The amount collected by HMRC from tax investigations into small businesses and individuals has increased by 23% over the last year.
The average is £24,700 per investigation, up from £20,100 the previous year, according to analysis by accountancy group UHY Hacker Young.
HMRC closed 255,000 investigations into small businesses and individuals last year, recovering £6.3bn in additional compliance yield.
The report said the tax take from investigations into small businesses is rising as tax rules are becoming increasingly complex and time consuming.
For example, the Corporation Tax 600 form, used by small companies to disclose tax liability to HMRC, has more than 200 boxes that may need to be filled. In addition, there are 12 supplementary forms that may also need to be completed.
According to the Federation of Small Businesses, small firms spend an average of £4,500 a year on tax compliance, equivalent to 44 hours or 242 million hours across the UK.
Phil Kinzett-Evans, partner at UHY Hacker Young, said:
“Many small businesses don’t have the capacity to deal with the level of detail and box-ticking required to submit complex tax returns, so it is no surprise they are making more mistakes
“Most small businesses want to pay their fair share but tax rules hit them disproportionately hard compared to large firms. Too often tax rules are written as if every business has an accountant, which is far from true.
“A good month of sales at the end of the quarter can trigger a large VAT bill that must be paid before the revenue has been fully collected sometimes. That pressure can lead some to under-declare income simply to meet their tax bills.”
The report said small businesses that receive penalties from HMRC should challenge them if they believe they have complied properly, particularly in grey areas. However, it must be done so they on technical grounds by challenging HMRC on how their tax rules should be interpreted rather than simply arguing a penalty is unfair.
A common area of dispute are business expenses that HMRC sees as personal. Small businesses can challenge that with the right evidence. Another area is repairs or refurbishment costs that get treated as capital, meaning they cannot be deducted immediately for tax purposes.
Phil Kinzett-Evans added: “Fines and tax bills from HMRC can reach tens of thousands of pounds, so small businesses must agree a payment arrangement as early as possible. Otherwise, they risk having to sell valuable assets just to keep going.”