Keeping records: What your small business must do to stay within the law

Every business must keep records of the transactions it makes, to comply with rules set by HM Revenue & Customs (HMRC).

ICAEW chartered accountant Nila Khan explains why it's so important.

Record-keeping and the law

Whether you're trading as a sole trader or limited company at the end of each financial year, you need to complete a tax return in the required format and send it to HMRC. Sole traders return figures on a Self Assessment tax return, while companies will complete a corporation tax return.

In both cases, HMRC require the figures declared on these tax returns to be supported by proper documentation. As a result, by law, your business must keep records that show the transactions it has undertaken.

As a minimum, your business should keep for six years copies of:

• sales and purchase invoices

• receipts for business expenses

• bank statements

Keeping these records is also vital when it comes to monitoring your cash flow and staying on top of your debtors (the customers who owe you money).

Enquiries into your tax return

HMRC can select your tax return for an enquiry or a check. This means it's looking for verification that there are documents to support the transactions you've entered on your tax return.

Consequently, it's vital that you keep these documents. That way, you and your accountant (if you have one) can satisfy HMRC that you've declared the correct business income and tax you owe.

Fail to do this, and you may face a penalty for mis-stating figures on the tax return and paying incorrect amounts of tax, whether by mistake or deliberately.

Keeping records if you're registered for VAT

If your business is above the £85,000 per annum threshold and registered for VAT, you need to keep records in a digital format. You can do this using an accounting software package designed for the purpose, or something more simple like a spreadsheet.

You then need to link the digital records to HMRC's system that files the figures on your business's VAT return. This whole process forms the basis of HMRC's new Making Tax Digital system.

You should keep digital records of the following:

• Your business's name, principal place of business, VAT registration number and any VAT accounting schemes you use

• For each sale, the time of supply (tax point), value of the supply (net value excluding VAT) and rate of VAT charged

• For each purchase received, the time of supply (tax point), value of the supply and the amount of input tax you'll claim

Keeping records as an employer

If you employ people on a payroll, you're responsible for collecting and paying HMRC the correct amount of Pay As You Earn (PAYE) tax and national insurance, as well as sending payroll information to HMRC electronically.

There are penalties for being unable to show how you've calculated these taxes, so make sure you keep the following details:

• Your employees' pay and the amounts you deduct to pay to HMRC

• Employee holidays and other work absences – for example, sickness, maternity, paternity

• PAYE coding notices

• Expenses or benefits employees have received

• Payroll Giving scheme documents

• Pension provider contributions – for example, to NEST

• Details of any salary sacrifice arrangements 

Relevant resources

• How to pay Self Assessment tax

• Making Tax Digital for VAT: New rules and how to register

• Small business taxes: A guide