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Tax Gap

A pile of British bank notes.

HMRC’s 2023 Tax Gap report: Proportion of tax going unpaid unchanged from previous year

21st June 2023 by TaxWatch
  • Latest HMRC estimate of non-compliance unchanged from previous year, at 4.8% of all tax owed
  • Absolute Tax Gap figure is £35.8bn – up from £30.8bn the previous year
  • Changes to small business corporation tax methodology reveal a significant increase in this tax gap

The amount of tax lost in the 2021-22 financial year was 4.8% of the total tax owed, the same figure as the previous year, according to HMRC’s latest Tax Gap report.

In absolute figures, the amount of tax lost was £35.8bn – up from £30.8bn in the previous year.

HMRC has been collecting data and making estimates of the Tax Gap since the early 2000s, and has published them every year since 2008.  It’s the only tax authority in the world that publishes an annual estimate of tax losses for all forms of taxation.

The Tax Gap is defined as “the difference between the amounts of tax that should, in theory, be collected by HMRC, against what is actually collected”. This is a broad measure of tax non-compliance, which covers tax losses arising for a variety of reasons – from innocent mistakes to complex frauds carried out by criminal gangs.

The Tax Gap takes into account the amount of tax collected through HMRC’s enforcement activity – known as the ‘compliance yield’.

Despite a long-term reduction in the reported percentage tax gap figures, there are a number of data points in HMRC’s report which deserve a closer look.

Points of interest

Small businesses are responsible for the largest proportion of the overall tax gap –  56%. Their share has been consistently increasing over the last few years, from a low of 38% in 2016-17. It’s clear that the main problem is with Corporation Tax, where small businesses have had a tax gap of almost 30% for the last three years – up from around 17% in the mid-2010s. No other major tax type has seen an increase in its tax gap figure of anything like these amounts. One possible explanation is that data collection has improved, as the report refers to a new random enquiry programme into small business corporation tax.

A recent House of Lords Finance Bill Subcommittee[1] in relation to R&D reliefs, hearing also heard evidence of a new random enquiry programme, which was expected to provide more accurate data around error and fraud in the small and medium enterprise (SME) scheme. It therefore seems likely that some of the increased corporation tax gap for small businesses is a result of R&D fraud and error, but this data is unlikely to be published before the HMRC annual return and accounts for 2022-23 are published in July. HMRC has already reported that 7.3% of claimed R&D by SMEs is thought to be incorrect, so it will be interesting to see if this increases by a significant amount.

Last year, HMRC committed to publishing figures for the “offshore” tax gap during 2023. HMRC receives data about assets owned by UK taxpayers in other countries via an automatic exchange of information programme. HMRC now says it will use this data in a random enquiry programme to calculate a standalone offshore tax gap for the Self-Assessment population. This will be published in the autumn[2]. The data included in the latest Tax Gap report uses a random enquiry programme to arrive at estimates for non-compliance, stratified to give more weight to wealthier taxpayers. However, with a total sample in 2019-20 of fewer than 2,000 enquiries, it seems unlikely that this will accurately reflect offshore compliance – which is, presumably, the reason for the new data.

Individuals classed by HMRC as wealthy – which covers around 800,000 people – are responsible for around 5% of the tax gap, while all other individuals combined are only responsible for around 6% of the gap. While wealthy taxpayers are dealt with by specialist teams and have a much greater level of scrutiny, it seems apparent that more could be done with this group of taxpayers to increase compliance. It’s also assumed that this group will be more likely to feature in the offshore tax gap, which is to be measured separately (see above), so the 5% figure may actually be an underestimate of their share of the tax gap.

Error and carelessness account for around 45% of the tax gap, indicating that other, more serious, behaviours are involved for over 50% of the gap – a sum of nearly £20bn.

Last year’s Tax Gap report specifically excluded figures for fraud and error arising in the Covid schemes. The CJRS and SEIS ended on 30 Sept 2021[3], but it isn’t clear from the 2023 HMRC Tax Gap report whether the data includes the Covid schemes. However, the estimate for Covid scheme fraud and error in the HMRC Annual Report and Accounts for 2021-22 is £617m, which wouldn’t have a significant impact on the overall percentage.

[1] House of Lords Economic Affairs Committee Finance Bill Sub-Committee – corrected oral evidence: Draft Finance Bill 2022-23 https://committees.parliament.uk/oralevidence/11607/pdf/

[2] HMRC Tax gaps: Methodological annex https://www.gov.uk/government/statistics/measuring-tax-gaps/methodological-annex#chapter-a-introduction

[3] Gov.uk – Claim for wages through the Coronavirus Job Retention Scheme https://www.gov.uk/guidance/claim-for-wages-through-the-coronavirus-job-retention-scheme

HMRC publishes its latest Tax Gap – TaxWatch analysis

27th June 2022 by Alex Dunnagan

HMRC’s Tax Gap has increased for the second year in a row on a like-for-like basis.

The latest HMRC estimates of non-compliance are £32bn for 2020-2021, or 5.1% of total tax revenues. This is the same gap as a percentage as seen in last year’s publication covering 2019-2020.

However, this year’s figure includes a £0.7bn revision downwards to compensate for lower compliance activity during Covid. This means that on a like-for-like basis HMRC’s Tax Gap increased.

Of the £32bn total tax gap, at least £14.4bn, or 45%, of it is attributable to fraud. Fraud as a percentage of the total tax gap hasn’t been this high since 2016-2017. This is based on the limited data available, and the actual figure for tax lost to fraud will be much higher. [1]TaxWatch’s methodology explaining how we arrived at this figure is explained in full detail in our assessment of the 2019-2020 figures, see our report  The Tax Fraud Gap – 2021 edition, … Continue reading

As TaxWatch has previously highlighted, HMRC’s tax gap publication significantly underestimates the true scale of non-compliance with the tax system. Profit shifting by multinationals appears not to be counted at all.

Estimates of error and fraud in the HMRC-administered Covid-19 support schemes are also not included in the figures and reported on separately. These run into the billions of pounds.

Our full analysis is available in a briefing here. HMRC’s publication is available here.

References[+]

References
↑1 TaxWatch’s methodology explaining how we arrived at this figure is explained in full detail in our assessment of the 2019-2020 figures, see our report  The Tax Fraud Gap – 2021 edition, here http://13.40.187.124/tax_fraud_gap_2021/

HMRC’s Tax Gap 2022 Edition – TaxWatch Briefing

23rd June 2022 by George Turner

HMRC’s Tax Gap increases for 2nd year in a row on like-for-like basis

  • Latest HMRC estimate of non-compliance £32bn, or 5.1% of total tax revenues – the same gap as a percentage in 2021.
  • This year’s figure includes a £0.7bn revision downwards to compensate for lower compliance activity during Covid. This means that on a like-for-like basis HMRC’s Tax Gap increased for a 2nd year in a row.
  • Tax Fraud a minimum of £14.4bn based on the limited data available in the HMRC Tax Gap report. An increase as a percentage on previous years.
  • Estimates of error and fraud in the HMRC administered Covid-19 support schemes are not included in the figures.
  • HMRC estimate continues to overlook key areas of public concern such as profit shifting by multinationals and offshore tax evasion.

23 June 2022 – George Turner

Summary

HMRC’s Tax Gap, the annual estimate of the amount of tax lost each year in the UK is a matter of huge public interest.

HMRC has been collecting data and making estimates of the Tax Gap since the early 2000s, and has published them every year since 2008. It is the only tax authority in the world that publishes an annual estimate of tax losses for all forms of taxation.

This year’s Tax Gap, covering the 2020-2021 financial year, stands at £32bn, or 5.1% of tax liabilities. This is down from £34.4bn the previous year, which was also 5.1% of tax liabilities.

The amount of the Tax Gap resulting from fraud has increased from 43.7% to 45%, with the Tax Fraud Gap standing at £14.4bn.

This briefing sets out some background to the Tax Gap, how it is calculated and how the presentation of data can be improved.

The UK Tax Gap

In the UK the Tax Gap is defined as “The difference between the amounts of tax that should, in theory, be collected by HMRC, against what is actually collected”.

This is a broad measure of tax non-compliance which covers tax losses arising from a variety of reasons, from innocent mistakes to complex frauds carried out by criminal gangs.

HMRC does not provide a break down of the amount of the Tax Gap that arises from fraud, although some conservative estimates can be made by analysing the HMRC data.

The UK Tax Gap is a net figure, and takes into account ‘compliance yield’ – which is the amount of tax collected though enforcement activity.

The difference between the net and gross Tax Gap is substantial. In previous years, the compliance yield figure is equivalent to 1/3rd of the net Tax Gap.

Estimates on tax losses are notoriously difficult to make. A significant amount of HMRC’s Tax Gap derives from historic data which is projected forward. For example, the amount of corporate tax avoided in the 2021 data comes from the percentage of estimated tax avoided in the previous year (2020), applied to the most recent year’s estimate of total tax liabilities.

The way in which the Tax Gap is constructed therefore means that there will be little change from year to year, with the main driver of a change in the figures coming from changes in the total amount of tax liabilities.

The reason for tax losses

The total amount of the Tax Gap arising from people making mistakes on their tax returns is £3bn. Negligence is the largest component of the Tax Gap – at £6.1bn

HMRC does not provide any estimate of the amount of tax lost to fraud, unlike the Department of Work and Pensions, which analyses benefits underpayments in terms of fraud, claimant error and official error.

Instead, HMRC identify several behaviours leading to non-compliance, which broadly correspond to the way in which HMRC manages their compliance work.

However, it is clear that some of these behaviours arise from fraudulent or dishonest behaviour, specifically “Criminal Attacks – £5.2bn”, “Evasion – £4.8bn”, “Hidden Economy – £3.2bn” and “Avoidance – £1.2bn”.

Taken together, these behaviours account for £14.4bn in tax losses, 45% of the entire Tax Gap. This is a small increase on previous years.

Avoidance is included given the way in which HMRC’s define avoidance. This excludes tax planning and is limited to non-compliance arising from tax schemes that attempt to “exploit” the tax system through “contrived or artificial” transactions. These schemes usually involve fraudulent behaviour at some stage of their execution.

Some categories of behaviour which HMRC use to define the Tax Gap will contain a mixture of honest and dishonest behaviour. For example, Legal Interpretation (£3.7bn) – can include disputes that arise from either honest or dishonest interpretations of tax law on the part of tax lawyers.

This means the figure of £14.4bn for tax fraud will not account for all tax losses arising from fraud. TaxWatch has recommended that HMRC should publish an estimate of all tax losses arising from fraudulent behaviour.

£bn

2021

2020

2019

2018

2017

Criminal Attacks

5.2

5.2

4.5

4.9

5.4

Evasion

4.8

5.5

4.6

5.3

5.3

Hidden Economy

3.2

3

2.6

3

3.2

Avoidance

1.2

1.5

1.7

1.8

1.7

Tax Fraud Gap

14.4

15.2

13.4

15

15.6

Total Tax Gap1

32

34.8

31

35

33

% of Tax Gap resultant from fraud

45.00%

43.68%

43.23%

42.86%

47.27%

1It should be noted that these figures are taken from the reports published at the time, and do not reflect future revisions in the Tax Gap, which can lead to fluctuations in the total Tax Gap.

