House of Commons - Public Accounts

Select Committee on Public Accounts Forty-Ninth Report

1 Tackling non-compliance

1. HM Revenue and Customs collected £33 billion in Corporation Tax in 2004-05, and expects to collect around £42 billion in 2005-06. The tax is charged on the profits of companies resident or conducting business in the United Kingdom. Taxable profits are derived from accounting profits after a range of adjustments and allowances.[1]

2. The Department manages Corporation Tax payers in two groups. A Large Business Service deals with the largest 900 groups of companies, who paid £18 billion in Corporation Tax in 2004-05. A network of 68 Areas deals with the 1.1 million returns from other companies, who paid £15 billion in 2004-05. This Corporation Tax work cost £220 million, or 1.4 pence per pound of revenue. Each Area is responsible for processing and checking the tax returns of its local companies. Areas assess the returns for possible risks of non-compliance and select some cases for more detailed enquiries.[2]

The tax at risk

3. Since 1999-2000, when self-assessment was introduced for Corporation Tax, the Department has reduced the number of Area enquiries by almost half. But it has improved its targeting of higher risk returns and thereby, as Figure 1 shows, has increased the additional tax generated by these enquiries by 42% in real terms. Areas generated £602 million in additional yield (tax, interest and penalties) from the 43,700 enquiries completed in 2004-05.[3]

Figure 1: Relative trends in the number of enquiries and the additional tax yields they achieved, in real terms (indexed-values; 1999-2000 = 100)

Source: C&AG's Report, Figure 3

Note: Additional yields and average yields are in real (2004-05) terms, derived from Treasury GDP deflators.

4. The effectiveness of enquiries in tackling non-compliance, however, must be viewed in the context of the 'tax gap' - the difference between the total tax that is theoretically payable and what is actually paid. Assessing the tax gap from macro-economic data is inherently difficult. The Department conducts a random enquiry programme to provide intelligence on the level of error in tax returns resulting in the under-payment of tax and the nature of non-compliance risks.[4]

5. The Department does not yet have sufficient data to draw robust conclusions on the likely amount of tax being lost overall,but results to date indicate that 40% of returns have errors that would result in underpayment of tax. The size of these errors varies greatly and can result from misunderstandings or carelessness on the part of companies, or from serious abuse. 5% of companies examined accounted for 70% of the underpaid tax. The Department uses the results to direct its enquiries to the areas of risk.[5]

The 'strike rate' of enquiries

6. Overall, Areas conduct enquiries on 4% of returns. The Department focuses its enquiries on those companies which it considers most likely to produce additional tax. Yet only 60% of enquiries produce a change in the tax or profit assessment. The annual cost of enquiries which produce no change in the tax or profit assessment is £9 million. The Department regards it as inevitable that some enquiries will not produce additional tax, but it does not set a target for an acceptable "success" rate for its enquiries.[6]

7. The number and cost of enquiries producing no change suggest scope to improve the risk assessment of returns. The success of this process depends on the experience of tax inspectors and the skilled use of databases on companies' affairs to inform the assessment. In recent years the Department has developed various databases and encouraged their greater use by Areas, as well as the use of risk-profiling 'projects'. Following successful piloting, the Department is introducing a new database that brings together data previously held in different sources. It is also seeking to bring a more strategic focus in its use of risk assessment expertise, and is introducing a 'team working' approach to make better use of inspectors' time by allocating tasks more closely to the level of staff experience needed.[7]

The mix of full and aspect Corporation Tax enquiries

8. Areas undertake a mix of 'aspect' and 'full' enquiries. Aspect enquiries examine the accuracy and tax treatment of one or more particular features of a return and tend to be used for larger, more complex companies. Full enquiries focus on the disclosure and accounting for the entire income and assets of a business and its owners, and tend to be used for smaller less complex companies. 81% of full enquiries secure additional Corporation Tax or a profit adjustment (Figure 2), and these include some random enquiries which are not risk-targeted. Aspect enquiries produce less yield on average and have a lower 'strike rate', with only 58% resulting in a change to the tax or profit assessment. Nevertheless, aspect enquiries have a better pay-back rate because they are much less costly than full enquiries.[8]

Figure 2: The results of 'full' and 'aspect' Corporation Tax enquiries, 2004-05[9]

