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fraud

R&D relief – still not working?

6th April 2023 by Alex Dunnagan

This piece on research and development tax relief was originally published in the R&D Tax Credit Insider newsletter on LinkedIn.

What does the money achieve?

R&D tax relief is an important government policy intended to incentivise businesses to incur expenditure on R&D that is ultimately expected to bring economic benefits. Efficient operation of the system behind it is vital to achieve this. One issue around tax reliefs more generally is that, once introduced, their costs and benefits generally get much less scrutiny than other direct government spending, even if they end up costing significantly more than forecast. It is critical that what is essentially government spending is producing beneficial results for the taxpayer alongside the claimant businesses.

There has long been debate about whether and how much R&D tax relief benefits the economy. Most advisers have stories of businesses that would not have been able to fund their innovations without the reliefs, and the generally held view is that businesses bring forward their R&D investment due to a greater appetite for risk resulting from the existence of the support. However, it also seems clear that at least a proportion of claims are made in relation to expenditure that was incurred without the businesses being aware of the relief so they could not have been incentivised to carry out that R&D.

The complexity of the schemes means many businesses and their ordinary advisers do not feel able to make claims themselves. This has resulted in the large market for R&D claims specialists in the same way that the increasing complexity of tax generally has increased the tax advice market. Of concern for R&D relief is the clear growth of firms of advisers using inappropriate marketing and promotion to persuade businesses to make unreasonable claims, taking a percentage cut in the process. It seems to be well accepted (and confirmed by HMRC estimates of fraud and error) that a proportion of the relief has been going to businesses who do not qualify, along with the fees to their advisers, in some cases a significant percentage of the claim. Recent years have seen little in the way of scrutiny from HMRC which has presumably encouraged more of this approach.

A further cut of the pot also goes in interest and fees to finance companies offering upfront loans against future receipt of claim repayments. It is understandable that businesses wish to improve their cashflow when waiting for repayments. However, the reliefs were not intended to support businesses changing their croissant recipe along with their associated advisers and finance companies.

These concerns have led to the legislative changes coming in this year, including the reduction in benefits in the SME scheme, which will ultimately impact genuine R&D claimants and their advisers alongside the less reputable end of the market.

‘Problem’ advisers

This piece will not rehearse the extreme examples of R&D projects claimed to be eligible for relief by a variety of less reputable advisers but it is clear that these are the source of significant numbers of problem claims.

The changes to legislation requiring pre-notification of claims six months after the end of the accounting period will go some way to preventing speculative backdated claims that appear to be part of the ‘overmarketing’ problem.

The requirement to identify advisers compiling the claims alongside a responsible officer within the claimant business is also expected to improve compliance. However, the first pre-notifications won’t happen until around September 2024 and it will be getting on for two years before HMRC are receiving information in a digital format to enable proper targeting of risk assessment. This is plenty of time for many more spurious claims, which could lead to further losses in the region of £1bn based on most recent estimates of fraud and error, which would further discredit the system.

Many people within the industry have been advocating for compulsory professional regulation for R&D advisers (and more widely in the tax adviser industry)1. Research has shown that 80% of advisers that are not members of professional bodies have no professional qualification2, which is surely unusual in the financial services industry and gives rise to significant risks to both clients and HMRC. However, consultation last year on improving the tax advice market resulted in no changes and intentions for a further consultation that has not yet appeared. In the meantime, problem advisers, who are generally unregulated, are continuing to abuse the system and potentially cause financial damage to those unwittingly accepting their advice if boundary-pushing claims are eventually refused.

The issue of regulating tax advice is obviously a complex one and there is no straightforward answer but the fact that HMRC are still failing to deal properly with problem agents results in poor outcomes for everyone involved in R&D reliefs. It is therefore critical that targeted compliance efforts against problem advisers are stepped up prior to the new legislation kicking in.

HMRC approach and resources

TaxWatch recently submitted evidence to the Public Accounts Committee enquiry into managing tax compliance following the pandemic and many of the issues raised are relevant to how R&D policy is formed, how it works in practice and how HMRC handle compliance3.

The report highlights issues with increasing complexity of tax legislation alongside the closure of the Office for Tax Simplification, reductions in the numbers of tax professional staff in HMRC and inexperienced staff working in compliance, lack of long term funding and resourcing for compliance, and lack of evaluation of new legislation and different compliance approaches.

Recommendations included:

  • urgently explaining the new mandate to be given to HMRC and the Treasury to simplify the tax code
  • committing greater funding to compliance given its positive return on investment
  • putting in place long term resource planning to ensure a consistent and robust compliance response
  • putting in place a programme of evaluation in relation to all new legislation and compliance projects
  • considering what other action can be taken against problem advisers.

As Malcolm Henderson said in a previous piece, the majority of staff at HMRC want to provide good customer service, and the experience held within the previous specialist R&D units encouraged claims where they were due as well as ensuring compliance with the rules4. Obviously that level of support has been overwhelmed by the huge increase in the numbers of claims, and the current rush to tackle compliance concerns has resulted in the reported scattergun approach to identifying risks and inconsistent treatment between different officers.

Of particular concern is recent evidence from the Institute for Government that between March 2016 and March 2022 there has been a reduction of 8,160 Full Time Equivalent (FTE) staff working within the tax profession in the civil service.5 A reduction of that level of highly qualified staff within HMRC obviously impacts on their performance across all sectors and will almost certainly affect the department’s approach to R&D compliance.

There is clearly a concern in the R&D industry that HMRC’s approach to compliance is not working. It has been suggested that compliance staff are not properly trained for the role and do not have enough experienced support to advise on the R&D definition. There appears to be a general feeling that they are often challenging the wrong cases, costing businesses time and money, creating a disincentive to make future claims

The definition of R&D belonged to the Department for Business, Energy, and Industrial Strategy (BEIS) (possibly now Science, Innovation and Technology?). That definition is a specific difficulty as it is vital for establishing eligibility but is not a tax concept. The original R&D teams had sector specialist who were available to assist with applying the definition. It is not clear whether those roles still exist, except for software cases where staff from the Chief Digital and Information Office (CDIO) are providing guidance. However, this raises the question whether there are non-tax professionals within government who would be better able to test claims against the eligibility definition, alongside the tax compliance staff dealing with other aspects.

