An inspector calls – part one: HMRC is upping its game under increasing political pressure to reduce the ‘tax gap’

8 October 2018

We do mind the gap!

Attitudes are changing. There was a time when those who managed to reduce their tax bill were silently applauded by some members of the community. The years of austerity though, have generated a spirit of outrage; the public at large now links tax evasion and avoidance with a worsening in public services, particularly those provided by the NHS. During the latest House of Commons Public Accounts Committee’s review of HMRC’s performance, a representative was questioned intensively on that organisation’s plans to further reduce the tax gap.

The ‘tax gap’ is the difference between the amount of tax that should theoretically be collected and that which HMRC actually receives. It is calculated by statisticians at HMRC and the Office for National Statistics and involves some degree of what the layperson would call educated guesswork. It nevertheless highlights trends in HMRC’s performance and identifies sectors of the economy where investigations might achieve the best results.

In 2016-17 the amount of tax lost to the Exchequer was £33 billion or 5.7% of the theoretical tax take. (This excludes taxes not collected by HMRC such as Council Tax, business rates and vehicle excise duty.) In 2005/06 the percentage was 7.3%. It fell to 5.6% in 2011/12 peaking again at 6.6% in 2013/14. It has remained at 5.7% for two consecutive years. HMRC statistics analyse the gap in three ways: by customer group (type of organisation), type of tax and behaviour. ‘Behaviour’ relates to the various causes of tax loss as follows:

  • Failure to take reasonable care – £5.9 billion
  • Criminal attacks – £5.4 billion
  • Legal interpretation – £5.3 billion
  • Evasion – £5.3 billion
  • Non-payment – £3.4 billion
  • Error – £3.2 billion
  • Avoidance – £1.7 billion

These definitions raise further questions. When, for example does legal interpretation become avoidance?

And surely the dividing line between failure to take reasonable care and error must often be somewhat subjective, although the difference will always be important to the taxpayer when penalties are assessed. The distinction between avoidance and evasion, although these terms are often synonymous in the eyes of the public, is clearer. Evasion is manifestly illegal, whereas avoidance is described by HMRC as “Bending the rules of the tax system to gain a tax advantage that Parliament never intended.”

Artificial tax avoidance schemes have been under constant attack by HMRC for a number of years, using new methods and powers that are outside the scope of this blog. As a result, the amount of tax lost annually to avoidance has fallen from £4.9 billion in 2005/06 to £1.7 billion in 2016/17.

Targeting small businesses

So, with avoidance losses at an all-time low, where will HMRC direct its efforts to further reduce the tax gap?

The answer lies in HMRC’s analysis by ‘customer group’:

  • Small businesses – £13.7 billion
  • Large businesses – £7.6 billion
  • Criminals – £5.4 billion
  • Mid-sized business – £3.9 billion
  • Individuals – £3.4 billion

Small businesses are the obvious target, a fact emphasised during the Parliamentary Review. HMRC acknowledged that this presented a challenge, because there are so many small businesses in operation. According to HMRC’s spokesman at the review hearing, “We are seeing in the economy a movement away from employment towards small businesses, so the underlying pressure is people moving out of an area of taxation that is highly compliant [payroll taxes] into an area that is highly non-compliant.” HMRC expects that the imminent introduction of ‘Making Tax Digital’ [MTD] will improve compliance among small businesses in that it will involve businesses reporting significantly more detail to HMRC than was the case with the previous method of submitting year-end accounts.

In our next blog, we will consider why you might be selected for investigation, what this might involve and how to mitigate the risk of you becoming a target.

As one of the leading firms of accountants in the North East, with offices in Newcastle, Sunderland and Jarrow, we have the expertise to advise you on a wide range of business and tax related issues. If you would like to speak to one of our local experts, please contact us.