	Full enquiries	Aspect enquiries	All enquiries
Number completed	4,500	39,200	43,700
Average yield	£26,700	£12,300	£13,800
Average staff cost	£5,600	£500	£1,100
Average yield:cost ratio	4.8 : 1	22.6 : 1	13.1 : 1
Proportion of enquiries resulting in a tax or profit adjustment	81%	58%	60%

9. To check a company's tax position, the Department has to open a formal enquiry. In recent years, Areas have developed 'enabling' relationships with some of their larger local companies to discuss and resolve Corporation Tax issues, and companies may provide supporting records to the Department for review before they submit their returns. The advantage for the Department is that points of uncertainty can be resolved and compliance improved without the need for a formal enquiry. Such enabling work, however, accounted for only 1% of the time spent by Areas on Corporation Tax compliance work in 2004-05.[10]

The balance of enquiry workloads

10. In planning the number and mix of enquiries by Areas, the Department takes account of the number and grade-mix of Area staff and their company caseloads. It seeks to cover the spectrum of companies submitting returns - both large and small companies. The Department plans this coverage, however, without a detailed assessment of the relative compliance risk of different sizes of business, and without a clear view of what marginal changes in the enquiry mix might produce in terms of yield and cost.[11]

11. With an underlying error rate in returns of 40%, it is likely that higher yields could be achieved if additional resources were deployed to increase the number of Corporation Tax enquiries. But whether a 4% level of coverage is appropriate depends not just on the marginal yields and costs of such work but also on wider considerations about the deployment of enquiry effort and resources across the different taxes, and the demands they place on business. The Department is developing a risk strategy for business taxes, to help it reassess its levels of enquiry coverage.[12]

12. The risks posed by a particular company for Corporation Tax may also be indicative of its risk on other taxes, for example VAT, PAYE and Income Tax. Some of the more common errors found in Corporation Tax returns may also affect the personal tax affairs of the directors. 9% of Corporation Tax full enquiries also covered other taxes in 2004-05.[13]

Penalties

13. Penalties for negligently inaccurate returns, geared to the tax at stake, can discourage non-compliance. Of the 19,000 enquiries which produced an increased tax assessment, only 13% were penalised. Legislation allows the Department to impose penalties of up to 100% of the additional tax payable but, as with other taxes, it applies abatements for voluntary disclosure of errors, the seriousness of the offence and the co-operation the company gives the Department in the enquiry. The Department does not record centrally the types of cases that are penalised and those which are not, or the scale of the abatements applied, to assess whether penalties are being used effectively to deter non-compliant behaviour. Without such analysis, it is also unable to show that it applies penalties equitably across Areas and for companies of different size and type.[14]

14. The Department applies fewer penalties on aspect enquiries than full enquiries. It imposed penalties in half of the full enquiries where it identified an additional tax liability, compared with only 5% in aspect cases.In imposing penalties, the Department has to establish that the return is incorrect and understates the tax due, and that the error arises from the negligence of the company. Aspect enquiries often involve questions of interpretation of accounting and tax rules. If a company makes an error having relied in good faith on external professional advice, the Department cannot apply a penalty.[15]

15. If the Department considers that advisers and agents are in breach of their professional ethics, it can refer them to their professional bodies. But it has done so only five times in the last five years. Yet in response to our predecessor Committee's Report on Tackling VAT fraud in 2004, HM Customs and Excise, having previously referred only four cases, had expected to increase the numbers reported to professional bodies.[16]

16. The Department can impose a penalty if companies do not provide information it requests for its enquiry. But the Department acknowledges that a rate of £30 a day is only a minor inconvenience for many companies.[17]

1 C&AG's Report, Corporation Tax: companies managed by HM Revenue and Customs' Area Offices (HC 678, Session 2005-06), para 1.1; Q 31; Budget 2006 (HC 968, Session 2005-06), Table C8 Back

2 C&AG's Report, paras 1.5, 2.1 Back

3 ibid, para 2.7 and Figure 3; Qq 3, 18 Back

4 C&AG's Report, para 2.11; Qq 21, 37, 44 Back

5 Qq 2, 49, 71, 83, 85, 87, 105; Ev 14-15 Back

6 Qq 2-3 Back

7 C&AG's Report, paras 2.18, 4.9; Qq 8, 50, 109 Back

8 Qq 3, 39 Back

9 C&AG's Report, paras 2.7-2.8, 4.4-4.5, Figure 5 Back

10 C&AG's Report, para 3.7; Qq 3, 71 Back

11 C&AG's Report, paras 2.15, 2.20; Q 16 Back

12 Qq 16-17 Back