It seems clear that without a significant improvement in HMRC’s compliance performance on R&D cases, the schemes are likely to suffer further damage impacting on the overall benefits to the economy.

1Raising standards in the tax advice market: Summary of responses and next steps, HMRC, November 2020, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/934614/Raising_standards_in_the_tax_advice_market_-_summary_of_responses_and_next_steps.pdf

2Understanding the characteristics of unaffiliated tax agents, HMRC, November 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1037031/Understanding_the_characteristics_of_unaffiliated_tax_agents.pdf

3Written evidence submitted by TaxWatch, Public Accounts Committee, January 2023, https://committees.parliament.uk/writtenevidence/115783/pdf/

4R & D tax credits: Customer service examined, R & D tax credit insider, 2 February 2023, https://www.linkedin.com/pulse/rd-tax-credits-hmrc-customer-service-examined-rufus-meakin?trk=news-guest_share-article

5Civil Service Staff Numbers, Institute for Government, 15 December 2017, https://www.instituteforgovernment.org.uk/explainers/civil-service-staff-numbers

Cross-party MPs call time on feeble approach to tax avoidance and urge HMRC to prosecute tax fraudsters

27th October 2022 by Alex Dunnagan

The All-Party Parliamentary Group for Anti-Corruption & Responsible Tax and TaxWatch have published a joint report outlining how supposedly ‘legal’ tax avoidance could actually be prosecuted as tax fraud. The report explains that there exists a serious enforcement gap in HMRC’s approach to tackling tax fraud, whereby criminal tax behaviour is systematically dealt with through civil channels provided that it complies with the “rules of the game” i.e. it has the superficial appearance of “legal” tax avoidance.

This means that, even if the tax is recovered, the underlying criminal behaviour goes unpunished. The deterrent effect of the criminal offence of “cheating the public revenue” is therefore disapplied in this context by HMRC policy, with the consequence that unscrupulous advisers, promoters and enablers face no serious downside risk in selling this kind of behaviour to taxpayers. This leads to substantial revenue losses. We argue that HMRC should enforce the law of the land rather than merely the “rules of the game”.

Dame Margaret Hodge MP, Chair of the APPG on Anti-Corruption & Responsible Tax, said:

The myth that tax avoidance is legal and tax evasion is illegal is a false distinction which is reinforced by the tax industry and HMRC’s feeble approach to enforcement. Our bold new paper attempts to explode these myths and recommends that HMRC should be enforcing existing criminal law by prosecuting the enablers of the most aggressive tax avoidance. HMRC should be enforcing the laws of the land, not the rules of the “tax fraud game” that let tax avoiders and their enablers off the hook. We need a real deterrent to stop bad behaviour or these tax cheats will continue to flout the rules while most taxpayers struggle with the cost of living crisis.

At a launch event in Parliament on 25th October  for the new report, Putting a Stop to the Tax Fraud Game, senior Parliamentarians, a Shadow Minister, academics and practitioners called on government to urgently close loopholes which allow egregious tax fraud to go unpunished. The paper argues the following:

  •  Much that is claimed to be “legal” tax avoidance is actually criminal tax fraud. The relevant criminal offence – ‘cheating the public revenue’ – is extremely wide and could include tax avoiders and the advisers that devise, market and enable tax avoidance schemes.
  • HMRC prioritises cases where there is clear “active deception”, like hiding information or falsifying documents.
  • Because of this, tax advisers know they can recommend ineffective tax avoidance schemes with impunity, provided they comply with the notional “rules of the game” by making a cursory effort to present it as legal, with no “active” deception or concealment.
  • Lack of fear of criminal sanction removes any real deterrent to this behaviour and so tax fraud, including supposedly “legal” tax avoidance, goes largely unpunished.
  • HMRC cannot keep up with better-resourced lawyers and accountants concocting potentially fraudulent avoidance schemes for their clients, and so many succeed without so much as a second glance, leading to major revenue losses and the undercutting of our public services, like the NHS and police.
  • The focus of a change in policy in this area should be on the unscrupulous promoters and advisers who are the root cause of the problem by bringing forward more criminal prosecutions against these enablers.

Dame Margaret continued:

For me, tax lies at the heart of the social contract. During this time of crisis after crisis, it has seldom been more important for our country to come together and pull in the same direction – toward security and prosperity for all. We must all pay into the common pot, for the common good, in order to fund the public services and infrastructure that we all rely on, including our NHS, our schools, and our roads. Any person or company that attempts to dodge paying their fair share – the tax avoiders and evaders – should be met with the full force of the law.

Alex Dunnagan, Acting Director of TaxWatch said:

The idea that tax avoidance is legal, and that tax evasion is illegal, has done untold damage to the state of taxation in the UK. Pursuing tax avoidance as a civil matter when there has clearly been fraudulent behaviour, does not act as a deterrent. Put simply, HMRC should pursue tax fraud for what it is – a crime. Laws already exist to prosecute those committing tax fraud. HMRC should use them.

The report can be found as a webpage here, and as a PDF here.

Photo by niu niu on Unsplash

Organised Crime in the Department of Health and Social Care supply chain

7th March 2022 by Alex Dunnagan

TaxWatch is calling on the Department of Health and Social Care (DHSC) to investigate the fraudulent use of Mini Umbrella Companies in DHSC’s procurement process.

TaxWatch has written to the Department of Health and Social Care (DHSC) multiple times asking what has been done about apparent abuses in the department’s procurement process.

MUCs are used when an agency divides its contractor workforce into a series of small companies, fraudulently claiming that each company is an independent entity. This can cut their annual Employers’ NICs liability by up to £4,000 per employee by claiming Employment Allowance which is intended to help legitimate small businesses. The act of setting up a mini umbrella company is in itself not illegal.

