As HMRC steps up VAT compliance activity, how should company directors prepare?

VAT-registered businesses that have had no review from HMRC in the last five years are currently receiving ‘one-to-many’ letters from HMRC, indicating that they may be selected for a VAT compliance check over the next two years.

Interestingly, the HMRC letter, also known as a ‘nudge letter,’ warns that exactly 50% of businesses receiving it will be targeted.

To us, this is a clear signal of increased HMRC focus on VAT-registered businesses that have had little or no scrutiny in recent years, writes Jo Edwards, a manager specialising in VAT for and on behalf of PKF Francis Clark, a chartered accountancy and business advisory firm since 1911.

Can you ignore an HMRC nudge letter on VAT?

For business owners, this increased HMRC scrutiny on VAT is not something to ignore.

And HMRC’s message on VAT compliance is clear — taking action now can help avoid disruption, costs and potential penalties later.

Why is HMRC focusing on VAT in 2026/27?

A key driver behind this new activity is HMRC’s focus on closing the ‘VAT gap.’ The VAT gap is the difference between the VAT it expects to collect and what is actually paid.

Although the VAT gap has narrowed over time, it remains significant enough in 2026/27 to drive continued scrutiny by HMRC.

Is MTD still part of VAT compliance?

One of HMRC’s key measures to help close the VAT gap has been the introduction of Making Tax Digital (MTD).

MTD requires businesses to keep digital VAT records and submit returns through compatible software.

Why is VAT so complicated?

Alongside MTD, three key changes have also made VAT more complex:

1. The UK’s exit from the EU
2. Temporary reduced VAT rates in certain sectors
3. Ongoing legislative changes.

These shifts often introduce complexity into VAT processes. Over time, even well-run businesses can develop inconsistencies, particularly where systems or processes have not kept pace with change.

HMRC is now actively targeting these risks.

What five key areas does a VAT compliance check focus on?

Under this current compliance initiative, HMRC’s approach to VAT-registered businesses appears broad rather than industry-specific.

At the time of writing, HMRC’s focus with these nudge letters is on general VAT compliance, including the following five key areas:

1. VAT records, reconciliations and controls
   • HMRC will check that VAT records are complete, accurate and match financial accounts
   • Weak controls can trigger concern, even where errors are unintentional.
2. Private or non-business use adjustments
   • Businesses must correctly account for any private or non-business use
   • Recent guidance changes to non-business income may affect input VAT recovery
   • Calculations must be clear and supported by evidence.
3. Partial exemption and input tax recovery
   • If a business makes both taxable and exempt supplies, input VAT must be properly apportioned
   • Errors in these calculations are common and can result in incorrect VAT claims.
4. International supplies
   • Post-Brexit rules have increased complexity
   • HMRC will review the treatment of overseas services, place of supply and establishment issues
   • Imports and exports must be supported by appropriate documentation.
5. VAT liability and classification
   • Ensuring supplies are correctly classified (standard, reduced, zero-rated or exempt) is critical
   • Misclassification is a frequent issue in VAT compliance checks.

How to respond to an HMRC letter on VAT compliance?

If you receive a letter, it is advisable to act early rather than wait.

A proactive review of your VAT arrangements does not need to be overly time-consuming.

What are the key benefits of a professional VAT review?

Such a review of VAT compliance can provide companies with five key benefits:

1. Identify and address technical or compliance risks
2. Strengthen VAT processes and controls
3. Ensure VAT treatment aligns with current legislation
4. Prepare documentation in case of HMRC review
5. Gain confidence that the business is VAT ‘inspection-ready.’

And there’s probably a sixth advantage of a proactive VAT review before an inspector calls.

Finding issues with your company’s treatment of VAT early allows them to be managed on your terms, rather than under the pressure of an HMRC enquiry.

What are some core VAT best practices?

We’re often asked for practical steps to strengthen your VAT position.

One effective approach is to create and maintain a tax risk register.

A tax risk register can help:

• Identify and document VAT risks
• Track actions taken to address them
• Assign responsibility
• Demonstrate oversight and governance.

This type of documentation can be valuable during an HMRC VAT review.

It shows the business is taking VAT compliance seriously and applying appropriate controls (and for large companies and groups, adhering to review principles expected under the Senior Accounting Officer regime).

Can ‘reasonable care’ protect me from paying VAT penalties?

HMRC guidance makes clear that penalties are less likely where a business has taken “reasonable care.”

Examples of ‘reasonable care’ are important for businesses to note. We’ve put three main examples below.

How does HMRC define reasonable care?

1. Keeping accurate and complete records
2. Reviewing uncertain areas
3. Seeking professional advice where needed.

How else to lower HMRC penalties on VAT?

HMRC also encourages voluntary disclosure of errors, with lower penalties often available where issues are identified before HMRC intervenes.

What five business activities increase VAT risk?

Certain business activities typically increase VAT risk and should be reviewed more closely, notably these five:

1. Corporate transactions (such as sales or acquisitions)
2. Group restructures
3. Changes to systems or accounting software
4. Expansion into new markets or territories
5. Complex land and property transactions.

Any of these five events can significantly affect VAT treatment. However, VAT is not always reviewed in detail once the transaction is complete. As a transactional tax, it is important to get VAT right at the time.

The takeaway

HMRC’s new and increased focus on VAT compliance reflects its wider goal of closing the VAT gap. In reality, it means closer scrutiny of whether businesses:

• Follow HMRC guidance
• Maintain accurate records
• Operate effective systems and controls
• Take reasonable care in managing VAT.

Owner-managed businesses can take some simple steps now to review and strengthen their VAT position and be prepared.

If you have received an HMRC ‘one-to-many’ or nudge letter relating to Value Added Tax (VAT), or would benefit from an independent sense-check of your VAT position, seeking professional advice can provide reassurance and help you address any areas of concern.