returns quarterly via my accountant"
- Admit if you don't know – "I'd need to check with my accountant" is better than guessing
- Take notes – Write down what they ask for, what they find, what they say needs fixing
DON'T:
- Volunteer extra information – Answer what's asked, nothing more
- Lie or exaggerate – If they catch you in a lie, they'll assume everything is fraudulent
- Guess at numbers – "I think..." or "Probably around..." = red flag for poor record-keeping
- Make excuses – "I've been busy" doesn't justify missing £10K of sales from your VAT return
- Get defensive – "Are you accusing me of fraud?" escalates the situation unnecessarily
- Refuse reasonable requests – If they ask to see your van (to verify business use), let them
Script for common questions:
| Inspection Question | Safe Answer | Dangerous Answer |
|---|---|---|
| "Do you take cash payments?" | "Yes, occasionally. All cash jobs are invoiced and recorded in my accounting software." | "Sometimes, if the customer prefers" (implies you might not record them) |
| "Why did your VAT refund increase in Q3?" | "I purchased a van in August for £25K+VAT, here's the invoice." | "Not sure, my accountant handles that" (you should know your own business) |
| "Can you show me receipts for this £8K materials claim?" | "Yes, here's the folder with all Q2 purchase invoices." | "I think I have them somewhere..." (implies poor record-keeping) |
| "Do you use your van for personal trips?" | "Occasionally on weekends. I don't claim fuel VAT for personal mileage." | "No, never" (obviously untrue, undermines credibility) |
Common Mistakes That Raise Red Flags
HMRC sees these patterns repeatedly. Avoid them:
Top VAT Compliance Mistakes (UK Trades)
1. Claiming input VAT on non-business expenses
The mistake: You buy a £60 meal at a pub, claim the £10 VAT back. But the receipt says "2× Sunday roast, 1× kids meal" (clearly personal).
The fix: Only claim VAT on expenses wholly and exclusively for business. No family meals, no personal fuel, no home shopping.
2. Missing VAT numbers on purchase invoices
The mistake: You claim £500 input VAT from a supplier, but their invoice doesn't show a VAT number (they might not be VAT registered).
The fix: Verify every supplier's VAT number via HMRC's online checker before claiming input VAT.
3. Not charging VAT on all taxable supplies
The mistake: You quote £5,000 for a job, customer pays £5,000, but you don't add VAT (should be £6,000 inc. VAT). You've underpaid HMRC £1,000.
The fix: All your quotes should state "Plus VAT" unless the customer is explicitly VAT-exempt.
4. Treating cash sales differently
The mistake: Customer pays cash, you pocket £500 without invoicing or declaring it. HMRC compares your bank deposits to declared sales and spots the gap.
The fix: Every job gets an invoice—cash, card, or bank transfer. No exceptions.
5. Claiming VAT on vehicles over 3,500kg (incorrectly)
The mistake: You buy a double-cab pickup (classified as a car for VAT), claim back the full VAT, but HMRC only allows 50% recovery on cars with private use.
The fix: Understand vehicle VAT rules—vans (yes), cars (no), commercial vehicles over 3.5T (special rules).
If They Find Discrepancies (What Happens Next)
HMRC completes the inspection and finds problems. Here's the likely outcome:
| Severity | What They Found | Likely Outcome | Your Action |
|---|---|---|---|
| Minor errors | £200-500 of incorrect VAT claims (genuine mistakes, no pattern) | Letter requesting correction + pay shortfall + interest (no penalty) | Pay immediately, improve record-keeping, move on |
| Careless mistakes | £2K-10K underpaid VAT due to poor record-keeping or misunderstanding rules | Assessment + 15-30% penalty + interest | Pay the bill, get an accountant, implement better systems |
| Deliberate understatement | £10K+ hidden sales, systematic VAT evasion, falsified records | Full investigation + 50-100% penalty + potential criminal prosecution | Hire a specialist tax lawyer immediately (this is serious) |
| No issues found | Records accurate, VAT correctly calculated and declared | "No further action" letter within 4-6 weeks | File it away, sleep soundly |
Penalty mitigation:
- Unprompted disclosure (you tell HMRC before they find it): Up to 70% penalty reduction
- Prompted disclosure (you admit it during inspection): Up to 40% reduction
- Full cooperation (you provide all documents, don't obstruct): Up to 30% reduction
- Payment plan (if you can't pay the full bill upfront): HMRC will usually agree to 6-12 month installments
Key principle: Honesty reduces penalties. Obstruction increases them. If you made a mistake, own it, fix it, and move forward.
The Verdict: VAT Inspections Are Survivable
Most VAT inspections end with either "no issues" or minor corrections.
Here's your survival system:
- 1. Keep accurate records year-round – Don't scramble when the inspection letter arrives
- 2. Only claim legitimate business expenses – No personal meals, no family shopping, no dodgy receipts
- 3. Declare all sales (including cash) – HMRC can see your bank deposits; hiding cash doesn't work
- 4. Prepare thoroughly – Organize documents, reconcile returns, fix obvious errors before they arrive
- 5. Be cooperative during inspection – Polite, direct answers; provide requested documents promptly
- 6. If they find problems, own them – Voluntary disclosure + cooperation = reduced penalties
The businesses that panic during VAT inspections are the ones who've been cutting corners. The ones with clean records and organized systems? The inspection is just a box-ticking exercise.
Which business do you want to be?