Covid 19

This year’s figures are the first impacted by Covid-19. During the pandemic, HMRC paused a large amount of its compliance work. Because the Tax Gap is a net figure which includes compliance yield, then this should have led to a significant increase in the Tax Gap figures. However, HMRC made an adjustment to their methodology to change how they accounted for compliance yield. This apportioned the drop in compliance yield to previous years and reduced this year’s Tax Gap by £700m or 0.1% of total tax liabilities. [1]See Tax Gap section on Self Assessment – https://www.gov.uk/government/statistics/measuring-tax-gaps/4-tax-gaps-income-tax-national-insurance-contributions-and-capital-gains-tax

This is significant because had this adjustment not been made, the Tax Gap will have increased as a % of total tax liabilities for two years in a row.

The 2020-2021 figures do not include estimates of fraud and error arising from the three coronavirus support schemes which HMRC administered; Coronavirus Job Retention Scheme (CJRS, more commonly known as furlough), Self-Employment Income Support Scheme (SEISS), and Eat Out to Help Out (EOHO).

HMRC’s 2020-2021 annual accounts, published in November 2021, estimated the error and fraud in these three schemes for that year at £5.8bn. How much of this exactly is fraud not yet clear.

If the Tax Gap were to include the drop in compliance yield in line with previously published figures, and the losses to the Covid relief schemes, then the total Tax Gap would be £38.4bn, or 6% of total tax liabilities, an increase of nearly 20% on the previous year’s figures.

Tax Avoidance by Multi-national Corporations

The UK Tax Gap does not estimate the impact of all types of tax avoidance and evasion. HMRC’s definition of avoidance explicitly does not measure the impact of profit shifting by multi-national companies in their Tax Gap methodology. This is a serious problem. Profit shifting is the most high profile form of tax avoidance, the type of avoidance employed by large global businesses like Google, Starbucks, Apple and Nike.

Although it is notoriously difficult to develop an accurate estimate for the impact of profit shifting on the tax take, academic studies found that losses to the UK Treasury due to profit shifting could by up to £20bn a year. HMRC’s figure for non-compliance of all forms by large companies is £0.6bn.

The exclusion of profit shifting from the Tax Gap calculations means that these figures cannot really be considered to be a comprehensive or reliable estimate of tax avoidance in the UK. It is certainly not a measure of tax avoidance that the public would recognise.

Other tax losses

Another area of concern is the potential tax losses arising from offshore bank accounts.

An FOI request from 2021 by Dan Neidle, a tax lawyer, found that HMRC did not have an estimate of the amount of money held in offshore bank accounts by UK tax payers that resulted from tax evasion. [2]Dan Neidle, Tax Policy Associates report: UK taxpayers have £570bn in tax haven accounts, and HMRC has no idea how much of this reflects tax evasion, … Continue reading

In total, the data supplied by HMRC showed that UK taxpayers had £570bn held in tax haven bank accounts as of 2019. HMRC’s estimate of the Tax Gap for all types of non-compliance by wealthy taxpayers is £1.2bn.

Another area of concern is the payment of corporate subsidies via the tax system. There is no mention in the Tax Gap of non-compliance in the area of tax reliefs, such as R&D tax credits. The National Audit Office has failed to sign off on HMRC’s accounts for the previous two years because of concerns over R&D tax credits.

Under HMRC’s own estimates, the Treasury lost £336m to fraud and error in the R&D tax credit system. HMRC should clearly state how it deals with corporate benefit payments in its Tax Gap, and whether fraud and error in these programmes are included in their Tax Gap estimate.

HMRC’s interpretation of tax law

The term, “what should be collected” is also problematic as the word “should” is of course open to interpretation. HMRC defines what “should” be collected as – “the tax that would be paid if all individuals and companies complied with both the letter of the law and HMRC’s interpretation of the intention of Parliament in setting the law (referred to as the spirit of the law)”. This is in effect a measure based on how HMRC chooses to apply the law.

This is problematic. It suggests that HMRC can easily reduce the Tax Gap by simply being more lenient in the way it interprets the law.

This puts HMRC in a difficult position with regards to the Tax Gap. If there was demand for HMRC to take a tougher stance on tax avoidance, that in itself would cause an increase in the Tax Gap, leading to a perception that the agency was performing poorly. It means that the way in which the Tax Gap is calculated creates an incentive for HMRC to take a more lenient approach.

Another consequence of this approach is that the Tax Gap does not consider how legislation should be changed to deal with problems with the tax system. Say for example HMRC considers a certain practice to be a form of tax avoidance, but some defect in the law prevents HMRC from pursuing the matter – the classic case of the legal loophole. HMRC would not count the impact of such loopholes in their calculation of the Tax Gap. Indeed, where HMRC has decided that a particular scheme employed by a company or individual is an unlawful act of tax avoidance, but has lost the case in the courts, future users of that scheme will not be included in the Tax Gap.

This is inconsistent with the approach taken with the HMRC compliance yield calculation, which includes estimates of the impact of changes in legislation that HMRC has advised on.

HMRC could look at a broader gap, a tax policy gap, assessing what could be collected if all forms of evasion and avoidance were eliminated and all tax subsidies were abolished. HMRC was advised to put together these estimates by the International Monetary Fund when it last reviewed the HMRC Tax Gap methodology in 2013 – HMRC has not implemented this recommendation.

Uncertainty

One significant change in the 2022 Tax Gap edition is the amount of uncertainty in the figures. HMRC categorise their estimate of various tax losses that comprise the Tax Gap by the level of uncertainty in the figures.

In 2022 the amount of the Tax Gap that fell into the “low uncertainty” category halved from 63% to 31%.

The reason for this is the impact of the pandemic on tax collection, which saw VAT payments deferred and more time given for people to pay their tax returns. HMRC say in their figures that they have used historic trends to estimate this year’s figures where data is not available. This would appear to be conservative given the circumstances of the pandemic, where we would expect to see higher levels of tax losses due to insolvency and business failure.

The lowest Tax Gap in the world?

It is frequently stated that the UK has one of the lowest Tax Gaps in the world. This is misleading. It suggests that at the very least there are a number of countries that measure Tax Gaps in a broadly comparable way.

In fact, HMRC themselves say that the UK is the only country in the world that publishes an annual Tax Gap figure that deals with a comprehensive range of direct and indirect taxes.

Many countries publish Tax Gaps looking the Tax Gap on specific taxes such as VAT. As the Tax Gap varies considerably between different types of taxes, it is not possible to compare the UK’s broad Tax Gap figure with these estimates. Indeed, VAT is a tax which is particularly targeted by criminal attacks and as such, comparing the Tax Gap across all forms of tax with published VAT gaps in other countries will make it appear that the UK’s Tax Gap is low by international standards. However, when the figures are compared on a like for like basis (i.e. comparing the UK VAT gap with other VAT gaps) the UK does not perform particularly well.

The European Commission regularly assess the VAT gap across all EU states. The latest figures are for 2019, when the UK was still a member of the European Union. This put the UK as mid-table with the 12th highest Tax Gap of all EU states as a percentage of total potential VAT revenues. [3]European Commission, The VAT Gap in the EU: 2021 Edition, available from: https://op.europa.eu/en/publication-detail/-/publication/bd27de7e-5323-11ec-91ac-01aa75ed71a1/language-en/

Some countries do publish comprehensive Tax Gap estimates, however, the they use very different methodologies and techniques. For example, the Internal Revenue Service in the US publishes two estimates, the gross Tax Gap which it defines as the difference between true tax liability for a given tax year and the amount that is paid on time. The agency also publishes a net Tax Gap including the amount it will recover after late payments and enforcement action. The study is not published on an annual basis, but retrospectively on a periodical basis. The latest IRS Tax Gap estimate covers the tax years 2011-2013.

Italy publishes a Tax Gap that looks at a broad range of taxes on an annual basis. However, the methodology used differs substantially from the HMRC methodology, making like for like comparisons impossible.

References[+]

References
↑1 See Tax Gap section on Self Assessment – https://www.gov.uk/government/statistics/measuring-tax-gaps/4-tax-gaps-income-tax-national-insurance-contributions-and-capital-gains-tax
↑2 Dan Neidle, Tax Policy Associates report: UK taxpayers have £570bn in tax haven accounts, and HMRC has no idea how much of this reflects tax evasion, https://www.taxpolicy.org.uk/2022/05/27/crs-evasion/
↑3 European Commission, The VAT Gap in the EU: 2021 Edition, available from: https://op.europa.eu/en/publication-detail/-/publication/bd27de7e-5323-11ec-91ac-01aa75ed71a1/language-en/

The tax fraud gap – 2021 edition

16th September 2021 by George Turner

16th September 2021

  • The Tax Gap Attributable to Fraud was at least £15.2bn in 2019/20

 

  • At least 43% of tax losses arise from fraudulent behaviour

Executive Summary

HMRC’s annual estimate of non-compliance, “the Tax Gap” is regarded by the department as an important indicator of their long term performance and is used as a tool in developing HMRC’s strategy towards compliance. It is listed as a key performance indicator in HMRC’s annual report under their primary objective, “collecting revenues due and bearing down on avoidance and evasion”.

It is a broad measure of non-compliance defined by HMRC as “the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid”. What should be collected is the total amount of tax due under the law.

There are a number of reasons why any taxpayer may be non-compliant. This can range from the taxpayer making a mistake on their tax return, to not knowing about a liability to pay tax, through to criminal attempts to defraud the Treasury through filing false claims or hiding income.

HMRC break down the Tax Gap by eight “taxpayer behaviours”, which appear to be related to the department’s internal arrangements, namely: (1) criminal attacks; (2) evasion; (3) hidden economy; (4) avoidance (which does not include Base Erosion and Profits Shifting (BEPS) or tax planning); (5) legal interpretation; (6) non-payment; (7) failure to take reasonable care; and (8) error.

In this paper, we propose an alternative categorisation of non-compliance based on the three behavioural categories defined in law: Fraud, Negligence, and Honesty.

Fraudulent non-compliance is a deficiency of tax where the underlying behaviour is dishonest. Dishonest tax behaviour can lead to criminal charges, but can also be addressed through civil and administrative penalties.

Negligent non-compliance arises from carelessness or a failure to pay due care and attention on the part of the taxpayer with regard to a tax liability. Negligence, where detected, results in a tax liability and civil penalties.

Honest non-compliance can arise if a taxpayer makes an honest mistake in the filing of a tax return which is not caused by negligence or dishonesty.

If a taxpayer has ended up as non-compliant through an honest mistake and that mistake is discovered, they will have to pay any taxes due, but may not suffer any penalties, although there are some strict liability cases where a penalty may be levied.

We believe that defining the Tax Gap in these terms would provide a number of advantages. Firstly, as a matter of principle, it is right that a measure of non-compliance with the law should be defined in terms that are recognised by law.

