HMRC collected an extra £3.75 billion from small to mid-sized businesses (SMEs) last year through investigations into underpayment of VAT, up 12 per cent on the previous year.

Revenue from VAT investigations represented 50 per cent of all revenue collected through investigations into SMEs in 2017-18, according to tax investigation experts PfP.

In 2016 to 2017, the latest year for which official data is available, HMRC said it believed firms underpaid £11.7 billion in VAT – a 10 per cent rise from £10.6 billion the year before.

PfP said HMRC has become more adept at reacting to any potential underpayment by businesses, with VAT receipts hitting a record high of £125 billion last year, up 60 per cent from £78 billion a decade ago.

VAT has become a key revenue stream for government, said PfP and, as a result, HMRC has become increasingly quick to react to any potential underpayment by businesses.

Kevin Igoe, managing director at PfP, said: “HMRC is clearly finding VAT investigations into SMEs fruitful so businesses can expect more of the same over the coming year.”

VAT now represents over a fifth of total tax receipts.

Investigations can be particularly burdensome for SMEs that may not have the capacity to deal with the administration involved in a tax investigation. This stands in contrast to larger businesses, which often have in-house legal teams and access to tax experts.

PfP said it is crucial that businesses take care when filing their VAT returns as mistakes may trigger costly, time-consuming and disruptive investigations.

Igoe said: “VAT become a large component of total receipts so we will likely see HMRC bulking out its compliance teams to ensure that it squeezes as much as it can from businesses in this area.”

“Investigations really take their toll on small businesses as managers get sucked in at the expense of day-to-day management and strategic planning. Investigations can also substantially increase legal spend, using up resources that may have been earmarked for elsewhere.”