A recent HMRC publication on Umbrella Companies stated that:

“MUC fraud is perpetrated by organised criminals [emphasis added]. It presents a threat to the UK Exchequer and creates an uneven playing field for those employment businesses and umbrella companies who follow the rules. Workers in MUCs usually do not know who their employer is and may not be aware of their entitlement to employment rights. They can be moved regularly between MUCs to help maximise profits from the fraud.”[1]Call for Evidence: Umbrella Company Market, HM Treasury, HMRC, Department for Business, Energy & Industrial Strategy, November 2021, … Continue reading

The scandal first emerged in 2015 when the BBC Today Programme revealed Anderson Group, then one of the recruitment industry’s most high profile companies, was found to be promoting an abusive scheme.[2]BBC uncovers ‘aggressive’ tax avoidance scheme, BBC, 29 May 2015, https://www.bbc.co.uk/news/business-32914372

HMRC’s Fraud Investigation Service has taken action in order to combat MUC fraud, including working with government departments to raise awareness, and stresses that it is the responsibility of the business using temporary labour to undertake necessary and proportionate due diligence checks.[3]Mini umbrella company fraud, HMRC, 10 May 2021, https://www.gov.uk/guidance/mini-umbrella-company-fraud

In May of last year, a BBC Radio 4 File on 4 documentary revealed that more than 40,000 people from the Philippines have been recruited to front MUCs in the UK.[4]Britain’s Ghost Companies, File on 4, 11 May 2021, https://www.bbc.co.uk/sounds/play/m000vwtm File on 4 went on to reveal that some staff at G4S run Covid test centres have been employed by subcontractors using MUCs. We know of no legitimate purpose for the usage of these MUCs by those subcontractors.

As the G4S contract for these centres will ultimately have been provided by the DHSC, then it is the responsibility of the DHSC to seek assurances from those in the supply chain that fraudulent activity will not be conducted. HMRC guidance states that any business utilising temporary labour should “be aware of the potential dangers posed to their business by mini umbrella company fraud in their supply chain”.

The Department of Health & Social Care clearly states in its terms for a short-form contract that the supplier, in this case G4S, must

“comply with the Income Tax (Earnings and Pensions) Act 2003 and all other statutes and regulations relating to income tax, the Social Security Contributions and Benefits Act 1992 (including IR35) and National Insurance contributions”.[5]Short-form contracts, Department of Health & Social Care, March 2020, … Continue reading

In this case the G4S appears to have sub-contracted some of the work to agencies that appear to have used MUCs. G4S said that when this usage of MUCs came to its attention, HMRC was notified, and that all payments to agencies included appropriate NICs. [6]Anna Meisel and Angus Crawford, Thousands recruited to front UK firms in ‘tax dodge’, BBC News, 10 May 2021, https://www.bbc.co.uk/news/uk-57021128

We have written to the DHSC several times over the past six months, though have received no response.

A G4S spokesperson said: “To deliver these services, G4S works with employment agencies which are Recruitment and Employment Confederation accredited and members of the government’s Crown Commercial Service (CCS) Framework.”

It said their payments to agencies include all of the appropriate national insurance contributions – and all staff working on the G4S contracts pay their national insurance contributions correctly.

 

Photo by Ricardo Resende on Unsplash

References[+]

References
↑1 Call for Evidence: Umbrella Company Market, HM Treasury, HMRC, Department for Business, Energy & Industrial Strategy, November 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1037093/Umbrella_Company_CfE_Final.pdf
↑2 BBC uncovers ‘aggressive’ tax avoidance scheme, BBC, 29 May 2015, https://www.bbc.co.uk/news/business-32914372
↑3 Mini umbrella company fraud, HMRC, 10 May 2021, https://www.gov.uk/guidance/mini-umbrella-company-fraud
↑4 Britain’s Ghost Companies, File on 4, 11 May 2021, https://www.bbc.co.uk/sounds/play/m000vwtm
↑5 Short-form contracts, Department of Health & Social Care, March 2020, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/876546/DHSC_short-form_contract.pdf
↑6 Anna Meisel and Angus Crawford, Thousands recruited to front UK firms in ‘tax dodge’, BBC News, 10 May 2021, https://www.bbc.co.uk/news/uk-57021128

HMRC’s record on covid support and tax fraud under the microscope

14th February 2022 by George Turner
  • HMRC’s record on tax fraud has been questioned by two select committees and in several parliamentary debates in recent weeks

  • The last select committee inquiry on Tax Fraud was in 2015

Recent weeks have seen HMRC being put under intense scrutiny on their record on tackling tax fraud.

Part of the trigger for this was the revelation that on current estimates, the department would only recover 25% of the £5.8bn paid out in fraud and error via the Covid relief schemes, furlough, Eat Out To Help Out and the Self-Employment Income Support Scheme.

This figure is arrived at if you take the amount HMRC has already managed to recover from overpayments, added to the £800m-£1bn that HMRC says they hope to get back with their Taxpayer Protection Task Force.

HMRC’s estimate of how much the new Taxpayer Protection Taskforce would seek to recover has been around for a while,[1]Richard Partington, HMRC boosts efforts to recoup £1bn in suspect Covid payouts, The Guardian, 16 November 2021, … Continue reading however, HMRC had previously suggested that they could recover substantially more. Notably, when Jim Harra gave an interview to the Financial Times late last year, he said that they would struggle to recoup more than 50% of the funds lost (£2.9bn)[2]Emma Agyemang, HMRC expects to recover less than half £5.8bn lost in Covid fraud and errors, Financial Times, 21 November 2021, https://www.ft.com/content/3991505c-8311-401e-aece-55342f2b07df.

In January, HMRC put out a myth-buster which appeared to disclose for the first time that £1bn is the total of the department’s current ambition in Covid support scheme fraud and error recovery given the resources they currently have to deal with the problem.[3]HMRC responses to inaccurate claims, HMRC, 12 January 2022, https://www.gov.uk/government/news/hmrc-responses-to-inaccurate-claims

TaxWatch picked up on this, noting the apparent revision down from Jim Harra’s 50% remarks to the FT, and tipped off The Times, which ran the story the following week.[4]David Byers, Treasury writes off £4.3bn in Covid payments lost to fraud, The Times, 17 January 2022, … Continue reading

On the day the article was published, Jim Harra was asked about the story at his appearance before the Public Accounts Committee,[5]Public Accounts Committee, Oral Evidence: HMRC’s management of tax debt, HC 953, House of Commons, 17 January 2022, https://committees.parliament.uk/oralevidence/3288/default/ and on Friday 11th February, the committee published a highly critical report, stating that HMRC’s current plans “risks rewarding the unscrupulous and sending a message that HMRC is soft on fraud.”[6]https://committees.parliament.uk/committee/127/public-accounts-committee/news/160942/hmrc-ignorance-and-inaction-rewarding-the-unscrupulous-and-looks-soft-on-fraud/

After HMRC’s grilling before the PAC, next, it was the turn of Treasury Ministers when Labour’s Pat McFadden put down an Urgent Question forcing the Government to make a statement on the issue.