Secondly, these three categories of behaviour are easily understood by the public. If HMRC were to present their Tax Gap in these terms, we believe that the public’s understanding of the nature of non-compliance would be significantly improved.

Finally, using these categories would provide clarity in developing HMRC’s strategy, as there is a risk that what is not recognised as fraud will not be treated as fraud.

For the purposes of this paper, we have assessed HMRC’s behavioural categories as found in the Tax Gap and find that many easily fall under the legal definitions of fraud, negligence or honesty.

We find that when categorised in this way, fraudulent behaviour accounts for at least £15.2bn of the Tax Gap – 43% of the total Tax Gap and 2.25% of the total amount of tax due according to HMRC.

In order to reach this figure, we added the sum total of tax lost to what HMRC term, “Criminal Attacks – £5.2bn”, “Evasion – £5.5bn”, “Hidden Economy – £3bn” and “Avoidance – £1.5bn”.

The categorisation of Avoidance as fraud arises because, unlike HMRC that consider only “taxpayer behaviours”, we consider the behaviour of tax professionals and conclude that this approach places tax avoidance in the fraud category.

Although tax avoidance is generally thought of as “legal” activity, it is clear that avoidance as defined by HMRC, which is an incidence of non-compliance arising from the use of a scheme, developed by tax professionals, which seeks to “exploit” the tax system through “contrived or artificial” transactions that have no commercial purpose, should properly be defined as arising from dishonest behaviour on the part of the professionals who design and market the schemes.

Our interpretation is supported by the new definition of tax fraud adopted by HMRC in the latest edition of Measuring tax gaps:

“Any deliberate omission, concealment or misinterpretation of information, or the false or deceptive presentation of information or circumstances in order to gain a tax advantage.”

More detail on our approach to this issue is provided in the main body of this paper.

However, some of the behaviours used by HMRC do not easily fall into one of the proposed categories. For example one of the largest components of the Tax Gap is “legal interpretation” which comprises £5.8bn of the Tax Gap. This is where a taxpayer disputes HMRC’s interpretation of the law. These disputes could easily arise from either dishonest or honest behaviour.

Furthermore, HMRC does not count most international tax avoidance, characterised as “BEPS”, in their Tax Gap calculations. It is clear, from HMRC’s publications in this area, that much of what HMRC categorise as BEPS arises from fraudulent conduct. If all of this is taken into account, it would not be unreasonable to assume that the Tax Fraud Gap is at least £20bn.

Even at the lower estimate, which only includes categories clearly falling under the definition of fraud, tax fraud is a far larger problem than fraud impacting other areas of public finance. For example, the latest estimates of fraud in the benefits system show that fraud accounts for £6.3bn of potential losses – before any recoveries (HMRC’s figures are after compliance efforts).1

Given that the behaviours we identify are grounded in law, it should be relatively easy for HMRC to publish a more detailed estimate of the amount of tax lost to fraud, having assessed the amount of fraud included in categories such as Legal Interpretation, BEPS and Non-Payment. We recommend that HMRC do this in their next update to the Tax Gap.

HMRC’s Tax Gap

The Commissioners for Her Majesty’s Revenue and Customs (HMRC) was established through the merger of the Commissioners of Inland Revenue (IR) and Her Majesty’s Customs and Excise (HMCE) by the Commissioners for Revenue and Customs Act 2005.

Section 5 provided that the Commissioners shall be responsible for “the collection and management of revenue” for which the Commissioners of Inland Revenue and the Commissioners of Customs and Excise were previously responsible.

The management of revenue includes policing the tax system and conducting criminal investigations with a view to prosecution. While the former Customs and Excise prioritised both the collection of revenue and the punishment of offenders, the former Inland Revenue considered their primary objective to be the collection of revenue and not the punishment of offenders.

Against this background, HMCE published estimates of the Tax Gap in HMCE-administered taxes known as the indirect tax gap from 2001 in technical papers published alongside each Pre-Budget Report (PBR): Measuring Indirect Tax Fraud (Nov 2001), Measuring indirect tax losses (Nov 2002), Measuring and Tackling Indirect Tax Losses (Dec 2003, Dec 2004), published with the 2001, 2002, 2003, and 2004 Pre-Budget Reports.

Following the 2005 merger, HMRC continued to publish the indirect tax gap. At the same time, a broader estimate of tax losses of all taxes administered by HMRC was developed for internal use. After some resistance, HMRC made this information public after the journalist Richard Brooks sought the estimates under the Freedom of Information Act.

HMRC began regularly publishing estimates of the Tax Gap in all HMRC-administered taxes (including direct taxes) alongside the 2009 PBR. It estimated the tax gap to be around £40 billion in 2007-08 and identified the eight underlying taxpayer behaviours: (1) criminal attacks; (2) evasion; (3) hidden economy; (4) avoidance (which does not include Base Erosion and Profits Shifting (BEPS) or tax planning); (5) legal interpretation; (6) non-payment; (7) failure to take reasonable care; and (8) error. These eight behaviours remain the foundation for HMRC’s analysis of non-compliance today.

Protecting Tax Revenues detailed HMRC’s approach in using analysis of the tax gap to tackle the drivers of the Tax Gap and described the range of measures that HMRC were taking to reduce the Tax Gap. The behaviours are critical to this approach. According to the report:

“Analysis of the underlying behaviours that drive the tax gap is useful as by identifying these behaviours HMRC can most effectively develop a targeted approach, prioritising operational resources and identifying where policy solutions are required.”2

HMRC’s stated reasons for measuring the Tax Gap are as follows:

“The tax gap provides a useful tool for understanding the relative size and nature of non-compliance. This understanding can be applied in many different ways:

 

It provides a foundation for HMRC’s strategy — thinking about the tax gap helps us understand how non-compliance occurs and how we can address the causes and improve the overall health of the tax administration system

 

our tax gap analysis provides insight into which strategies are most effective at reducing the tax gap

 

although the tax gap isn’t sufficiently timely or precise enough to set annual targets or manage detailed operational performance, it provides important information which helps us understand our long-term performance.

 

The tax gap also provides important information to the public on tax compliance, creating greater transparency in the tax system.”3

Fraud, Negligence and Honesty

As far as the law is concerned, there are only three types of behaviours that lead to non-compliance: Fraud, Negligence and Honesty. Every incidence of non-compliance can be said to arise from one of these three behaviours depending on the knowledge, abilities and circumstances of the taxpayer or tax professional involved.

Fraud, cheating and dishonesty

In tax and indeed other areas of law, the terms ‘fraud’, ‘cheating’ and ‘dishonesty’ mean essentially the same thing and can be used interchangeably.

According to Justice Hardy’s widely-accepted definition of the common law offence of Cheating the Public Revenue in R v Less:

“The common law offence of cheating the Public Revenue does not necessarily require a false representation either by words or conduct. Cheating can include any form of fraudulent [or] dishonest conduct by the defendant to prejudice, or take the risk of prejudicing, the Revenue’s right to the tax in question knowing that he has no right to do so.”4

Dishonesty is also the essence (or essential requirement) of the relatively new criminal offence of fraud under the Fraud Act 2006, which applies to tax and other areas of law.

UK tax legislation also contains criminal offences that criminalise dishonesty. These include: fraudulent evasion of income tax (section 106 of the Taxes Management Act 1970); fraudulent evasion of VAT (section 72(1) of the Valued Added Tax Act 1994); and fraudulent evasion of excise duty (section 170(2) of the Customs and Excise Management Act 1979).

Each Act also provides for civil penalties for fraud, where the essential requirement is dishonesty.5

In 2021 HMRC adopted the following definition of fraud in their “Measuring tax gaps” report.6 The definition is as follows:

Any deliberate omission, concealment or misinterpretation of information, or the false or deceptive presentation of information or circumstances in order to gain a tax advantage. Tax evasion is fraud.

This was a significant departure from previous editions of Measuring tax gaps and other publications, which always stated that tax fraud is tax evasion. For example, in Measuring tax gaps 2020 edition fraud is defined as simply, “Deliberate, dishonest evasion of tax.”7

The broader definition now used by HMRC begs the question, what else, other than “evasion” should be considered fraudulent behaviour?

As we demonstrate in this report in relation to the Tax Gap behaviours, what HMRC consider to be “Tax Avoidance” and some “Legal Interpretation” could easily be described as behaviour arising from “any deliberate omission, concealment or misinterpretation of information, or the false or deceptive presentation of information or circumstances in order to gain a tax advantage.”

Negligence

The classic common law definition of negligence was set out by Baron Alderson in Blyth v Birmingham Waterworks as follows:

“Negligence is the omission to do something which a reasonable man, guided upon those considerations which ordinarily regulate the conduct of human affairs, would do, or doing something which a prudent and reasonable man would not do.”8

In the context of tax non-compliance negligence is defined as carelessness in section 95 of the Taxes Management Act 1970 or failure to take reasonable care under Schedule 24 of the Finance Act 2007.

In tax disputes, the courts have broadly followed the test set out in Blyth when considering penalties under these provisions of these Acts. For example in Anderson v HMRC Judge Berner stated:

“The test to be applied … is to consider what a reasonable taxpayer, exercising reasonable diligence in the completion and submission of the return, would have done.”9

Honesty

Honesty is simply the opposite of dishonesty or fraud or cheating. It is a subjective assessment based on an individual’s knowledge at the time. According to Lord Nicholls in Royal Brunei Airlines v Tan:

“Honesty has a connotation of subjectivity, as distinct from the objectivity of negligence. Honesty, indeed, does have a strong subjective element in that it is a description of a type of conduct assessed in the light of what a person actually knew at the time, as distinct from what a reasonable person would have known or appreciated.”10

The role of professional advisers

The role played by professional advisers is crucial to the understanding of the nature of non-compliant behaviour on the part of a taxpayer.

Paragraph 18 of Schedule 24 to Finance Act 2007, which deals with the liability of a taxpayer to penalties for negligence or fraud where professional advisers are acting on his behalf, was considered in Hanson v HMRC. Judge Cannan confirmed the well-established law and practice thus:

“What is reasonable care in any particular case will depend on all the circumstances. In my view this will include the nature of the matters being dealt with in the return, the identity and experience of the agent, the experience of the taxpayer and the nature of the professional relationship between the taxpayer and the agent. In my view, if a taxpayer reasonably relies on a reputable accountant for advice in relation to the content of his tax return then he will not be liable to a penalty under Schedule 24.”11

The corollary of the highlighted principle is that a taxpayer using a tax avoidance scheme, which is invariably devised and implemented by the professional enablers, to misrepresent or conceal his tax liability in a tax return submitted to the Revenue is more likely to do so honestly than negligently or fraudulently.

Tax evasion, tax avoidance and tax mitigation

The terms tax evasion, avoidance and mitigation are commonly used to describe a range of behaviours associated with both compliant and non-compliant tax behaviour.

The terms have no universally accepted definition, and are used in different and sometimes opposing ways in different contexts. HMRC have particular definitions they use, which will be set out later on in this report. In this section we look at meaning of these terms in law.

