What should a sole trader do if HMRC asks for explanations of figures?

What it means when HMRC asks for explanations of figures

If you’re a sole trader and HMRC asks you to explain figures in your tax return, accounts, or records, it can feel alarming. In reality, it’s often a standard compliance step. HMRC compares information from many sources—your Self Assessment return, VAT returns (if registered), CIS records (if you work in construction), bank interest reports, card processor summaries, and sometimes information from third parties. Where something looks unusual, incomplete, or inconsistent, HMRC may ask you to clarify it.

The most important thing is to respond calmly, methodically, and with evidence. A clear response that demonstrates you understand your numbers and can support them with records can resolve the issue quickly. A rushed, emotional, or poorly evidenced reply can prolong the enquiry and may lead to further questions, adjustments, or penalties.

For a sole trader, “explanations of figures” usually means HMRC wants you to show how you arrived at a particular total and why it is reasonable for your business. That might include income totals, expense categories, profit margins, private use adjustments, stock figures, or any entries that stand out compared with previous years or typical patterns for your trade.

First steps: read the letter carefully and identify exactly what HMRC is asking

Before you do anything else, read HMRC’s communication slowly and more than once. The wording matters. HMRC may be asking for:

1) An explanation of how a figure was calculated (a narrative and a calculation);

2) Supporting evidence (invoices, receipts, bank statements, mileage logs, contracts, till reports);

3) Reconciliations (for example, bank to turnover, VAT to sales, or bookkeeping totals to the tax return boxes);

4) A correction if something was entered incorrectly; or

5) Information about business practices (cash sales, discounts, refunds, record keeping systems).

Check whether HMRC is opening a formal enquiry (often referred to as a “compliance check”) or simply requesting information. Either way, deadlines matter. Look for a date by which you must respond. If there is no explicit deadline, it is still wise to respond promptly and politely, asking for confirmation if you need more time. Avoid ignoring the letter—silence can escalate things.

Make a list of each figure HMRC mentions and the period it relates to. Sometimes HMRC will reference a box number on the Self Assessment return, or a line in the accounts, or a discrepancy between two submissions. Your aim is to transform a scary letter into a practical checklist.

Don’t panic, but do treat it seriously

Most enquiries are resolved by supplying records and explanations. However, HMRC does have powers to request documents and can charge penalties for inaccuracies, late responses, or careless record keeping. The best mindset is: take it seriously, but do not catastrophise.

Being defensive or confrontational rarely helps. It is perfectly acceptable to be uncertain about something and to say you will check your records. It is also acceptable to correct genuine mistakes. HMRC generally distinguishes between an honest error and deliberate misstatement, and your behaviour and record quality can influence how HMRC views the situation.

Get organised: build an “enquiry folder” and freeze your records

Create a dedicated folder (digital and, if needed, paper) for the enquiry. Store:

- The HMRC letter(s) and envelope, noting dates received;

- A timeline of actions you take and calls you make;

- Copies of everything you send to HMRC;

- Proof of posting or submission receipts;

- Your working papers, calculations, and reconciliations;

- The underlying evidence (receipts, invoices, statements, logs).

Also, “freeze” your records in the sense that you should not rewrite history. You can tidy up your bookkeeping, but do not alter invoices, backdate documents, or create misleading paperwork. If you discover missing evidence, focus on finding legitimate substitutes (such as duplicate invoices from suppliers, bank transaction confirmations, or contemporaneous business notes) and be transparent about what you can and cannot evidence.

Check what type of figure is under question

HMRC’s questions usually fall into a handful of categories. Understanding which category you’re dealing with helps you answer properly.

Income and turnover figures

HMRC may ask how you arrived at your turnover, especially if:

- It differs significantly from prior years;

- It seems low relative to your lifestyle or bankings;

- It does not align with VAT returns, CIS statements, or card processor totals;

- You operate in a cash-heavy trade;

- There are large refunds or write-offs.

What HMRC typically wants is a link from source records to the total declared. For example, if you use accounting software, you may provide a sales report for the tax year and show how it ties to your bank statements and cash records. If you issue invoices, provide a sales ledger, invoice sequence evidence (showing no gaps or explaining gaps), and bank receipts.

If you have multiple income streams (for example, services plus product sales, or online sales plus local work), break the total down. A clear breakdown reduces suspicion because it demonstrates control over your records.