In that statement, the Government argued that the speed with which the Covid support systems were designed and implemented meant that a greater amount of fraud was inevitable. If the government put in place more checks that would have led to delays in getting cash into the hands of businesses that were in crisis, leading to far worse outcomes.[7]Coronavirus Grant Schemes: Fraud, Hansard vol. 707, Tuesday 18 January 2022

That is undoubtedly true, and it is worth noting that the furlough scheme has an estimated fraud and error rate of 8.7%, not wildly above the normal fraud and error rate in the tax system of around 5%.[8]Public Accounts Committee, HMRC Performance in 2020-21, House of Commons, https://publications.parliament.uk/pa/cm5802/cmselect/cmpubacc/641/report.html It is trite but true to say that the vast majority of claims were validly made by people entitled to them.

However, now that the money has gone, with billions currently sitting in the bank accounts of crooks, why are we not spending more to go after it?

This was a point made by Lord Agnew, the Government Minister responsible for counter fraud, in dramatic style later in the week when he resigned from the front bench when responding to a question from Labour on the £4.3bn tax fraud write off, stating that “a combination of arrogance, indolence and ignorance” was freezing the government machine.[9]Conservative minister resigns in anger over Covid fraud, BBC News, 24 January 2022, https://www.bbc.co.uk/news/uk-politics-60117513

Treasury ministers are now keen to stress that the £4.3bn which HMRC has said will, on current estimates, be unlikely to be recovered has not been written off. This point was made by the Chancellor himself in a tweet thread,[10]Rishi Sunak, Tweet Thread on Covid support measures fraud, Twitter, 26 January 2022, https://twitter.com/RishiSunak/status/1486332699337973763?s=20&t=AjAVwWPkHymzw2I7kcfPMw and again by Treasury ministers during an opposition day debate on fraud in the House of Commons.[11]Tackling Fraud and Preventing Government Waste, Hansard Vol. 708, Tuesday 1 February 2022, … Continue reading. The response by the Government that it would not be writing off the fraud prompted Lord Agnew to say that his resignation had at least “achieved something”.[12]Alice Thomson, Lord Agnew: ‘Billions were written off and no one seemed to care but me’, The Times, 28 January 2022, … Continue reading

However, the determination from Ministers to say that they will continue to chase down the missing £4.3bn has not yet been matched with any announcement of more money.

As TaxWatch has pointed out, the Treasury is investing far more money in going after the rise in benefits fraud coming out of the pandemic, giving the DWP a cash injection of £613m to tackle the problem.[13]Funding to fight covid related tax and benefits fraud, TaxWatch, 29 December 2021, http://13.40.187.124/covid_fraud_spending_dwp_vs_hmrc/

HMRC on the other hand appears to be funding their £100m taxpayer protection task force from their own resources. The staff are all being recruited internally, as was recently confirmed by HMRC.[14]Treasury Committee, Oral evidence: The work of HMRC, HC 1095 Q25, House of Commons, 2 February 2022, https://committees.parliament.uk/oralevidence/3394/pdf/

The growing disquiet about HMRC’s plans to recover losses to fraud and error in Covid relief schemes has also led to MPs raising questions about HMRC’s broader approach to tax fraud.

At a recent Treasury Select Committee hearing, Kevin Hollinrake MP began questioning HMRC officials on why levels of both criminal investigations and civil fraud investigations under Code of Practice 9 had been declining since 2016.

In response, HMRC said that they had taken a policy decision to do fewer fraud prosecutions and only concentrate on more serious and complex cases.

Hollinrake seemed unimpressed, saying that it sent the message that some crime doesn’t matter and comparing HMRC’s policy to telling a burglar, “ok so you stole the stuff out the house, give us it back, and a bit extra and you can carry on.”

Mr Hollinrake also questioned why there had been no successful prosecutions for promoters of disguised remuneration schemes, and called on HMRC to bring forward some cases in this area.

http://13.40.187.124/wp-content/uploads/2022/02/TRESCOMM20220202.mp4

This is not the first time MPs have raised concerns about HMRC’s approach to tax fraud in recent years. In 2015, the Public Accounts Committee’s annual report on HMRC’s performance described the number of criminal prosecutions for offshore evasion as “woefully inadequate”[15]HM Revenue & Customs Performance 2014-15, Public Accounts Committee, 28 October 2015, https://publications.parliament.uk/pa/cm201516/cmselect/cmpubacc/393/393.pdf.

The following year, the Committee completed a short inquiry into tax fraud which found that HMRC had “no strategy for tackling tax fraud” and that there was a “perception that HMRC does not tackle tax fraud by the wealthy”, which needed to be addressed.[16]Public Accounts Committee, Tackling Tax Fraud, House of Commons, 23 March 2016, https://publications.parliament.uk/pa/cm201516/cmselect/cmpubacc/674/674.pdf

At the time, HMRC told the committee that it was seeking funding to enable it to prosecute more cases of serious and complex tax fraud. This became a target to increase the number of prosecutions of “serious and complex” tax fraud to 100 a year by 2020.

As our recent State of Tax Administration report has found, HMRC appears to have quietly dropped that target, with progress against the target no longer appearing in HMRC’s Annual Report.[17]State of Tax Administration 2022, TaxWatch, 11 February 2022, http://13.40.187.124/state_of_tax_administration/

Given the growing concern about tax fraud, and indeed all types of fraud, falling levels of civil fraud investigations and criminal prosecutions, and a clear demand from both the public and Parliament for Government to do more in this area, perhaps this is the right time for Parliament to revisit the issue with another inquiry into HMRC’s approach to tax fraud.