Tax evasion

Tax evasion is when a taxpayer dishonestly fails to make a tax return when they had a legal requirement to do so, or when a taxpayer makes a false tax return by failing to declare all of their income. It is tax fraud and punishable under the common law offence of cheating the public revenue. In either case, the key issue is the behaviour and knowledge of the taxpayer in their dealings with the tax authority.

As set out in R v Mavji:

“This appellant was in circumstances in which he had a statutory duty to make value added tax returns and to pay over to the Crown the value added tax due. He dishonestly failed to do either. Accordingly, he was guilty of cheating HM The Queen and the public revenue.”12

In R v Hudson the taxpayer was convicted of cheating the public revenue by sending in false accounts relating to their farming business which deliberately understated the profits of the business. At the court of appeal, Goddard CJ stated:

“We think that the offence here consisted of sending in documents to the inspector of taxes which were false and fraudulent to the appellant’s knowledge … for the purpose of avoiding the payment of tax. That is defrauding the Crown and defrauding the public.”13

Avoidance and tax mitigation

On a proper analysis of the law, Tax Avoidance could be defined as a form of tax fraud by professional advisers that design, market, implement and otherwise facilitate the use of tax avoidance schemes in which the taxpayer using an individual scheme may or may not be complicit.

Tax avoidance is distinguished from tax evasion by the use of a tax avoidance scheme created and marketed by professional tax advisers.

In a tax avoidance scheme, a taxpayer reduces their tax liability by entering into an arrangement, or a series of transactions which has the effect of making a taxpayer appear to suffer a reduction in their taxable income when in fact no real reduction has taken place.

As stated above, it is well established in tax law that a taxpayer should be able to reasonably rely on professional advice in the field of tax, and if they do so then they should not be considered to be negligent (let alone dishonest!) even if the tax return they make on the basis of that advice turns out to be wrong.

It follows from this that a tax payer that submits an incorrect tax return based on the use of a tax avoidance scheme is more likely to be behaving honestly rather than dishonestly, or negligently (depending on whether their reliance on the professional advice in question was “reasonable”).

However, just because the taxpayer may be acting honestly by entering into a tax avoidance scheme, does not mean that all participants in a scheme are acting honestly.

R v Charlton, Cunningham, Kitchen and Wheeler14, was a case which started as a standard enquiry into a taxpayer’s return, but became a criminal investigation after the Inland Revenue raided the premises of the accountants that had devised the tax avoidance scheme used by the taxpayer. It became the longest running prosecution by the Inland Revenue and ended with the conviction of a number of tax professionals for cheating the public revenue for their roles in devising, marketing, implementing and otherwise facilitating the use of tax avoidance schemes. According to Lord Justice Farquharson:

“The case for the prosecution was that Charlton had devised a dishonest, tax-avoidance scheme for the benefit of some of the firm’s clients and that the Appellants were involved with the implementation of the schemes or the concealment from the Revenue of the existence of the fraud.”15

The schemes in Charlton were designed to reduce taxable income in the UK by shifting profits using artificial transactions to intermediaries in Jersey. The type of scheme would readily be described as Base Erosion and Profit Shifting (BEPS) schemes. As set out by Farquharson LJ:

“It was the case for the Crown that the accounts presented to the Revenue by the United Kingdom companies were false in that by using Charlton’s scheme to transfer part of their profits to the Jersey companies they were not disclosing the full extent of the profits they had made. It was this lack of disclosure which formed the basis of the false representations alleged in the indictment. Each of the Appellants was charged in the relevant counts with cheating the Revenue by ‘… falsely representing that the apparent purchases (by the United Kingdom company) from (the Jersey company) were bona fide commercial transactions’.”16

Tax avoidance is usually not considered to be fraudulent behaviour by HMRC because the tax system as it currently operates is designed for the relationship between the Revenue and the taxpayer (who is usually an honest participant in the scheme). Where HMRC discover tax avoidance their usual approach is to amend the taxpayer’s return and deny them the benefit of using the scheme.

Where a tax assessment is appealed by the taxpayer, the fraudulent nature of tax avoidance scheme is obscured, because the dispute is between the participating taxpayer and the Revenue to which their tax advisors or the scheme operators are not parties.

This, combined with the fact that HMRC vary rarely prosecute dishonest tax advisors, has led to some confusion over the true nature of tax avoidance, a point neatly summarised by a leading criminal barrister Robert Rhodes in his commentary on the Charlton case:

“Amongst professional tax advisers, alarm and concern have been expressed at the approach of the Revenue and the conduct of the case. It has been argued that there is a general move to ‘blur’ the ‘very clear’ distinction between legal tax avoidance and illegal evasion. However, it might well be suggested that the distinction is not and has never been as clear as many professional advisers (and their clients) would like to believe. Where avoidance arrangements are wholly artificial and have no substance then clearly it is and always has been open to the Revenue and the courts to consider whether they are in fact ‘devices to cheat the public revenue’.

Moreover, the terms ‘tax avoidance’ and ‘tax evasion’ have been created by the legal and accountancy professions as convenient generic terms to distinguish what is legal from what is illegal, and the fact that they have also been adopted by the courts should not blind us to what they actually are.”17

It is important to understand that tax avoidance is separate from tax planning or tax mitigation, which is often confused with avoidance in common usage.

Tax planning is properly defined as when a taxpayer reduces their taxable income by making a real expense that takes advantage of a real tax benefit provided for by Parliament. This could be for example investing in plant an machinery that attracts capital allowances or putting money into an ISA. As set out by Lord Templeman in CIR vs Challenge, where the concept of tax mitigation was first developed:

“Income tax is mitigated by a taxpayer who reduces his income or incurs expenditure in circumstances which reduce his assessable income or entitle him to reduction in his tax liability. In tax mitigation … the taxpayer’s tax advantage is not derived from an ‘arrangement’ but from the reduction of income which he accepts or the expenditure which he incurs….18

Analysing HMRC’s Tax Gap behaviours using the legal concepts of fraud, negligence and honesty

HMRC’s Tax Gap is defined as “the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid”. It is therefore a measure of non-compliance and all non-compliance can fall under the three behavioural categories found in law and set out above – Fraud, Negligence or Honest non-compliance. Indeed, these three categories of behaviour are the bedrock of how the courts approach tax law, both civil and criminal.

HMRC presents the Tax gap as arising from eight different “taxpayer behaviours”. The use of the term “taxpayer behaviours” is significant because it underscores HMRC’s focus on the taxpayer and the failure to consider the behaviour of professional advisers, which is critical to tax avoidance. The eight behaviours are: error; failure to take reasonable care; evasion; hidden economy; criminal attacks; avoidance; legal interpretation; and non-payment.

Some of these behaviours are clearly dishonest, negligent or honest, whereas others can cover more than one category. In this section we go through each of the behaviours contained in the Tax Gap analysis used by HMRC to see into which legal category the behaviour should fall.

Tax Evasion, Hidden Economy and Criminal Attacks – £13.7bn

HMRC define “evasion”, “hidden economy” and “criminal attacks” as three separate behaviours. According to the latest Tax Gap publication, HMRC considers “evasion” to be “where registered individuals or businesses deliberately omit, conceal or misrepresent information in order to reduce their tax liabilities.”

This focus on “registered individuals or businesses” distinguishes “tax evasion” from “hidden economy” which is defined as where “whole sources of income have not been declared to HMRC for tax purposes”.

HMRC define “criminal attacks” as “co-ordinated and systematic attacks on the tax system” including “smuggling goods such as alcohol or tobacco, VAT repayment fraud and VAT Missing Trader Intra-Community (MTIC) fraud.”

In reality, all three behaviours would be considered tax evasion by the general public with the category “criminal attacks” specifically covering tax evasion which relates to the work of the former Customs and Excise.

Indeed all three are considered tax evasion by HMRC in all other publications apart from the Tax Gap. For example, the joint HMRC & HMT document Tackling tax avoidance, evasion, and other forms of non-compliance, states:

“Tax evasion is always illegal. It is when people or businesses deliberately do not declare and account for the taxes that they owe. It includes the hidden economy, where people conceal their presence or taxable sources of income.”19

As our discussion of tax evasion above demonstrates, all these forms of evasion found in the Tax Gap are from a legal perspective cheating the public revenue by a taxpayer, and so can easily be categorised as fraudulent or dishonest behaviour.

Avoidance – £1.5bn

HMRC’s definition of avoidance defines tax avoidance in terms of “schemes” which often involve “contrived” or “artificial” transactions designed to “exploit” the tax system. The definition provided in Measuring tax gaps 2021 is as follows:

“Avoidance involves bending the tax rules to try to gain a tax advantage that Parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage. It involves operating within the letter but not the spirit of the law.”

This is a from the previous edition of the Tax Gap which described avoidance as “exploiting the tax rules” rather than “bending them”.20

Tax planning is clearly differentiated from avoidance in the HMRC’s tax gap analysis. As set out in Measuring tax gaps 2021:

“Tax avoidance is not the same as tax planning. Tax planning involves using tax reliefs for the purpose for which they were intended. For example, claiming tax relief on capital investment, saving in a tax-exempt ISA or saving for retirement by making contributions to a pension scheme are all forms of tax planning.”

Tax professionals involved in fraudulent tax schemes could be pursued by HMRC under the criminal law, as they were in the Charlton case, but these kinds of prosecutions are exceptionally rare.

Where they do occur, the approach taken by HMRC confirms the proposition that tax avoidance can involve both dishonesty on the part of tax professionals and honest behaviour on the part of the taxpayer.

To give an example of a more recent case, in 2019 three men pleaded guilty to various counts of cheating the revenue for their role in promoting and enabling what HMRC termed “a fraudulent tax avoidance scheme”. Anthony Blakey, John Banyard and Professor Ian Swingland were convicted on indictment after enticing wealthy people into investing an a scheme which purported to invest in carbon credits and research into a cure for HIV. However, HMRC found little evidence of the investments having actually been made.

As set out in the press release issued by HMRC:

“Investors were able to claim tax rebates on the losses that the businesses apparently generated, or lower their tax bills, by offsetting losses against £160 million of income, attempting to avoid £60 million in tax. The majority of repayments claimed were withheld by HMRC….

There is no suggestion that the investors knew the scheme was a sham, or knew that their money was not being spent on research and development and carbon trading business activity.”

The press release went onto say:

“HMRC is working with the tax profession to tackle those who promote tax avoidance schemes. Promoters of Tax Avoidance Schemes legislation, introduced in Parliament in 2014, is aimed at tackling those who push the boundaries of the rules, and carries consequences for those who fail to change their behaviour.”21

HMRC clearly categorises the Banyard scheme as “Avoidance”, yet the successful prosecution of the tax professionals behind the scheme confirms that the tax losses arose from fraudulent or dishonest conduct, even in the circumstances where the participating taxpayers were were unaware of the fraudulent nature of the scheme.

Given that HMRC’s definition of “avoidance” expressly excludes planning and is limited to schemes that are exploitative, contrived, and artificial, then the tax loss under HMRC’s “avoidance” category should be considered to be part of the fraud gap.