Expense figures and “unusual” deductions

Expenses are a frequent focus. HMRC may query large amounts in categories like motor costs, travel, subsistence, home office, repairs, professional fees, or “other”. They may also query expenses that appear personal.

Your job is to show that each expense is:

- Wholly and exclusively for business (or appropriately apportioned if mixed use);

- Supported by evidence;

- Correctly treated for tax (for example, revenue vs capital, private use adjustments).

HMRC may not want every receipt for small items; sometimes they want a sample or a schedule. Provide what is asked for, and if they ask for “all receipts,” comply unless it is disproportionate—then you can ask whether they will accept a representative sample with totals and a list.

Profit margins that look “off”

In some trades HMRC has benchmarks or expectations. If your gross profit or net profit margin is much lower than typical, HMRC may ask why. There can be perfectly legitimate reasons: price reductions to win work, increased material costs, higher subcontractor costs, bad debts, start-up inefficiencies, downtime due to illness, or one-off investments in marketing (though marketing is still an expense, it may not increase revenue immediately).

When margins are questioned, respond with a narrative supported by numbers. For example, show material invoices rising, show reduced sales prices, show a new competitor in the area, or show a period of reduced trading. If you had a one-off event, explain it clearly and keep it factual.

Private use and apportionments (vehicle, phone, home office)

Many sole traders legitimately apportion costs that are partly business and partly personal. HMRC may ask how you calculated the business percentage. This is where contemporaneous records help a lot.

For a vehicle, you may need mileage logs or a reasoned estimate supported by diaries, job sheets, or routing history. For a phone, you may provide itemised bills and show a business-use percentage. For home office, you may rely on a simplified method or a detailed calculation based on area and time used. Whatever your method, consistency and reasonableness are key.

Stock, work in progress, and year-end adjustments

If you keep stock or have work in progress, HMRC may ask about opening and closing stock figures or large year-end adjustments. They might also ask about prepayments, accruals, or whether you have used the cash basis or traditional accounting.

Be ready to show stock counts, valuation methods (cost, lower of cost and net realisable value), and how you identified what was on hand at year end. If you do not have a formal stock system, document your method now and explain your approach honestly.

Reconcile first, then explain

A strong response often starts with reconciliations. Reconciliations are simply bridges between one set of numbers and another. They give HMRC confidence that totals are complete and that you are not omitting income or overstating expenses.

Common reconciliations for a sole trader include:

- Turnover per accounts to money received in bank (adjusting for cash takings, refunds, timing differences, and drawings);

- Sales per bookkeeping to invoices raised (if you invoice);

- VAT sales to accounts turnover (if VAT-registered), explaining differences such as zero-rated items, exempt sales, outside scope income, VAT accounting schemes, or timing differences;

- CIS deducted tax suffered to CIS income declared (if relevant);

- Expense totals to bank statements and cash payments, with clear notes on any personal payments or transfers.

Even if HMRC didn’t ask for a reconciliation explicitly, including one can pre-empt further questions, provided it is accurate and easy to follow.

Gather evidence: what HMRC usually expects you to provide

HMRC typically wants documentary evidence that existed at the time of trading (or close to it). The following are commonly requested:

Business bank statements and payment processor statements

Bank statements are often the backbone of an enquiry. If you have a separate business account, it’s easier. If you use a personal account for business, HMRC may scrutinise it more closely. Provide the requested period and be prepared to explain personal transactions and transfers.

If you take card payments through services like Stripe, Square, PayPal, or online marketplaces, download monthly summaries and fee reports. HMRC may ask why the amounts received in the bank differ from your sales totals—fees, chargebacks, reserve holds, and timing delays are common reasons.

Sales records: invoices, till rolls, booking logs, or job sheets

If you invoice, provide invoice lists and samples of invoices requested. If you run a retail or hospitality business, till summaries, Z-reports, and daily takings sheets can support income figures. If you operate via appointments, booking system exports can help explain how revenue is generated and why it fluctuates.

Purchase invoices and receipts

For expenses, provide supplier invoices (especially for materials, subcontractors, and high-value items) and receipts. Where a receipt is missing, look for alternative evidence: a bank transaction plus an email confirmation, an online order receipt, or a duplicate invoice from the supplier.

