Small businesses worst offenders owing £14bn in tax

The amount of uncollected tax has hit £35bn, with small businesses accounting for the largest percentage of the tax gap at £14bn while VAT evasion remains a major drain on tax revenues, reports Sara White

The actual revenue lost is starting to creep upwards again, increasing £2bn in just 12 months to £35bn, and it has shot up from £30bn just two years ago.

HMRC figures show that the tax gap has grown from £27bn in 2009-10 (6.6% of liabilities) to £35bn in 2017-18 representing 5.6% of liabilities, despite the huge number of HMRC settlement agreements and tax amnesties, as well as the clampdown on the use of aggressive tax avoidance, including film schemes and attempts to increase the tax take from multinationals.

Small businesses account for 40% of the tax gap with £14bn in unpaid tax for reasons of failure to take reasonable care, legal interpretation or errors. Of the total £600,000 was for non payment of PAYE tax, with 13% of small businesses failing to comply with PAYE rules. This figure used to be much higher with one in three small businesses falling foul of PAYE just five years ago.

The improvement in PAYE compliance figures can be attributed to real time information (RTI) reporting.

‘The introduction of real time information (RTI) in April 2013 is likely to have made a significant contribution to this reduction. RTI has led to information on payroll taxes being recorded more accurately and on a more frequent basis as it requires all UK employers to tell HMRC of their liability to PAYE when or before they make payments to employees, such as around each payroll run. Previously employers paid on account monthly and reported actual liabilities annually,’ HMRC stated in the annual tax gap report.

Large businesses were responsible for a further £7.7bn with £4.9bn for mid-sized businesses. Individuals were only responsible for £3.9bn.

Income tax, national insurance contributions (NICs) and capital gains tax has overtaken VAT as the most evaded, at £12.9bn, while VAT accounts for £12.5bn – 9.1% of the tax gap. Estimates show the VAT gap has risen in the past two years, partly down to rising VAT debt which has hit £2.2bn.

HMRC expects the rollout of Making Tax Digital for VAT to improve VAT compliance and make it easier for the tax authority to identify evasion and fraud.

The corporation tax gap was £5.2bn, with 8.1% of unpaid tax, which HMRC claimed has fallen from 12.5% in 2005-6 during the Labour government and before the 2008 crash, although this would still have been estimated at £3.8bn.

Jason Piper, head of taxation at ACCA, said: ‘While the corporation tax gap has reduced from 12.5% to 8.1% in 2017-18 in a little more than 10 years, the biggest single taxpayer group responsible for the tax gap is small businesses, costing society nearly twice as much as big business.

‘This doesn’t mean HMRC should devote twice as much resource to small business as big business. In reality it should probably devote even more than that to the issue. The challenges of dealing with this sector differ from that of multinationals.

‘Small businesses by definition will have smaller tax bills, which means that HMRC will need to open more enquiries and handle more pieces of correspondence per pound than for large businesses. However, it is vital that HMRC remains sensitive in managing SME relationships every bit as carefully as they do multinationals.’

The increasing complexity of the tax system is another contributor to small business compliance issues.

James Hender, head of private wealth at Saffery Champness said: ‘The burden of tax compliance has increasingly shifted on to the taxpayer but there remains a general shortfall in tax knowledge, particularly in small businesses which are unlikely to have professional tax teams and may not always be able to afford advice. This is likely to mean innocent errors or misinterpretation continue to form a large chunk of the tax gap.

‘Taken together, failure to take reasonable care – an arguably subjective metric – and plain, simple error account for more than £9bn of the tax gap. With a range of tools at its disposal, HMRC is increasingly quick to levy penalties in the case of genuine errors and this can cause real challenges, economic and emotional, for taxpayers.’  

There has also been an increase in court cases influencing the tax gap with £1bn attributed to legal interpretation, highlighting issues where courts have ruled against HMRC over tax matters.

‘It is interesting to note that HMRC cites “legal interpretation” as a growing contributor to the tax gap, increasing by £1bn on the previous year. HMRC implies that it is tax payers who are getting things wrong, but recent cases – notably those where HMRC has targeted journalists and television presenters it believes are liable for tax under the IR35 rules - have shown that in fact the courts are frequently correcting HMRC’s view of the law and are taking the tax payers’ side,' said Hender.

'Put simply, what HMRC thinks it should be collecting is not always correct in the eyes of the courts.’

The tax gap on personal income taxes due to the hidden economy tax gap is estimated at £1.9bn in 2017-18. This consists of ‘ghosts’ (whose entire income is unknown to HMRC), which accounted for £1bn and moonlighters (who have at least one source of undeclared income to HMRC), which accounted for £900m.

The annual tax gap measures the amount of unpaid tax based on HMRC calculations of uncollected revenue, either unpaid through evasion, avoidance or errors.

HMRC Measuring Tax Gaps – 2019

Sara White

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