Error – £3.7bn

HMRC’s definition of “error” is clearly limited to error arising from honest mistake because it only includes errors that arise “despite customers taking reasonable care”. It therefore excludes errors arising from negligence.

Under the description of behaviours, “Error” is described as “Errors result from mistakes made in preparing tax calculations, completing returns or in supplying other relevant information, despite the customer taking reasonable care” in the Measuring tax gaps 2021 edition.

Failure to take reasonable care – £6.7bn

The tax behaviour which HMRC describes as “Failure to take reasonable care” clearly corresponds to negligence as explained above. According to the Measuring tax gaps 2021 edition:

“Failure to take reasonable care results from a customer’s carelessness and/or negligence in adequately recording their transactions and/or in preparing their tax returns. Judgments of ‘reasonable care’ should consider and reflect a customer’s knowledge, abilities and circumstances.”

Non-Payment – £4bn

The Non-payment component of the Tax Gap reflects the impossibility of collecting every penny of tax that is owed because HMRC cannot collect outstanding tax from individuals and businesses that become bankrupt or insolvent.

According to Measuring tax gaps 2021:

“For direct taxes, non-payment refers to tax debts that are written off by HMRC and result in a permanent loss of tax — mainly as a result of insolvency. It does not include debts that are eventually paid.

VAT non-payment differs as it is based on the difference between new debts arising and debt payments.”

Non-payment can, therefore, be honest (genuine inability to pay) or fraudulent (deliberate failure to pay such as the use of phoenix companies).

Legal interpretation – £5.8bn

The behaviour which HMRC define as “legal interpretation” is the second largest component of the Tax Gap. It is also one of the most difficult to interpret as the wording is wide enough to encompass honest and dishonest behaviours. There is no mention of the term in the methodological annex of the Tax Gap.

Under the heading ‘Resolving issues of legal interpretation’, ‘Protecting Tax Revenues 2009’ stated:

“Legal interpretation relates to the potential tax loss from cases where HMRC and customers have different views of how, or whether, the law applies to specific and often complex transactions. Examples include the correct categorisation of an asset for allowances, the allocation of profits within a group of companies, or VAT liability of a particular item. In these situations the customer will have an alternative view of the law and of how it applies to the facts in their case to that held by HMRC.22

It follows from this that legal interpretation could cover issues arising from both honest and dishonest behaviour, even tax compliance. For example, it is possible that HMRC’s interpretation of the law in any particular case turns out to be wrong, in which case the incidence of non-compliance defined by HMRC as “legal interpretation” will be compliant, assuming that the issue under dispute does not fall foul of any other law.

If, after the case has been resolved in favour of the taxpayer HMRC continues to maintain that the disputed amount should not have been claimed, they can seek to change the law but losses that arise from a deficiency in the law should not be counted in the Tax Gap as defined by HMRC.

If HMRC end up prevailing in their view, the claiming of an allowance the taxpayer is not in fact actually entitled to claim could have been an honest mistake or a dishonest interpretation of the law.

Many avoidance schemes are characterised as honest disputes over legal interpretation, usually by the people that design and operate them, when in fact the legal interpretation claimed by the creators of the scheme is dishonest.

In Charlton, which involved a transfer pricing scheme using a Jersey registered company, the behaviour of the barrister involved, Cunningham, was described in the following terms:

“Charlton used Cunningham to reassure any doubting participants. The Crown’s case against Cunningham had been that he advised Wheeler that the scheme was effective although to his knowledge it was not.”

The fact that many tax avoidance schemes will involve the provision of legal advice to scheme users (taxpayers or customers in HMRC’s terminology) that testifies to the legality of the scheme means that by definition avoidance includes “cases where HMRC and customers have different views of how, or whether, the law applies to specific and often complex transactions.”

The examples given by HMRC of what constitutes “legal interpretation” and in particular “the correct categorisation of an asset for allowances” and “the allocation of profits within a group of companies” indicate that legal interpretation was intended to cover tax non-compliance, or avoidance by companies, particularly multinational companies as opposed to tax avoidance by individual taxpayers which is defined under the “tax avoidance” behaviour.

This proposition is fortified by the following passage contained in ‘Protecting Tax Revenues 2009’:

“HMRC’s approach to issues of legal interpretation is strategic and risk based. This has been developed to deal with the tax affairs of large businesses”23

Whether or not an incidence of legal interpretation arises from honest or dishonest behaviour will be a matter of subjective judgment. The case of GE vs HMRC provides a good example of where HMRC have significantly changed their position over time.

In this case, which involves a dispute over whether anti-avoidance legislation should have applied to a number of transactions carried out by GE, HMRC allege that GE failed to disclose relevant information regarding the scheme. At first, HMRC alleged that this failure to disclose was due to an honest mistake on the part of GE, which resulted in HMRC being mislead as to the true nature of the scheme. More recently HMRC applied to the High Court to amend their case to allege that the non-disclosure was fraudulent.24 GE and HMRC have now settled the case with no blame to either party.

In their 2019 edition of Measuring tax gaps, HMRC attempted to draw a distinction between avoidance and legal interpretation for the first time:

“Legal interpretation losses arise where the customer’s and HMRC’s interpretation of the law and how it applies to the facts in a particular case result in a different tax outcome, and there is no avoidance. Specifically, this includes the interpretation of legislation, case-law, or guidelines relating to the application of legislation or case-law.

Examples include categorisation such as an asset for allowances or VAT liability of a supply, the accounting treatment of a transaction, or the methodology used to calculate the amount of tax due as in transfer pricing, or VAT partial exemption.

The definition adopted in 2019 remains the same in the 2021 edition of Measuring gax gaps.

The reference to transfer pricing is interesting, as transfer pricing disputes frequently arise from tax avoidance by multinational companies, which demonstrates the difficulties of seeking to distinguish between “avoidance” and “legal interpretation”.

This, and the proposition that a significant amount of “legal interpretation” is fraudulent is further demonstrated by HMRC’s guidance on their profit diversion compliance facility. The facility is a form of amnesty for multinationals that have moved their profits out of the UK in a non-compliant manner. Under the heading: behaviours and conclusions on penalties, the facility states the following:

“If we find that additional tax is due, we will always consider the behaviours that have given rise to the error and whether penalties should be charged. The Facility does not offer special terms and the normal penalty provisions and HMRC practice apply.

Our investigations into Profit Diversion to date have established that in a large number of cases the factual pattern outlined to HMRC at the start of an enquiry does not stand up to scrutiny once tested. That may be a result of a careless error (for example individuals within a group being unaware of what the actual facts are) but it may also be a result of a deliberate behaviour, that is a group knowingly submitting a TP [Transfer Pricing] methodology in a Corporation Tax Return based on a false set of facts….

Where HMRC suspects there has been an attempt by a group to deliberately mislead, then we will refer the issue to Fraud Investigation Service for consideration of a criminal investigation or civil investigation into fraud.”25

It should be noted that disputes over transfer pricing methodology are the most significant cases that HMRC take on. The latest figures for tax under consideration show that “Transfer Pricing and Thin Capitalisation” make up 1/3rd of the total tax receipts being disputed between HMRC and large businesses – £10bn.26

Drawing all of this together, the term “legal interpretation” appears broad enough to cover a wide range of tax behaviour.

However, the subjective nature of how HMRC assesses tax behaviour, and the fact that questions of legal interpretation will often arise before any assessment of whether or not a company or individual’s interpretation is honest or not, will mean that a significant part of the “legal interpretation” category will arise from fraudulent behaviour.

A good exercise would be for HMRC to conduct an analysis of cases that fell into the legal interpretation category five years ago, and publish what the outcomes of those cases were with an assessment of any underlying behaviour that led to non-compliance.

Base erosion and profit shifting (BEPS)

HMRC appear to recognise a separate type of tax behaviour – BEPS – which falls outside the Tax Gap. BEPS is a term which emerged from the OECD’s 2013 study commissioned by the G-20 entitled ‘Addressing Base Erosion and Profit Shifting’ and has been used to describe tax avoidance by multinational enterprises.

BEPS appeared for the first time in HMRC’s ‘Measuring tax gaps 2014 edition (Tax gap estimates for 2012-13)’ following tax avoidance and incorporating the OECD definition in these terms (emphasis added):

“It [tax avoidance] does not include international tax arrangements such as base erosion and profit shifting (BEPS). Measures for tackling this are overseen by the Organisation for Economic Co-operation and Development (OECD). The OECD defines BEPS as tax planning strategies that exploit gaps and mismatches in tax rules to make profits disappear for tax purposes or to shift profits to locations where there is little or no real activity, but the taxes are low resulting in little or no overall corporate tax being paid.”27

In ‘Measuring tax gaps 2015 edition (Tax gap estimates for 2013-14)’ 2015, HMRC added the following paragraph to the existing description (emphasis added):

“Where we can challenge cross-border tax avoidance or aggressive tax planning under UK law, it is reflected in the tax gaps for avoidance and legal interpretation, but where the effect of such activity is the result not of frustrating UK law but of exploiting the international tax framework, we do not include it in the avoidance tax gap.28

Measuring tax gaps 2021 contains a more nuanced but essentially similar description:

“Some forms of base erosion and profit shifting (BEPS) are included in the tax gap where they represent tax loss that we can address under UK law.

As new measures introduced in accordance with recommendations made in the BEPS project by the G20 group of world-leading economic nations and the Organisation for Economic Co-operation and Development (OECD) take effect, our ability to address BEPS under our domestic law will be greatly strengthened.

The tax gap does not include BEPS arrangements that cannot be addressed under UK law and that will be tackled multilaterally through the OECD.

HMRC have never provided a breakdown of how much BEPS activity they categorise as avoidance and legal interpretation, and how much they don’t count at all.

The descriptions given by HMRC suggests that the tax authority believes that a substantial amount of tax avoidance by BEPS arises from the honest use of international tax system, albeit with outcomes that the UK government may not like. This is the natural conclusion of the proposition that BEPS cannot be dealt with under UK law and requires changes in the law agreed internationally to be addressed.

That confusion is not aided by the OECD’s own characterisation of BEPS (which is repeated in HMRC’s Measuring gax gaps document), which describes BEPS as follows:

“What is BEPS?

Base erosion and profit shifting (BEPS) refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low, resulting in little or no overall corporate tax being paid.”29

The use of the term “planning” is clearly a misnomer. The definition, with references to attempts to exploit the tax rules by what are clearly artificial transactions closely aligns with HMRC’s own definition of avoidance.

The schemes in Charlton would be described today as Base Erosion and Profit Shifting (BEPS) schemes because they were devised to erode the UK’s tax base by shifting the taxable profits of UK companies to Jersey intermediaries. According to Farquharson LJ:

“It was the case for the Crown that the accounts presented to the Revenue by the United Kingdom companies were false in that by using Charlton’s scheme to transfer part of their profits to the Jersey companies they were not disclosing the full extent of the profits they had made. It was this lack of disclosure which formed the basis of the false representations alleged in the indictment. Each of the Appellants was charged in the relevant counts with cheating the Revenue by ‘… falsely representing that the apparent purchases (by the United Kingdom company) from (the Jersey company) were bona fide commercial transactions’.”30

The avoidance scheme used by Google, which would clearly be described as BEPS by both the OECD and the UK government, was subject to criminal procedures for “aggravated tax fraud” in France31 – an OECD member.