References[+]

References
↑1 Richard Partington, HMRC boosts efforts to recoup £1bn in suspect Covid payouts, The Guardian, 16 November 2021, https://www.theguardian.com/world/2021/nov/16/hmrc-boosts-efforts-to-recoup-1bn-in-potentially-fraudulent-covid-payouts
↑2 Emma Agyemang, HMRC expects to recover less than half £5.8bn lost in Covid fraud and errors, Financial Times, 21 November 2021, https://www.ft.com/content/3991505c-8311-401e-aece-55342f2b07df
↑3 HMRC responses to inaccurate claims, HMRC, 12 January 2022, https://www.gov.uk/government/news/hmrc-responses-to-inaccurate-claims
↑4 David Byers, Treasury writes off £4.3bn in Covid payments lost to fraud, The Times, 17 January 2022, https://www.thetimes.co.uk/article/treasury-writes-off-4-3bn-in-covid-payments-lost-to-fraud-dfkxt5fr7
↑5 Public Accounts Committee, Oral Evidence: HMRC’s management of tax debt, HC 953, House of Commons, 17 January 2022, https://committees.parliament.uk/oralevidence/3288/default/
↑6 https://committees.parliament.uk/committee/127/public-accounts-committee/news/160942/hmrc-ignorance-and-inaction-rewarding-the-unscrupulous-and-looks-soft-on-fraud/
↑7 Coronavirus Grant Schemes: Fraud, Hansard vol. 707, Tuesday 18 January 2022
↑8 Public Accounts Committee, HMRC Performance in 2020-21, House of Commons, https://publications.parliament.uk/pa/cm5802/cmselect/cmpubacc/641/report.html
↑9 Conservative minister resigns in anger over Covid fraud, BBC News, 24 January 2022, https://www.bbc.co.uk/news/uk-politics-60117513
↑10 Rishi Sunak, Tweet Thread on Covid support measures fraud, Twitter, 26 January 2022, https://twitter.com/RishiSunak/status/1486332699337973763?s=20&t=AjAVwWPkHymzw2I7kcfPMw
↑11 Tackling Fraud and Preventing Government Waste, Hansard Vol. 708, Tuesday 1 February 2022, https://hansard.parliament.uk/Commons/2022-02-01/debates/151F8D55-94D6-408A-88CC-970D350C6F9D/TacklingFraudAndPreventingGovernmentWaste#main-content
↑12 Alice Thomson, Lord Agnew: ‘Billions were written off and no one seemed to care but me’, The Times, 28 January 2022, https://www.thetimes.co.uk/article/lord-agnew-billions-were-written-off-and-no-one-seemed-to-care-but-me-cvnsqjbzp
↑13 Funding to fight covid related tax and benefits fraud, TaxWatch, 29 December 2021, http://13.40.187.124/covid_fraud_spending_dwp_vs_hmrc/
↑14 Treasury Committee, Oral evidence: The work of HMRC, HC 1095 Q25, House of Commons, 2 February 2022, https://committees.parliament.uk/oralevidence/3394/pdf/
↑15 HM Revenue & Customs Performance 2014-15, Public Accounts Committee, 28 October 2015, https://publications.parliament.uk/pa/cm201516/cmselect/cmpubacc/393/393.pdf
↑16 Public Accounts Committee, Tackling Tax Fraud, House of Commons, 23 March 2016, https://publications.parliament.uk/pa/cm201516/cmselect/cmpubacc/674/674.pdf
↑17 State of Tax Administration 2022, TaxWatch, 11 February 2022, http://13.40.187.124/state_of_tax_administration/

HMRC reveals new estimate for Covid fraud recovery

17th January 2022 by Alex Dunnagan

Three-quarters of Covid support claimed in fraud and error won’t be collected

HMRC has revealed that they expect to recover just 25% of a total £5.8bn paid out due to fraud and error in relation to the coronavirus support schemes. [1]HMRC responses to inaccurate claims, HMRC, 12 January 2022, https://www.gov.uk/government/news/hmrc-responses-to-inaccurate-claims

The latest figure has appeared in a document published on 12th January entitled “Myth Busters – HMRC’s responses to inaccurate claims” and sought to spin the figures as an achievement. Under a heading “HMRC has successfully tackled coronavirus help scheme fraud and error” HMRC explains “We recovered £500 million of overpayments in 2020 to 2021. The government then invested £100 million in a Taxpayer Protection Taskforce of 1,265 HMRC staff to combat fraud in the schemes. We expect the taskforce to recover £800 million to £1 billion between 2021 and 2023.”

This equates to a total of between £1.3bn and £1.5bn, or 22% and 26% of the amount lost to fraud and error.

The new figures appear to be a significant revision down from November last year, when Jim Harra, the head of HMRC, told the FT that the organisation will struggle to recover more than half of the losses. [2]HMRC expects to recover less than half £5.8bn lost in Covid fraud and errors, Financial Times, 21 November 2021, https://www.ft.com/content/3991505c-8311-401e-aece-55342f2b07df

The published figures suggest that HMRC will be seeing up to a 10x return on investment when tackling fraud and error in the coronavirus support schemes. It is therefore difficult to understand why the department is not being given more cash to tackle the problem and instead is leaving ¾ of the money lost to fraud and error in the hands of people that wrongfully claimed it.

Recent research from TaxWatch showed that the DWP is receiving more than 2x the funding HMRC is getting to tackle fraud and error in the benefits system arising from the pandemic – demonstrating that when an issue is deemed to be important enough, the Treasury finds the money.

This research was featured in The Times, The Daily Mail, and Public Finance, among others. This then lead to Jim Harra being questioned by the Public Accounts Committee on the figures, and to an Urgent Question in the House of Commons on fraud.