Contracts and correspondence

Contracts, statements of work, and client correspondence can support why certain amounts were charged or why a job was cancelled or discounted. Keep these limited to what is necessary—HMRC generally wants facts relevant to the figures.

Mileage logs and travel evidence

A mileage log is ideal. If you don’t have one, you can still build a reasonable reconstruction using diaries, job sheets, calendar entries, and mapping distances between job sites. Be clear that it is reconstructed and explain your method. HMRC may accept it if it is credible and consistent.

Home office calculation

Provide a simple schedule showing your method: number of rooms (or area), proportion used for business, hours used, and the costs included (for example, electricity, heating, rent, mortgage interest if relevant, council tax, internet). Be careful not to claim capital repayments or non-allowable costs. If you used a simplified method, state so and show how you applied it.

Accountant working papers (if you used one)

If an accountant prepared your return, you can ask them for the working papers and schedules. HMRC may still address correspondence to you, but an accountant can help you respond efficiently and reduce errors.

How to write your explanation so it answers the question and avoids new problems

Think of your response as a small report: clear structure, plain language, and evidence attached. A good explanation usually includes:

- A short introduction referencing HMRC’s letter and the specific figures queried;

- A numbered response matching each question in order;

- A brief explanation of your business model and record keeping method (cash basis, invoicing, software used, how you record cash);

- The calculation behind each figure (a simple schedule is often enough);

- The supporting documents attached, labelled clearly;

- A closing note offering to answer further questions and confirming how you can be contacted.

Aim for a tone that is cooperative and factual. Avoid speculation. If you don’t know why something happened, say you are investigating and provide what you can. Do not bury HMRC in irrelevant paperwork. Overloading can look evasive and makes it harder for the officer to see the key evidence.

Be honest if you find an error, and correct it properly

Sometimes HMRC’s query reveals an actual mistake: an expense entered twice, income missed, the wrong basis used, or a private use adjustment forgotten. If you discover an error, it is usually better to disclose it rather than hope HMRC won’t notice. The way you handle it can affect penalties.

Explain what went wrong, how it happened (for example, a bookkeeping duplication, misunderstanding of an allowable expense, or missing information at the time), and what you have done to prevent recurrence (for example, improved record keeping, separate bank account, monthly reconciliations, or engaging professional help).

When you correct figures, do so in the way HMRC requires for the relevant tax. That may involve amending a Self Assessment return within the amendment window or writing to HMRC if outside that window. Keep a record of the correction submission and the revised calculations.

Common scenarios and how to explain them

Below are examples of issues that commonly trigger “explain the figures” requests, along with practical ways to address them.

Your turnover doesn’t match your bank deposits

If HMRC sees bank deposits higher than declared turnover, they may suspect undeclared income. Your response should identify what those deposits are. Common non-income items include:

- Transfers between accounts;

- Personal funds introduced (capital introduced);

- Loans received;

- Refunds or rebates;

- Sale of personal items (not trading income);

- Insurance claims or grants (treatment depends on context).

Provide a schedule listing the deposits HMRC is concerned about with explanations and, where possible, supporting evidence such as loan agreements, transfer references, or notes. If some deposits are indeed business takings that were missed, disclose and correct them.

Your expenses look high or include mixed personal items

High expenses can be legitimate, especially during growth periods or when costs rise. But HMRC may ask you to justify them. The key is to show that the expense was for business and that any personal element was removed.

For example, if you claimed motor expenses, include a schedule of costs (fuel, repairs, insurance, tax, finance interest where relevant) and show the business-use percentage applied. If you claimed a mobile phone contract, show bills and explain your business usage. If you used a personal Amazon account for business supplies, isolate the business items and provide order confirmations.

You claimed significant cash expenses

Cash expenses can raise eyebrows because they are harder to trace. If you pay cash for materials or small tools, keep receipts and record the purpose. HMRC may ask how you withdrew cash and what it was used for. You may need to link cash withdrawals to cash payments using a petty cash log.

If you don’t have a petty cash log, create a reconstruction carefully: list cash withdrawals, then list cash purchases with receipts, and reconcile the difference. If the difference is small, it may represent cash drawings, but be cautious—don’t guess. Explain your reconstruction method.