This suggests that a significant amount of tax behaviour described as BEPS and not counted in the Tax Gap should be classified as dishonest or fraudulent tax behaviour.

Measuring the tax fraud gap

From the above analysis, we can see that even on its own terms the behavioural categorisation by HMRC of non-compliance into eight categories (with a ninth BEPS, which falls outside the tax gap) is highly problematic.

The level of tax evasion and avoidance are grossly misstated by separating evasion into several different behavioural categories and via the inclusion of some avoidance in the “legal interpretation” category and the exclusion of BEPS. Through this approach, the overall level of dishonest behaviour is obscured.

The artificial nature of HMRC’s categorisations of tax behaviours in the Tax Gap may well be explained by the historical division between the work of the Inland Revenue and Customs and Excise and the fact that historically the Tax Gap was used as an internal performance measure and strategic tool. This has meant that Tax Gap the categorisation has followed how HMRC internally treat different types of tax non-compliance.

However, the dilution of categories such as avoidance and evasion as well as the exclusion of categories like BEPS also has the effect of diverting criticism that “HMRC has not been sufficiently challenging of multinationals’ manifestly artificial tax structures”32 in the words of the Public Accounts Committee.

Given that the Tax Gap has now developed into a measure by which HMRC presents their performance to the public and parliament, it would be better to move away from system based on technical definitions derived from HMRC’s internal arrangements, to categories based on clear legal concepts that everyone can understand. Fraud, Negligence and Honest non-compliance.

Categorising the Tax Gap in this way would provide a clearer way of presenting Tax Gap data to the public, and provide a better understanding of the scale of unlawful non-compliance.

The Department for Work and Pensions (DWP) already follows a similar approach in their equivalent of the Tax Gap, “Fraud and Error in the Benefit System”. This categorises non-compliance into just three categories, fraud, claimant error and official error (which does not differentiate between errors arising from honest mistakes or negligence).

As our analysis demonstrates, calculating the fraud, negligence, and honest non-compliance tax gaps should be relatively easy to do. There are already several categories which are clearly analogous to fraud, negligence and honesty.

If we take the HMRC behaviours that clearly arise from fraudulent conduct, we find that in 2019/20 fraud accounted for at least £15.2bn or 43% of the Tax Gap. To this would need to be added any fraudulent conduct that can be found in the categories of non-payment and legal interpretation, and of course BEPS.

HMRC have never published an estimate of how much tax is lost to BEPS and there are a number of studies from both academics and NGOs. Research from the University of Oxford calculated that profit shifting by multinationals results in foreign owned multinationals shifting 50% of their taxable profit outside of the UK, leading to tax losses of £25bn in 2014.33 A study by a number of academics produced for the European Parliament found that profit shifting could have cost £20bn in 2013.34

Taking BEPS into account, and assuming that a proportion of tax losses to Non-Payment and Legal Interpretation result from fraudulent tax behaviour, it would not be unreasonable to assume that Tax Fraud Gap is at least £20bn in the UK. However, more work would be needed to come to a reliable estimate. We recommend that HMRC complete this analysis as part of next year’s Tax Gap estimates.

TaxWatch, September 2021

The full report can be found as a PDF here.

 

1DWP, Fraud and error in the benefit system for financial year ending 2021, https://www.gov.uk/government/statistics/fraud-and-error-in-the-benefit-system-financial-year-2020-to-2021-estimates/fraud-and-error-in-the-benefit-system-for-financial-year-ending-2021#total-estimates-of-fraud-and-error-across-all-benefit-expenditure

2HMRC, Protecting Tax Revenues 2009, para 5.2 https://webarchive.nationalarchives.gov.uk/ukgwa/20101007004119/http://www.hmrc.gov.uk/pbr2009/protect-tax-revenue-5450.htm

3HMRC, ‘Measuring tax gaps 2021 edition’ https://www.gov.uk/government/statistics/measuring-tax-gaps/measuring-tax-gaps-2021-edition-tax-gap-estimates-for-2019-to-2020

4 The Times, March 30, 1993.

5 The standard of proof differs. Fraud is proved beyond reasonable doubt in criminal proceedings and on a balance of probability in civil cases.

6See, HMRC, Measuring tax gaps, 2021 Edition, Glossary, https://www.gov.uk/government/statistics/measuring-tax-gaps/measuring-tax-gaps-2021-edition-tax-gap-estimates-for-2019-to-2020

7 HMRC, Measuring tax gaps, 2020 Edition, Glossary, page 93. https://webarchive.nationalarchives.gov.uk/ukgwa/20200730195942/https://www.gov.uk/government/statistics/measuring-tax-gaps

8Blyth v Birmingham Waterworks (1889) 14 App. Cas. 337, 374 https://www.bailii.org/ew/cases/EWHC/Exch/1856/J65.html c

9 Anderson vs HMRC [2009] UKFTT 206 at [22].

10 Royal Brunei Airlines v Tan [1995] 2 AC 378, 389. Emphasis supplied.

11 Hanson vs HMRC [2012] UKFTT 314 at [21]. Emphasis supplied.

12 R vs Mavji, [1987] 84 Cr App R 34

13 R v Hudson, [1956] 2 QB 252, 261-262.

14 R vs Charlton and others, [1996] STC 1418.

15 Ibid

16 Ibid

17 Robert Rhodes et al, ‘Regina v Charlton, Cunningham, Kitchen and Wheeler’ (1999) Journal of Money Laundering Control, 197 page 206.

18 Commissioner of Inland Revenue (New Zealand) v Challenge Corporation Ltd. [1986] BTC 442

19 HMRC & HMT, Tackling tax evasion and avoidance, (CM9047, March 2015) https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/785551/tackling_tax_avoidance_evasion_and_other_forms_of_non-compliance_web.pdf

20 See: HMRC, Measuring tax gaps, 2020 Edition, table 1.7 page 24, https://webarchive.nationalarchives.gov.uk/ukgwa/20200730195942/https://www.gov.uk/government/statistics/measuring-tax-gaps

21 HMRC Press Office, Two jailed for £60m fraudulent HIV cure tax fraud, 25 February 2019, https://www.mynewsdesk.com/uk/hm-revenue-customs-hmrc/pressreleases/two-jailed-for-ps60m-fraudulent-hiv-cure-tax-fraud-2840331

22 HMRC, Protecting Tax Revenues 2009, para 5.14 https://webarchive.nationalarchives.gov.uk/ukgwa/20101007004119/http://www.hmrc.gov.uk/pbr2009/protect-tax-revenue-5450.htm

23 Ibid, pages 16-17, paragraphs 5.15-5.16.

24 For more information on the GE case see TaxWatch, Around the world with $5bn, http://13.40.187.124/ge_hmrc_tax_fraud_allegations/

25 Profit Diversion Compliance Facility Guidance, para. 4.4.1.

26 HMRC, Customer compliance: how HMRC’s compliance yield is split by business area and our approach to tax compliance and large businesses.

27 HMRC, Measuring tax gaps, 2014 Edition, P.15. https://webarchive.nationalarchives.gov.uk/ukgwa/20150612044958/https://www.gov.uk/government/statistics/measuring-tax-gaps

28 HMRC, Measuring tax gaps, 2015 Edition, P.20. https://webarchive.nationalarchives.gov.uk/ukgwa/20160615051045/https://www.gov.uk/government/statistics/measuring-tax-gaps

29 OECD, Bitesize BEPS, available from: http://www.oecd.org/ctp/beps-frequentlyaskedquestions.htm#background.

30 R vs Charlton and others, [1996] STC 1418.

31 Following criminal investigations and with criminal proceedings looming, Google agreed to a EUR 1 billion settlement under a non-prosecution agreement. See: Reuters, Google to pay $1bn in France to settle fiscal fraud probe, September 12 2019, https://www.reuters.com/article/us-france-tech-google-tax-idUSKCN1VX1SM

32 Public Accounts Committee, Ninth Report, Tax Avoidance – Google, 10 June 2013 https://publications.parliament.uk/pa/cm201314/cmselect/cmpubacc/112/11204.htm

33 Bilicka, Comparing UK tax returns of foreign multinationals to matched domestic firms, American Economic Review, 2019, 109(8), 2921-53, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3682277

34 European Parliamentary Research Service, “Bringing transparency, coordination and convergence to corporate tax policies in the European Union I – Assessment of the magnitude of aggressive corporate tax planning”, September 2015 https://www.europarl.europa.eu/RegData/etudes/STUD/2015/558773/EPRS_STU(2015)558773_EN.pdf

What gets measured gets done?

14th January 2021 by George Turner

Following the 2008 financial crisis and a series of high profile scandals, the issue of tax avoidance and evasion was brought to the fore of public concern. There has been a concerted effort to tackle this on both a domestic and an international level.

HMRC has adopted “the need to bear down on avoidance” as a primary objective, with the government seeking to promote action taken in this area.

In our latest report, we ask whether the current metrics used by HMRC are sufficiently robust to allow Parliament and other interested parties to hold the government to account on this important issue. We found that while the intent to do more is there, the question as to whether progress is measured using appropriate benchmarks is one worth exploring.

This report was presented in December 2020 to The Tax Administration Research Centre at the University of Exeter Business School.

The report is available in full here.

A PDF of this report is available here.

Photo by StellrWeb on Unsplash

What gets measured gets done?

14th January 2021 by Alex Dunnagan

This paper was written by George Turner and was the basis of a presentation to the University of Exeter Business School’s Tax Administration Research Centre Conference in December 2020.

Introduction

The Global Financial Crisis in 2008 made tax avoidance and evasion of primary public concern. In the decade that followed, a series of high profile scandals, from Swiss leaks to revelations about the single digit effective tax rates achieved by many multinational companies have increased public awareness of the issue and kept it on the agenda.

On a political level, there has been a concerted effort to introduce new policies to combat artificial tax structures, and tax fraud, both on a domestic level and on an international level through the OECD.

Alongside this there has been an increased focus on the performance of HMRC in terms of tackling avoidance and evasion. HMRC have responded to this adopting “the need to bear down on avoidance” as a primary objective. The government has also sought to confront public concern about avoidance and evasion by seeking to promote the action it takes in this area.

This paper focuses on how HMRC’s performance in this area is measured and accounted for, and asks whether the current metrics used by HMRC are sufficiently robust to allow Parliament and other interested parties to hold the government to account on this important issue.

HMRC’s objectives

HMRC sets out its key objectives in its annual report each year. A look at these objectives demonstrates that “Maximise revenues due and bear down on avoidance and evasion” is now the top priority for the department.

This is a relatively recent development, with the need to “bear down on avoidance and evasion” only explicitly appearing in the list of objectives in 2017.