References[+]

References
↑1 HMRC responses to inaccurate claims, HMRC, 12 January 2022, https://www.gov.uk/government/news/hmrc-responses-to-inaccurate-claims
↑2 HMRC expects to recover less than half £5.8bn lost in Covid fraud and errors, Financial Times, 21 November 2021, https://www.ft.com/content/3991505c-8311-401e-aece-55342f2b07df

Funding to fight covid related tax and benefits fraud

29th December 2021 by Alex Dunnagan

UK Government has announced an extra £510m boost to DWP to fight benefits fraud following the pandemic. This is in addition to £103m already announced in the spending review

HMRC spending £155m to tackle covid related fraud

TaxWatch estimates the increase in benefits fraud due to covid was £3.39bn in 2020-21

Fraud and Error in HMRC administered Coronavirus Support Schemes is worth an additional £5.8bn

Intro & Summary

Analysis by TaxWatch has found that the DWP is spending more than twice the amount being spent by HMRC on recovering an increase in fraudulent payments arising from the pandemic. This is despite the increase in fraud seen in the benefits system in 2021 over the previous year being significantly lower than HMRC estimate of fraud and error in the Covid-relief programmes.

How much benefits fraud has there been during Covid?

During the pandemic, the amount of fraud in the benefits system more than doubled from 1.4% of total benefits payments to 3% according to the DWP. The reasons for this is the higher levels of Universal Credit payments, a benefit which has a disproportionately high level of fraud, and the fact that the department had to abandon face to face checks.[1]Fraud and error in the benefit system for financial year ending 2021, Gov.uk, 13 May 2021, … Continue reading

If we just look at the increase in the total rate of fraud in the system, 1.6%, this equates to £3.39bn of fraud that is attributable to Covid related effects.

Overall, the total amount of fraud in the benefits system is estimated by DWP to be £6.35bn. However, this figure is before anything is recovered by DWP. DWP recovered £0.8bn in 2021. Although we don’t know how much of this was fraud recovery versus error recovery, we do know that overpayments on benefits caused by error were 0.9%, or £1.9bn, which equates to 23% of the total figure given for fraud and error (£8.4bn).

Assuming that the DWP recover fraud and error overpayments in proportion to the amount of it that exists, we get a recovery of £616m (the remaining 77% of the compliance yield). With a total fraud of £6.35bn (3% of £211.7bn), if we subtract the £616m recovered, that leaves us with the net figure of losses to benefits fraud in 2021 of £5.73bn.

Covid related tax fraud

HMRC administered three Coronavirus support schemes throughout the pandemic, the Coronavirus Job Retention Scheme (CJRS, or Furlough as its commonly known), the Self Employment Income Support Scheme (SEISS), and Eat Out to Help Out (EOHO). These schemes were subject to widespread abuse, costing the UK government an estimated £5.8bn in fraudulent and erroneous claims.

On top of this, the 2019-20 tax gap revealed that “Criminal Attacks”, “Evasion”, “Hidden Economy” and “Avoidance” equated to £15.2bn in tax losses. These four behaviours are all clearly fraudulent and made up 43% of the entire 2019-20 tax gap.[2]The tax fraud gap – 2021 edition, TaxWatch, 16 September 2021, http://13.40.187.124/tax_fraud_gap_2021/ However, in addition to this, there are other behaviours identified by HMRC that may contain elements of fraudulent behaviour. HMRC’s TaxGap is presented net of compliance yield.

While we don’t have the figures for 2020-21 yet, there is nothing to indicate that the amount of fraud within the tax gap will have decreased.

How much are HMRC and DWP being given to combat covid related tax and benefit fraud?

An analysis of government announcements over the last year reveals that the amount of effort being put into tackling tax fraud and benefits fraud is wildly disproportionate to their relative tax losses.

In December 2021, the DWP announced that £510m of additional funding had been awarded to the department over the next three years to tackle the increase in benefits fraud seen as a result of Covid. This would allow the recruitment of 2000 new fraud investigators and was in addition to the £103m DWP secured for fraud and error at the Spending Review 2021.[3]Autumn Budget and Spending Review 2021, Gov.uk, 27 October 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1029973/Budget_AB2021_Print.pdf [4]Counter-fraud Funding, Hansard, 13 December 2021, https://hansard.parliament.uk/commons/2021-12-13/debates/21121315000012/Counter-FraudFunding This takes the total amount allocated to the DWP to deal with the problem to £613m over a three year period, starting in April 2022, a little over £200m a year.

The contrast with the amount being spent by HMRC is stark. In the March 2021 Budget Chancellor Rishi Sunak confirmed the creation of a £100m “Taxpayer Protection Taskforce”, to be staffed by 1,265 “HMRC operatives”, seeking to recoup money wrongly claimed from pandemic support schemes.

With HMRC announcing on multiple occasions that it was not intending on hiring new staff to deal with fraud and error in Coronavirus support schemes,[5]It was reported in City Wire in March of 2020 that HMRC wasn’t planning on increasing its recruitment despite the new workload that had arisen out of the pandemic. HMRC confirmed this again in … Continue reading it is thought that these 1,265 staff are likely to have been moved from other departments.

The PCS Union reported in June 2021 that the Fraud Investigation Service of HMRC had been asked to contribute 37 staff members, which begs the question of how many of the others are fraud investigators.[6]FIS resourcing for the Covid taxpayer protection taskforce at HMRC, PCS, 23 June 2021, https://www.pcs.org.uk/news-events/news/fis-resourcing-covid-taxpayer-protection-taskforce-hmrc

The Autumn 2021 Budget revealed that the Taxpayer Protection Taskforce would see an additional £55m of funding next year. The Taskforce is a time limited operation believed to be currently funded until 2022-23. This puts the amount spent on recovering Covid related fraud at HMRC at £77.5 a year, less than 50% of the resource allocated to the DWP.

However, none of this appears to be new money. An Office for Budget Responsibility (OBR) analysis produced alongside the Autumn Budget showed is that the amount of tax HMRC is going to collect will fall in the next two years, in part because of the reallocation of staff away from their jobs to the new taxpayer protection task force [7]For more information see: Budget 2021 – Four tax takeaways, TaxWatch, 02 November 2021, http://13.40.187.124/budget-2021/.

This lack of funds is leaving money on the table. Jim Harra, the head of HMRC, stated in an interview with the FT in November 2021 that the organisation will struggle to recover more than half of the losses to fraud and error to Coronavirus support schemes, and plans to recoup the money lost may not go beyond 2022-23 [8]HMRC expects to recover less than half £5.8bn lost in Covid fraud and errors, Financial Times, 21 November 2021, https://www.ft.com/content/3991505c-8311-401e-aece-55342f2b07df.