Your drawings are low compared to your living costs

HMRC sometimes considers whether a taxpayer’s declared income seems consistent with their lifestyle. If your drawings were low, be prepared to explain how you supported yourself: savings, a partner’s income, loans, benefits, or other non-trading income. Provide evidence where appropriate, such as savings statements or loan documentation. Keep it factual and relevant.

Large “other” expenses category

“Other” is a red flag category because it can hide non-allowable items. If HMRC queries it, break it down into clear subcategories. For example: software subscriptions, protective clothing, small tools, training, postage, bank charges, stationery. Provide a list and totals, and evidence for the larger items. Reclassifying your internal schedule (without altering the submitted return unless necessary) can make the figure understandable.

Capital items claimed as expenses

Some purchases are capital rather than day-to-day running costs, such as equipment, vehicles, or major tools. If you claimed them as expenses, HMRC may challenge the treatment. The correct approach can involve capital allowances rather than full deduction as a revenue expense. If this is the issue, consider professional advice quickly because the tax treatment can be technical and the best outcome may depend on timing and the nature of the asset.

How to communicate with HMRC: practical do’s and don’ts

How you communicate can materially affect the speed and outcome of the process.

Do be clear, polite, and structured

Use the reference number on HMRC’s letter. If you send documents, label them (for example, “Appendix A: Sales ledger summary”, “Appendix B: Bank statements April–March”). Use page numbers if you’re sending large PDFs. If you respond by post, keep copies and use tracked delivery if the information is important.

Do keep to the scope of the request

Answer the questions asked. If HMRC queries one expense category, don’t volunteer unrelated issues unless you discover a genuine error that affects tax. Oversharing can widen the enquiry. That said, if a short additional explanation prevents misunderstandings, include it.

Do ask for more time if you need it

If you cannot gather the information by the deadline, contact HMRC as early as possible. Explain what you are doing and request an extension. It is better to ask than to miss a deadline and appear uncooperative.

Don’t ignore the letter or hope it goes away

Non-response can lead to formal information notices or assessments. Even if you think HMRC is mistaken, respond and provide evidence.

Don’t send original documents unless specifically requested

Send copies (scans or photocopies). If HMRC requires originals, ask about the safest method and keep duplicates.

Don’t backfill records in a misleading way

Reconstructing records is different from fabricating them. If you create a reconstruction, label it as such and explain how you produced it. Misleading HMRC can escalate matters substantially.

When to get professional help and what an adviser can do

Many sole traders can handle simple information requests themselves, especially when they have good records. But professional help can be valuable if:

- The sums are large or the issues are complex (VAT, CIS, capital allowances, partial exemption, cash businesses);

- HMRC suggests errors, penalties, or deliberate behaviour;

- You feel unsure about what is allowable or how to present evidence;

- The enquiry expands to multiple years or multiple taxes;

- HMRC requests an in-person meeting or a detailed interview.

An accountant or tax adviser can help you prepare reconciliations, draft responses, ensure you do not inadvertently admit something incorrect, and negotiate deadlines. They can also help you understand the likely areas HMRC will probe and shore up weak parts of your records.

Preparing for a meeting or call with HMRC

Sometimes HMRC will suggest a call to talk through the figures, or a meeting to review records. Treat this like a professional appointment. Prepare by:

- Reviewing your return, accounts, and bookkeeping reports for the year(s) in question;

- Having your reconciliations and schedules in front of you;

- Having a concise explanation of how you record income and expenses;

- Noting any unusual events in the year (illness, major client lost, equipment failure, one-off costs);

- Being ready to explain cash handling if relevant (how cash is recorded, where it is stored, when it is banked).

During the call, answer what you know, and if you don’t know, say you will check and come back. Don’t guess. Make notes of what was asked and what you agreed to provide. After the call, follow up in writing summarising what you understood, especially if the call covered multiple points.

Handling record-keeping weaknesses: how to respond if your records are incomplete

Not every sole trader has perfect records. If HMRC asks for evidence you simply don’t have, respond transparently and provide the best alternative support available.

For missing receipts, consider:

- Requesting duplicates from suppliers;

- Using bank statement entries plus emails or order confirmations;

- Using contemporaneous diaries or job sheets to show business purpose;

- Providing photos of assets or tools if the purchase relates to equipment (as supporting context, not as primary proof).