Year

Objective 1

Objective 2

Objective 3

09/10

Improve the extent to which individuals and businesses pay the tax due and receive the
credits and payments to which they are entitled which contributes to PSA 9

Improve customers’ experiences of HMRC and improve the UK business environment which contributes to PSA 6

Reduce the risk of the illicit import and export of material which might harm the UK’s physical and social well-being. Seizures of Class A drugs and interventions in support of the Serious Organised Crime Agency, contributes to PSA 25; and the screening of traffic entering the United Kingdom contributes to PSA 26.

10/11

Improve the extent to which individuals and businesses pay the tax due and receive the
credits and benefits to which they are entitled

Improve customers’ experience of HMRC and contribute to improving the UK business
Environment

Improve our professionalism in dealing with: the security of our customers’ information;
our stakeholders; and our external impact

11/12

No objectives given this year

12/13

No objectives given this year

13/14

No objectives given this year

14/15

Maximise revenues

Improve the service that we give our customers

Make sustainable cost savings.

15/16

Maximise revenues

Make sustainable cost savings

Improve the service that we give our customers

16/17

Maximise revenues

Improve the service that we give our customers

Make sustainable cost savings

17/18

Maximise revenues due and bear down on avoidance and evasion

Transform tax and payments for our customers

Design and deliver a professional, efficient and engaged organisation

18/19

Maximise revenues due and bear down on avoidance and evasion

Transform tax and payments for our customers

Design and deliver a professional, efficient and engaged organisation

19/20

Collecting revenues due and bearing down on avoidance and evasion

Transforming tax and payments for our customers

Designing and delivering a professional, efficient and engaged organisation

Before 2017, efforts to tackle tax avoidance and evasion were cited in the Annual Reports of HMRC under the objective of “Maximising Revenues”, however it is significant that after 2017 HMRC put the fight against avoidance and evasion in the title of this objective.

The objective to “Collect revenues due and bearing down on avoidance and evasion” in the latest Annual Report (objective 1) includes a set of key performance indicators which are:

  • The total increase in tax revenues

  • The additional tax generated by tackling avoidance, evasion and non-compliance (a.k.a compliance yield)

  • The level of fraud and error in the tax credit system

  • The UK tax gap (as a percentage of total tax)

  • The total revenue protected or generated by tackling organised crime

  • The total number of criminals and fraudsters successfully convicted

Further to this HMRC sets out a number of public commitments it has made in this area against which it reports progress. With regards to avoidance and evasion, these commitments are:

  • Maintaining the overall long term downward trend in the tax gap over the past decade.

  • Deliver compliance revenues of £34.5 billion in 2019 to 2020 through our compliance activity.

  • Continue to invest £800 million in additional work to tackle evasion and non-compliance in the tax system, with a further £155 million of investment announced at Autumn Budget 2017 for future years up to 2019 to 2020.

  • Raise an additional £5 billion a year on 2015 to 2016 by 2019 to 2020 by tackling tax avoidance and aggressive tax planning,evasion and non-compliance, and by addressing imbalances in the tax system.

  • We will tackle the hidden economy by:

    • developing options for legislation to make the renewal of some public sector licences conditional on applicants being appropriately registered for tax (conditionality)

    • implementing powers to tackle hidden UK businesses trading via online marketplaces (VAT Joint and Several Liability), and embedding new operational approaches to address the hidden economy.

  • Continue to tackle tax avoidance, close schemes and collect yield of more than £170 million in 2019 to 2020 through the Accelerated Payments regime and collect yield of £1.3 billion in tax settlements.

  • Ensure global companies pay their fair share in tax by supporting the government’s leading role in the reform of international tax rules.

In the 2018-19 annual report there was an additional commitment noted, which was to achieve 100 prosecutions a year by the end of the Parliament. This does not appear in the latest annual report. This is perhaps due to the fact that Parliament ended early due to the 2019 General Election.

The big picture

It is clear from the key performance indicators (KPIs) set out in HMRC’s annual report that the government regards the Tax Gap and the Compliance Yield as two of the primary measures against which progress in combatting tax avoidance and evasion should be measured.

However, it is extremely questionable as to how much use these statistics are in creating a meaningful benchmark against which performance can be measured.

The Tax Gap

The Tax Gap is an estimate of all tax losses arising from non-compliance, error and fraud. The estimate was originally designed as an internal performance measure, a check to understand how HMRC should allocate resources to various areas of non-compliance, but was made public following an Freedom of Information Request from journalist Richard Brooks. It is now published by government every year.

HMRC is one of the very few tax authorities in the world that seeks to measure the tax gap across the whole economy and all forms of taxation. Other countries that publish estimates usually focus on one area, such as VAT.

Tax avoidance and evasion are not figures that are easily objectively verifiable. As such the Tax Gap involves combining complex methodologies looking at various different areas of non-compliance.

Methodologies have been updated over time, causing significant changes to the estimated figures, and over 20% of the tax gap is comprised of estimates using experimental methodologies. Although confidence intervals are not available for all estimates that comprise the tax gap, the ones that are available suggest there is a wide margin of error in the figures. All of this led the Public Accounts Committee to describe the Tax Gap as “highly uncertain”.1

International tax compliance

Ask the the average citizen about their view of tax avoidance and they no doubt immediately start talking about Amazon, Google, Starbucks and other large multinational companies which have been the focus of media attention for their tax affairs over the last decade.

However, that person may well be surprised to learn that a great deal of tax avoidance by large multinationals does not appear in HMRC’s main measure of tax avoidance, the Tax Gap.

HMRC appear to take the view that because the current preferred way of dealing with the tax structures employed by large multinationals is to seek to reform the international tax system through agreement at the OECD, then losses should not form part of the tax-gap. Their latest “measuring tax gaps” publication states the following:

“The tax gap does not include BEPS [Base Erosion Profit Shifting] arrangements that cannot be addressed under UK law and that will be tackled multilaterally through the OECD.”

The justification for this is that the BEPS project refers to profit shifting as “tax planning” rather than tax avoidance. The document goes onto state:

“Tax avoidance is not the same as tax planning. Tax planning involves using tax reliefs for the purpose for which they were intended. For example, claiming tax relief on capital investment, saving in a tax-exempt ISA or saving for retirement by making contributions to a pension scheme are all forms of tax planning.”2

Likening the tax structures of companies like Google, which has historically poured billions of dollars each year into tax haven subsidiaries with no real economic activity, with someone depositing £20,000 in an government sponsored ISA account is a bizarre position to take. It is also not consistent with the position taken previously by HMRC on BEPS.

In 2014, George Osborne, in the foreword to the HMRC position paper on BEPS stated the following:

“International cooperation is the only way to tackle the challenge of tax avoidance in the global economy.”

The executive summary of the document drew little distinction between tax avoidance and “aggressive tax planning” stating:

“Tax avoidance and aggressive tax planning by MNEs [multinational enterprises] is an international issue that will require a comprehensive and coordinated approach to come up with effective international solutions. For this reason, the Government helped to initiate and continues to fully support the G20/ OECD BEPS project.3

The issue becomes even more confused when we look at the recent answers given by HMRC to the Public Accounts Committee on this issue, which describes BEPS effects as arising from “sophisticated tax planning” which may meet the letter of the law, but is not “desirable in tax policy terms”.4

Given that the HMRC definition of avoidance is “operating within the letter, but not the spirit, of the law”, it is difficult to understand what the difference is between a structure that is undesirable in policy terms and one which does not meet the spirit of the law!

In any event, much of this discussion becomes meaningless when we look at real case studies, which demonstrate that the structures employed by multinational companies to move profits out of the UK easily meet the definition of tax avoidance as described by HMRC.5

Estimates of the size of the tax gap due to this form of profit shifting vary widely. Whatever the figure, the fact remains that the UK government has no objective measure of how it performs in closing down the form of tax avoidance which is of most concern to the public.

This was an issue that was seized upon recently by members of the Public Accounts Committee, which recommended that HMRC specifically report on the tax impact of “sophisticated tax planning”:

“Parliament needs to know when taxpayers do not follow the spirit of the rules, and how much tax revenue is lost as a result. In addition to the tax gap, HMRC should look at ways to measure and report the estimated scale of sophisticated tax planning that is legal but undesirable from a policy perspective by tax type and taxpayer group each year.”6

The Compliance Yield

Compliance Yield is not simply a measure of the cash collected by HMRC as a result of compliance activity. This is less than 1/3rd of the total Compliance Yield figure.

The yield figure contains items like “future revenue benefit” which is an estimate of the impacts on future tax behaviour of compliance interventions.

According to HMRC,

“compliance yield records many aspects of compliance work, including tax recovered directly from our work, future revenue benefit and losses prevented. It can also cover more than one tax year. Different factors, such as the number of new businesses, new customers, changes in levels of voluntary compliance, economic factors, tax policy and rate changes all affect the tax gap.”7

The figures for Compliance Yield are therefore complex estimates and suffer many of the same problems associated with the Tax Gap.

Delving deeper

Given the problems inherent in using broad measures of Compliance Yield and the Tax Gap to measure the performance of HMRC, an alternative approach would be to look at the individual policies and their effectiveness in combatting avoidance and evasion.

In March 2019 HMRC published a document entitled: ‘Tackling tax avoidance, evasion, and other forms of non-compliance’, it states;

“This government has introduced over 100 measures to tackle tax avoidance, evasion and other forms of non-compliance since 2010 which, alongside HMRC’s compliance work, have secured and protected an additional £200 billion in tax revenue which would otherwise have gone unpaid.”8

Alongside the document a list of the 100 polices was produced in an Annex.

Both the £200 billion figure and the 100 policies have frequently been used by the government to defend its record on tax avoidance and evasion. In May 2019, the then Chancellor of the Exchequer, Philip Hammond MP, said the following in response to a question in the House of Commons.

“We are chasing tax dodgers everywhere. [Interruption.] Yes, we are. We have raised £200 billion of additional revenue since 2010 by clamping down on tax avoidance and evasion.”9

The Conservative Party Manifesto in 2019 adopted this figure, stating:

Since 2010, we have introduced more than 100 anti-avoidance measures and secured more than £200 billion which would otherwise have gone unpaid – £24 billion in the last year alone.

In February 2012, the Chief Secretary to the Treasury Steve Barclay wrote

“Since 2010, we have introduced over 100 new measures to tackle tax avoidance, evasion and other forms of non- compliance, which, alongside HMRC’s other compliance work, have secured and protected significant revenue that would otherwise have been lost.”10

TaxWatch was keen to learn more about the £200bn figure. We asked HMRC what was behind the figure and how much of it was contributed by the 100 tax avoidance policies. We received the following answer:

“The £200bn in additional tax revenue mentioned in the publication ‘Tackling tax avoidance, evasion, and other forms of non-compliance’ reflects our overall compliance activity and not solely the result of the measures listed in its Annex A. There are also some measures included in Annex A which do not contribute towards the £200bn figure but do contribute to overall tax receipts. The following diagram explains the components of each:

It is clear from this answer that the figure of £200bn raised since 2010 is simply an expression of the compliance yield added up over the past decade. In fact, later on in their response to us, HMRC refer to the £200bn figure as the “overall compliance yield figure”.