TaxWatch has already reported the stark disparity of funding to tackle all forms of tax and benefit fraud, with the result that many fewer people that engage in tax fraud end up with a criminal record than those engaging in benefits fraud. The latest figures show this pattern repeating for covid related tax and benefit fraud.

This research was featured in the Daily Mail.

References[+]

References
↑1 Fraud and error in the benefit system for financial year ending 2021, Gov.uk, 13 May 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
↑2 The tax fraud gap – 2021 edition, TaxWatch, 16 September 2021, http://13.40.187.124/tax_fraud_gap_2021/
↑3 Autumn Budget and Spending Review 2021, Gov.uk, 27 October 2021, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1029973/Budget_AB2021_Print.pdf
↑4 Counter-fraud Funding, Hansard, 13 December 2021, https://hansard.parliament.uk/commons/2021-12-13/debates/21121315000012/Counter-FraudFunding
↑5 It was reported in City Wire in March of 2020 that HMRC wasn’t planning on increasing its recruitment despite the new workload that had arisen out of the pandemic. HMRC confirmed this again in October 2020, stating that it does not believe it can recruit additional staff to deal with furlough fraud and error due to the 18-month time-lag between starting recruitment and getting staff fully trained.
↑6 FIS resourcing for the Covid taxpayer protection taskforce at HMRC, PCS, 23 June 2021, https://www.pcs.org.uk/news-events/news/fis-resourcing-covid-taxpayer-protection-taskforce-hmrc
↑7 For more information see: Budget 2021 – Four tax takeaways, TaxWatch, 02 November 2021, http://13.40.187.124/budget-2021/
↑8 HMRC expects to recover less than half £5.8bn lost in Covid fraud and errors, Financial Times, 21 November 2021, https://www.ft.com/content/3991505c-8311-401e-aece-55342f2b07df

How should HMRC treat the victims of tax fraud?

2nd December 2021 by George Turner

What should be the tax liability of people who are the victims of fraud? That is the important question raised by the case of Mike Grogan, reported in The Times last weekend.

Mr Grogan is one of a number of victims of tax advisor fraud, where scam tax advisors make fraudulent claims for tax rebates on behalf of their clients, pocketing the money themselves before disappearing, leaving the victim with a large tax liability when HMRC uncovers the fraud and seeks to reclaim the tax.

In Mr Grogan’s case, a colleague recommended an adviser who claimed to be able to access tax reliefs on out of pocket expenses connected to his work. Many financial frauds rely on referrals, that see clients paid to refer friends and colleagues. People will let their guard down when approached by a trusted contact.

After engaging in some correspondence with the person from the firm, he provided them with his identity documents to make a claim on his behalf, and he received £3,883. Having an agent submit a tax return on your behalf is nothing unusual, however, as Mr Grogan would later discover, the fraudsters had used his details to impersonate him and submit returns in his name. They changed the nominated bank account to their own account and put in claims for £11,494, pocketing the difference.

The claims were made on the basis that Mr Grogan had invested in an enterprise investment scheme company which entitled him to tax relief. When HMRC would later investigate the claim, they would discover that the company did not exist, and no investment had been made. However, by that point, they had already paid out the money.

As the claim was made in Mr Grogan’s name, they presented him with a demand for the full amount – £11.5k, an amount he had never received. Before he was contacted by HMRC, he was completely unaware of what had happened.

He provided all the details of his contacts with the scam advisor to HMRC, who accept that he is the victim of fraud. However, they have not waived the liability and continued to demand full payment. In a review of his case carried out by an HMRC officer, he was told: “I cannot see that HMRC is at fault in this matter. The fraud has been enabled by you and you are sadly the victim.”

He was also told that providing login information to the scammers for his government account “was akin to providing [the scam company] with a pin code for your bank account in terms of security.”

HMRC are putting all of the blame on what they accept is the victim of crime, whilst accepting no responsibility for the fact that they made a payment on the basis of a false claim without making any checks themselves.

This was an issue picked up by James Wild MP, Member of Parliament for North West Norfolk at a recent hearing of the Public Accounts Committee. He raised the advisor fraud case reported in The Times and asked Jim Harra, the head of HMRC, whether they carried out any checks before making payments to these kinds of scams. Mr Harra confirmed that HMRC’s policy since the mid-nineties has been “process now check later”.

In this case there were a number of red flags which HMRC could have picked up on. The tax relief was being claimed under a scheme usually accessed by high net worth individuals, yet Mr Grogan is not a high earner. The company that the scheme was being claimed for did not exist.

With EIS, it is a requirement for companies involved in the scheme to seek certification from HMRC, and for investors to obtain a compliance certificate from the company before making the claim.[1]Venture Capital Schemes Manual, HMRC, 09 March 2016, https://www.gov.uk/hmrc-internal-manuals/venture-capital-schemes-manual/vcm14130. It could be argued that given that in this case HMRC had not received a valid claim, they should not have been able to make the payment in the first place.

The case of Mr Grogan shows how HMRC’s policy of “process now check later” can easily be abused by fraudsters to pile liabilities onto their victims before HMRC get around to checking. For HMRC to accept no responsibility for the deficiencies in their own processes, whilst accusing the victim of being “careless” is victim blaming.

There is no dispute that Mr Grogan is a victim of crime, HMRC acknowledge that, and in pursuing Mr Grogan for the money that has been obtained fraudulently, they end up punishing the victim rather than the perpetrator of the crime.

This unfortunate situation is not inevitable. HMRC are the public body entrusted with “care and management” of the tax system and they have broad discretion over how they execute that duty. It would be perfectly within HMRC’s power to settle the matter for a much lower amount (i.e. the amount that Mr Grogan actually received). HMRC makes settlements with large taxpayers all of the time.[2]TaxWatch calls for scrutiny over “sweetheart” tax deal between HMRC and GE, TaxWatch, 23 September 2021, http://13.40.187.124/ge_sweetheart_tax_deal/

HMRC also have broad powers of criminal investigation which would allow them to pursue the advisor, and recover funds under proceeds of crime legislation, relieving them of the need to recover the funds from the victim. This is a much more difficult process for HMRC, but surely a course of action more in line with the principles of justice.

