VAT compliance checks are changing — here’s what contractors need to know

There are concerning reports of HMRC VAT compliance checks affecting owner-managed businesses.

But for the purposes of this article, HMRC confirmed that VAT compliance checks, where no HMRC review of VAT has taken place in the past five years, do not apply to limited company contractors.

So while VAT checks into businesses that haven’t had a VAT review by the taxman in the last five years are indeed underway, they are underway only at mid-sized businesses.

This clarification from HMRC, exclusively to ContractorUK, might reassure some contractors.

But please don’t get complacent!

In fact, there was no word from HMRC yesterday on whether small companies might be next in its VAT crosshairs.

Therefore, it’s hard to imagine a better time for contractors directing their own limited company to prepare for a VAT compliance check, writes Caroola Accountancy operations director, Carl Bridges, an accountancy expert with 15+ years’ professional experience specialising in contractor taxation.

Have VAT inspections changed?

While VAT inspections themselves are not new, the focus and expectations from HMRC have changed significantly.

This changes matters because many contractor-directors still wrongly view VAT as a straightforward compliance task, whereas we recommend that Value Added Tax should be treated as a genuine risk area.

And given that it’s an HMRC risk area, VAT compliance is no longer just about submitting VAT returns; it’s about being able to evidence, explain and justify everything that goes into them.

What triggers an HMRC VAT investigation?

HMRC carries out VAT compliance checks to ensure businesses are paying or reclaiming the right amount of VAT. Such VAT checks are typically risk-based, meaning they may be triggered by errors, unusual patterns or repayment claims.

Is a small company less visible to HMRC?

For contractors, this risk-based rather than random approach by HMRC means that even simple structures are within scope.

Therefore, a small company (like a Personal Service Company — ‘PSC’) does not mean low visibility.

How far back can a VAT investigation go?

An inspection of VAT will typically review up to four years of records.

However, longer periods may apply in more serious or deliberate cases.

What happens during a VAT compliance check?

A VAT compliance check is usually conducted either remotely or via a scheduled visit.

HMRC typically provides seven days’ notice before the visit.

A VAT inspector from HMRC will typically request five things:

1. VAT returns and supporting calculations
2. Sales and purchase invoices
3. Expense records and receipts
4. Bank statements
5. An explanation of how VAT is calculated.

What do VAT inspectors look for?

Beyond the hard numbers, HMRC’s VAT inspectors assess whether there is a clear audit trail showing how the VAT position was arrived at.

If discrepancies are identified, HMRC may require corrections and apply interest and penalties.

Fortunately, cooperation can reduce the level of penalty applied.

What HMRC expects from contractors

HMRC guidance states that VAT-registered businesses, including contractor limited companies, must keep records that are:

• Complete
• Accurate
• Up to date
• Capable of supporting VAT calculations.

What are MTD VAT requirements?

Additionally, under Making Tax Digital (MTD), all VAT-registered businesses must:

• Maintain digital records
• Use compatible software
• Submit VAT returns electronically.

What is VAT compliant in 2026/27?

These requirements underline the key shift in VAT probes mentioned at the top. Compliance is now about systems and processes, not just the final figures.

HMRC has also published guidance entitled “Help with VAT compliance controls.”

Although the guidance dates back to 2024, it’s still helpful for contractors in 2026/27, because it outlines what HMRC considers “good practice” in VAT controls and processes.

The HMRC guidance sets a clear benchmark for how businesses are expected to manage VAT risk.

Where VAT-registered contractors often get caught…

In practice, VAT issues in contractor businesses are rarely deliberate. They tend to arise from operational weaknesses such as:

• Incomplete or inconsistent record keeping
• Manual adjustments with no supporting rationale
• Incorrect treatment of specific transactions
• Over-reliance on software without review
• Lack of documented processes.

Issues such as these often go unnoticed until a VAT compliance check exposes them.

HMRC expects businesses to demonstrate “reasonable care”, and that demonstration becomes difficult where processes are unclear or undocumented.

VAT penalties: common causes and cost impacts

VAT penalties from HMRC typically arise from:

• Late filing or payment
• Errors in VAT returns
• Failure to meet compliance requirements.

Since 2023, HMRC has operated a points-based system for late submissions, alongside penalties for late payment and interest charges.

For inaccuracies, penalties depend on taxpayer behaviour. Where HMRC identifies a careless error, penalties can range from 15% to 30% of the VAT due, whereas voluntary disclosure can reduce this significantly.

The difference often comes down to whether the business can demonstrate that “reasonable care” was taken.

My view: VAT risk is being underestimated

A common misconception among contractors is that VAT is handled by the accountant or fully managed by software.

In reality, HMRC places responsibility firmly on the business and its director.

That said, working with a proactive accountant who takes an active role in reviewing VAT treatment, spotting anomalies and strengthening processes can make a significant difference in managing that responsibility effectively.

What’s a good VAT position for a contractor?

The sort of accountancy support contractors should look for must not just be reactive or compliance-driven, but focused on helping you maintain a robust and defensible VAT position throughout the year.

Remember, the shift we are seeing from HMRC is away from just the final numbers and towards process-based compliance. So it is no longer enough to get the figures “broadly right” — you must show how those numbers were produced and why your approach is correct.

For contractor limited companies, then, the VAT risk is not complexity, but increasingly the lack of structure and oversight. And that is exactly what HMRC scrutiny will uncover.

What five practical VAT steps can I take to reduce HMRC risk?

A contractor directing their own limited company can take straightforward steps to strengthen their VAT position. Here are five we recommend:

1. Maintain complete and accurate digital records
2. Ensure there is a clear audit trail from transactions to VAT returns
3. Minimise manual adjustments and document them where necessary
4. Periodically review VAT treatment, especially for non-standard income
5. Address anomalies early, rather than waiting for HMRC to raise them.

Key takeaway

VAT compliance checks in 2026/27are becoming more focused, more data-driven, and more process-oriented.

HMRC may not be probing small companies in the same way with VAT that it’s currently probing mid-sized companies, but, for HMRC, there’s always tomorrow.

So for contractors directing their own PSC, the key takeaway is:

It’s not just about whether your VAT return is right; it’s about whether you can prove it is right.

Those directors who treat VAT as an ongoing compliance process, rather than a quarterly task, will be far better placed to manage HMRC scrutiny when it arises.