It is therefore misleading to describe the money raised as “additional” it is only additional in the sense that if HMRC did nothing, then every extra pound raised would be additional income. However, HMRC has of course always done compliance work.

With regards to the contribution made to the £200bn by the 100 new policies, it seems that this makes up only a small proportion of the “overall compliance yield figure”.

HMRC also told us:

“While many of the measures in the list are known to contribute to the £200bn overall compliance yield figure, the precise amounts they contribute are not monitored. The chart below shows our total compliance yield outturn between 2011-12 and 2018-19. It provides the scale of the impact of compliance activity which supports the £200bn figure.

The yield from most of the measures in Annex A are captured in the Product and Process element of the chart as they are principally legislative changes. Yield from any operational measures in the list are captured in the other yield categories, along with the rest of our business as usual activity.”

As can be seen from the chart provided, Product and Process makes up just a small fraction of total compliance revenues.

Looking beyond the headline figures

The low levels of monitoring of the impact of specific policy interventions on tax receipts is surprising when we consider that policy interventions and legislative changes are often accompanied by significant estimates of the impact they will have on future tax revenues.

For example, in 2016 as part of the Government’s crackdown on avoidance, Parliament put in place a set of measures designed to improve the behaviour of large corporations.

The new rules would allow HMRC to put companies into “special measures” if they had been found to be persistently non-compliant with tax law. This was defined as persistently failing to disclose information requested by HMRC, or being a serial abuser of tax avoidance schemes.

By the time that the policy was announced in the 2016 budget, HMRC estimated that this policy, together with the requirement on large businesses to publish tax strategies, would bring in an additional £625m in tax in the 2020/2021 tax year.

We asked HMRC how many companies had been put into special measures since the legislation was enacted, and what assessment the department had made of the impact of the policies. The response was that no companies had been put into special measures, and no assessment had been made.11

It is worth noting that the lack of evaluation given to individual policies administered by HMRC is not limited to the field of avoidance and evasion. HMRC administers large programmes of government subsidies via tax credits. These include the creative industry tax credits and R&D tax credits.

The National Audit Office report, “The Management of Tax Expenditures” identified a number of issues with the current administration of tax reliefs, including large increases in expenditure over and above the forecast spend and deficiencies in evaluating value for money.12

For example, the cost of R&D reliefs is over double the initial forecast from when it was launched. The report stated “R&D tax reliefs have been subject to increased levels of abuse. HMRC does not hold data on tax lost from abuse and error for all tax expenditures.”

Gareth Davies, Comptroller and Auditor General at the NAO has also said HMRC lacks sufficient understanding of error and fraud and “why it has increased significantly in recent years, particularly in the small and medium-sized enterprise scheme.”13

Looking at sectors or specific areas of non-compliance

Most anti-tax avoidance and evasion policies are directed at specific types of avoidance in specific sectors. Therefore, when looking at how effective specific anti-avoidance policies are, it may well be better to look at how much the policy had contributed to reducing avoidance in those sectors.

Here we look at two areas of compliance where we have done this exercise.

Landlords

Tax evasion by residential landlords not declaring rental income has been a long term problem in the UK. The problem has become more serious as the the private rented sector has grown.

In 2013 HMRC began their ‘Let Property Campaign’. The campaign was initially set to run for 18 months although it has now been extended indefinitely. The idea was that it would allow landlords to “get up to date with their tax affairs in a simple way and take advantage of the best possible terms.”

The campaign involves HMRC sending threatening letters to landlords encouraging them to voluntarily disclose that they had not paid the full amount of tax on their income. If there is no response within 30 days of receiving these letters, landlords are liable to face penalties for non-compliance.

The approach seems to be having little impact. The accountancy firm Saffery Champness obtained data on the scheme through a Freedom of Information (FOI) request in 2019, which showed that in the five years since the campaign started just 35,099 people had made voluntary disclosures to HMRC, only 2.3 per cent of the individuals originally identified. This number falls far short of the estimated 1.5 million landlords who were underpaying or failing to pay tax in 2009-2010.

At the same time, the tax losses in the private rented sector appear to have increased substantially.

The last time that the government made an estimate of how much tax revenue had been lost by landlords failing to declare income was in 2013. In that year the government estimated that up to 1.5 million landlords had underpaid or failed to pay up to half a billion pounds in tax for the 2009-2010 financial year.

TaxWatch, using partial data supplied by HMRC which looks at a sub-set of landlords, estimates that today, the tax losses in the private rented sector could be as much as £1.73bn a year.14

VAT compliance

The fight against VAT fraud via online retailers is specifically highlighted as an action point under Objective 1 in the HMRC 2020 Annual Report.

According to HMRC’s own figures, online VAT fraud costs the UK between £1bn and £1.5bn in lost VAT a year. Often it involves third party sellers registering on platforms like Amazon and eBay and then failing to register for VAT.

To counter this the UK government introduced new legislation in 2016 which in theory allows HMRC to make the marketplace liable for any lost VAT.

Under the law, HMRC first has to identify non-compliant online sellers. Then the tax agency sends a notice to the online market place where they have an account. The marketplace then has 30 days to remove the seller, or face being landed with their VAT bill.

In 2019 TaxWatch undertook research to determine the effectiveness of this policy. We found that between 2018 and 2019 HMRC identified 4,650 sellers operating on online market places as being non-compliant with the VAT obligations.

Since the joint liability legislation was brought in in 2016, HMRC has issued 8,325 notices threatening the marketplaces with joint liability.

In responding to these figures, HMRC told the Mail on Sunday that as a result of the legislation there has been a large increase in VAT registrations from non-EU sellers (up 78,000).15 HMRC claim that this increase has resulted in £315m being raised in VAT.

HMRC also claim that the notices under the joint liability rules had resulted in £270m in compliance yield.

Clearly the policy is having some impact, but when considered against the £1 – £1.5bn a year lost to VAT fraud by online sellers, much work is still to be done.16

Conclusions

With increased pressure on HMRC to tackle the issue the department has put the objective of bearing down on tax avoidance and evasion at the top of its objectives in its Annual Report.

However, whilst the intent to do more is there, the question as to whether progress is measured using appropriate benchmarks is one worth exploring.

It is clear from the way in which HMRC presents its KPIs, along with public statements made about progress on fighting tax avoidance and evasion made by government ministers, that HMRC regards the Tax Gap and Compliance Yield as the two primary benchmarks against which to judge performance.

Both of these figures are problematic in defining a clear standard against which to measure progress. They both cover a wide range of policy and involve significant levels of estimation. When it comes to the Tax Gap, the one policy area which is of most concern to the public in terms of avoidance, tax avoidance by multinational companies via profit shifting, is largely uncounted.

HMRC already recognises in its public statements that there is a need to focus policy on particularly problematic areas, for example VAT evasion by online retailers operating outside the UK.

To some extent, HMRC already does this, tracking progress of the implementation of some specific measures within the public commitments section of their annual report.

However, these specific policies are then not benchmarked against any targets in terms of revenue raising, either against their predicted impact, or the impact they have on specific areas of non-compliance. Instead all is subsumed into the very large Tax Gap and Compliance Yield figures.

These figures do not break down tax losses in terms of specific areas of non-compliance (e.g. online VAT evasion or landlord tax evasion), and as such, do not have the granularity necessary to test the effectiveness of policy interventions in any specific areas of taxation in a meaningful way.

As such, it would be a development for HMRC to look at levels of non-compliance in specific areas, and use these as benchmarks to assess policies designed to address these issues.

Identifying priority areas could be done collaboratively with Parliament and the wide public.

 

A PDF of this report is available here.

Photo by StellrWeb on Unsplash

 

1 Tackling the Tax Gap, Public Accounts Committee, published 16 October 2020, https://publications.parliament.uk/pa/cm5801/cmselect/cmpubacc/650/65006.htm#_idTextAnchor010

2 Measuring Tax Gaps, 2020 Edition, page 24, HMRC, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/907122/Measuring_tax_gaps_2020_edition.pdf

3 Tackling aggressive tax planning in the global economy: UK priorities for the G20-OECD project for countering Base Erosion and Profit Shifting, HMRC and HM Treasury, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/293742/PU1651_BEPS_AA_-_FINAL_v2.pdf

4 Tackling the Tax Gap, Public Accounts Committee, published 16 October 2020, https://publications.parliament.uk/pa/cm5801/cmselect/cmpubacc/650/65006.htm#_idTextAnchor010

5 See for example, Netflix, tax reform and the unreal nature of digital taxation, TaxWatch, http://13.40.187.124/netflix_tax_reform/

6 Tackling the Tax Gap, Public Accounts Committee, published 16 October 2020, https://publications.parliament.uk/pa/cm5801/cmselect/cmpubacc/650/65006.htm#_idTextAnchor010

7 The tax gap and compliance yield, what they are and how they relate, HMRC, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/627609/The_tax_gap_and_compliance_yield___what_they_are_and_how_they_relate.pdf

8 Tackling tax avoidance, evasion and other forms of non-compliance, HMRC, https://www.gov.uk/government/publications/tackling-tax-avoidance-evasion-and-other-forms-of-non-compliance

9 Hansard, Volume 660, Tuesday 21 May 2019, Column 610 https://hansard.parliament.uk/Commons/2019-05-21/debates/F7F2DBCD-36AF-487E-B617-58726064843A/OralAnswersToQuestions#contribution-F6AC203D-8BBE-4BC3-9682-D506BC2D97E6

10 Hansard, Volume 672, Tuesday 25 February, Column 191 https://hansard.parliament.uk/Commons/2020-02-25/debates/7545B0D1-1D14-4296-843C-5CCB67A61A97/TaxAvoidanceAndEvasion?highlight=compliance%20yield#contribution-E1FE9204-E239-43A6-BBF5-3B4BB61C56A9

11 Threat to “name and shame” aggressive tax dodgers fails to bite, new stats show, TaxWatch, http://13.40.187.124/hmrc_special_measures/

12 Managing tax expenditures, NAO, https://www.nao.org.uk/report/the-management-of-tax-expenditures/

13 Bill Shaw, Tighter controls and further regulation needed to combat erroneous and fraudulent claims, BDAILY NEWS, 12 November 2020, https://bdaily.co.uk/articles/2020/11/12/tighter-controls-and-further-regulation-needed-to-combat-erroneous-and-fraudulent-claims

14 Rogue Landlords, TaxWatch, http://13.40.187.124/landlord_tax_evasion/

15 Helen Cahill, Taxman’s £585m crackdown on unpaid VAT from online sellers including Amazon and eBay, Thisismoney.co.uk, 19 October 2020, https://www.thisismoney.co.uk/money/markets/article-7591609/Taxmans-585m-crackdown-unpaid-VAT-online-sellers-including-Amazon-eBay.html

16 HMRC’s attack on digital Del Boys leaves much to be desired, TaxWatch, http://13.40.187.124/landlord_tax_evasion/


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