In this case, HMRC are refusing to disclose to Mr Grogan whether or not they have opened a criminal investigation. Again, this is a bizarre outcome of having the tax authority (which is under strict duties of confidentiality) taking on the role of the police. If someone was a victim of any other form of crime and walked into a police station to report it, it would not be acceptable for the police to reply, thanks, but we won’t tell you if we are going to do anything about it.

Overall the case raises important issues about how HMRC deals with the victims of tax crime. As the system is currently set up, the only victim is seen as the Crown, and HMRC seek to recover losses on behalf of the Crown. But as this case illustrates, taxpayers can be the victims of fraudulent tax advisors too, and it is often the taxpayer that ends up being severely impacted by HMRC action to recover the bill. Once that bill is recovered, there is little incentive for HMRC to go after the fraudster.

This is not a marginal issue involving a few shady actors. Recent years have seen an increasing number of claims brought by people involved in tax avoidance alleging negligence or even fraud against their advisors for recommending that they join a scheme and advising them that it was legal. When HMRC challenge the schemes and defeat them through the courts, that advice is demonstrated to be wrong but the tax bill lands at the feet of the taxpayer.

Many will be unsympathetic to the plight of people involved in tax avoidance schemes, but there is a broad spectrum of culpability on the part of the taxpayer. Mike Grogan’s case is an extreme example where the taxpayer had no clue what was being done in his name and the adviser stole money claimed on his behalf. In other cases, such as with some loan based disguised remuneration schemes, promoters have given wildly misleading statements about the schemes, in some cases claiming that they had been approved by HMRC.

The law is clear that where advisers behave dishonestly, they are committing tax fraud. HMRC needs to develop a better policy as to how it deals with the victims of tax fraud, beyond simply asking them to pay up and telling them it’s their fault.

References[+]

References
↑1 Venture Capital Schemes Manual, HMRC, 09 March 2016, https://www.gov.uk/hmrc-internal-manuals/venture-capital-schemes-manual/vcm14130
↑2 TaxWatch calls for scrutiny over “sweetheart” tax deal between HMRC and GE, TaxWatch, 23 September 2021, http://13.40.187.124/ge_sweetheart_tax_deal/

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

TaxWatch intervenes in GE tax fraud case

21st May 2021 by Alex Dunnagan
  • HMRC have filed an appeal to the Supreme Court seeking permission to make allegations of fraud in relation to an ongoing dispute with General Electric over a massive tax avoidance scheme.
  • TaxWatch has made submissions supporting HMRC’s application.
  • Should HMRC’s appeal be successful, then this would be the first time a major multinational corporation will have been forced to answer allegations of tax fraud in relation to an avoidance scheme in a public court in the UK.
  • TaxWatch’s submissions argue that there is no time limit on making allegations of fraud in relation to agreements reached between HMRC and companies like GE in relation to taxes.
  • Total value of taxes, penalties and fines HMRC is seeking from GE is worth over $1bn

TaxWatch has taken the preliminary step to intervene in a Supreme Court case between HMRC and General Electric (GE) as part of our Tax and the Rule of Law project.

The case involves a dispute between HMRC and GE on whether HMRC is allowed to rescind an agreement with the US-headquartered multinational due to an alleged fraud committed by GE.

The agreement meant that HMRC would not apply anti-avoidance rules to a set of financial transactions entered into by UK based subsidiaries of GE, on the basis of reassurances granted by the company that the transactions were genuine commercial transactions and not part of an avoidance scheme.

However, HMRC now allege that employees of GE fraudulently misrepresented the true nature of the transactions to HMRC and knowingly withheld information that would have revealed details of the avoidance scheme.

The tax authority is now seeking to rescind the agreement and apply the anti-avoidance rules to the transactions. GE have stated in their accounts that if HMRC prevail in their arguments it would be liable for “approximately $1 billion… not including interest and penalties.”

Last month, HMRC suffered a set-back in their case when the Court of Appeal found that the tax authority had run out of time to bring their claim under the Limitation Act 1980. HMRC have applied to the Supreme Court for permission to appeal the decision of the Court of Appeal.

TaxWatch’s submission argues that the Limitation Act excludes the recovery of taxes from time limits imposed under the act, meaning that HMRC is not prevented from bringing a claim based on an allegation of fraud in this case.

If accepted, TaxWatch’s arguments have wider significance as HMRC frequently enter into agreements with multinational enterprises over tax.

If this appeal is successful, then the allegation of fraud levelled by HMRC against GE will be heard in an open court. It is thought that this would be the first time a major multinational corporation will have had to answer allegations of fraud regarding a tax avoidance scheme in a public court in the UK.

With a High Court hearing set for October 2021 on the substantive issue of whether HMRC can rescind the 2005 agreement and apply the anti-avoidance rules to the transactions, the case will be heard regardless of whether or not the allegation of fraud can be heard. However, without the fraud element HMRC’s chances of winning the case are weakened, putting at risk a huge sum of money.

Public interest interventions are common in various areas of law, such as human rights and environmental law. However, we believe that this is the first intervention made by an NGO concerning UK tax law.

The full written submission to the Supreme Court is available here.

Our previous report on General Electric, Around the World with $5bn, is available here.

Furlough fraud to cost up to £7bn – with no civil penalties issued yet

12th May 2021 by Alex Dunnagan

• Furlough fraud and error set to cost between £3.5bn and £7bn

• 5 known arrests for fraud so far concerning £5m in fraud

• No civil penalties have yet been issued for furlough fraud

• More investment required to tackle the scale of the problem

Furlough fraud and error is set to cost between £3.5bn and £7bn by the time the Coronavirus Job Retention Scheme (CJRS) ends in September 2021 a new estimate produced by TaxWatch has found.

Despite being aware of the scale of the problem, and making several high profile arrests, HMRC appear not to have issued any penalties for furlough fraud yet.

DWP estimates that £4.6bn per year is lost to benefits fraud and error. To tackle this, the Counter Fraud, Compliance and Debt (CFCD) Department of the DWP had approximately 8,000 staff in 2019. By comparison, this new Taxpayer Protection Taskforce sees 1,265 HMRC staff chasing up to £7bn of money lost to fraud and error lost from CJRS, while also having to deal with issues arising from the multitude of other Covid-19 schemes.

Read the full report here.

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