If you operated cash sales without a robust till system, acknowledge the weakness and show your method: daily takings sheets, appointment logs, stock movement, or a consistent pattern of banking. Then explain improvements you have made since—such as moving to card payments, using bookkeeping software, keeping daily cash summaries, or opening a separate business account.

The goal is to demonstrate that any gaps are not deliberate concealment, and that your figures are still reasonable when viewed with the evidence available.

Penalties, behaviour, and why your approach matters

When HMRC identifies an inaccuracy that results in additional tax due, penalties can depend on behaviour—whether an error was careless, deliberate, or deliberate and concealed—and on the quality of disclosure and cooperation. This is one reason it’s important to be prompt, organised, and honest. Keeping a clear audit trail of how you calculated figures and how you responded can support your position if penalties are discussed.

If HMRC raises the possibility of penalties, it is wise to seek professional advice. The way you frame explanations and corrections can influence outcomes, and you should ensure you understand your rights and obligations.

Data protection and relevance: sharing information safely

You may worry about handing over client details, pricing, or sensitive information. HMRC can request documents relevant to checking tax position, but you should still handle data carefully. Provide what is necessary for the question. If documents contain unrelated personal data, consider whether redaction is appropriate while preserving key information like dates, amounts, and descriptions. If you are unsure, professional advice can help you strike the right balance.

Keep your own copies of everything you send. If you submit digital files, name them clearly and keep them in your enquiry folder so you can track exactly what HMRC has.

After you respond: what happens next

After you provide explanations and evidence, HMRC may:

- Accept your explanations and close the check;

- Ask follow-up questions on specific items;

- Request additional documents for a broader period;

- Propose an adjustment to your figures;

- Offer a contract settlement if multiple years are involved.

If HMRC accepts your position, ask for written confirmation that the matter is closed. Keep that confirmation with your tax records.

If HMRC proposes changes you disagree with, respond with evidence and reasoning. Don’t assume HMRC is always right or always wrong—treat it as a process of demonstrating what is correct. If the disagreement becomes technical or high stakes, obtain professional advice.

How to reduce the chance of future queries

Even if the enquiry resolves smoothly, treat it as a prompt to strengthen your systems. Practical improvements for a sole trader include:

- Use a separate business bank account so transactions are easier to trace;

- Record income promptly and keep invoice sequences complete;

- Keep digital copies of receipts and invoices, backed up securely;

- Reconcile bank accounts monthly so discrepancies are caught early;

- Keep a mileage log if claiming vehicle costs, or use a consistent method for simplified expenses;

- Avoid large “other” categories; use meaningful expense headings;

- Document private use apportionment methods and apply them consistently;

- Keep notes of unusual events affecting profits (lost client, illness, major repairs).

These steps not only help with HMRC compliance but also improve your understanding of the business and make tax preparation less stressful.

A practical template for your written response

A simple structure can make your reply much easier for HMRC to process:

Paragraph 1: Identify yourself and the tax year, reference the HMRC letter, and confirm you are responding to the request for explanations of figures.

Paragraph 2: Briefly describe your business and how you keep records (software used, invoicing approach, cash/card handling).

Section 1: Turnover/income explanation, including calculations and reconciliations, with attachments referenced.

Section 2: Expense explanation by category, highlighting any large or unusual items, with schedules and evidence.

Section 3: Any apportionments (vehicle, phone, home office), method and calculations.

Section 4: Any corrections identified, with amended computations and how/when amendments were made.

Closing: Confirm you are happy to provide further information, list attachments, and provide contact details.

This approach shows professionalism and reduces the chance of repeated back-and-forth.

Key takeaways for sole traders

When HMRC asks for explanations of figures, the best response is calm, prompt, and evidence-based. Focus on what HMRC has asked for, reconcile your numbers, and provide clear schedules that show how each figure was built. Support those schedules with the most relevant documents—bank statements, invoices, receipts, and logs. If you discover an error, disclose and correct it properly. If the matter becomes complex or high stakes, involve a qualified tax professional early.

Most importantly, remember that the aim is not to “win an argument” but to demonstrate that your tax position is correct and your records support it. A structured reply, backed by documentation and reasonable explanations, is often all it takes to bring the process to a close and let you get back to running your business.