Memorandum submitted by the Institute
of Chartered Accountants in England and Wales
Availability of the annual accounts on HMRC website
1. We are somewhat surprised that the annual
2005-06 accounts appear not to be available on HMRC's own website.
The Reports and plans part of the website (see http://www.hmrc.gov.uk/about/reports.htm
) only has the 2004-05 accounts posted and we have not found the
2005-06 accounts at any other location on the website. The HMRC
accounts are posted on the Official Documents website (see http://www.official-documents.co.uk/document/hc0506/hc11/1159/1159.pdf
) but we believe they should also be available on the HMRC website.
Missing Trader Intra Community Fraud
2. Missing Trader Intra-Community Fraud
(MTIC) is the most serious criminal attack on the VAT system since
3. We have been critical of the actions
taken by HMRC to counter MTIC fraud where they penalise the innocent
rather than the guilty, though we recognise that trading in goods
susceptible to this fraud is a high risk area and everyone should
exercise extreme caution before becoming involved. As we have
seen, disproportionate measures risk leading to litigation with
innocent businesses, when all efforts should be spent in combating
the fraudsters themselves.
We welcome the proposed reverse charge
but we are concerned that the fraud will switch to other goods
and services, and that its intended implementation has been "gold
plated". We also believe the current proposals should be
amended to prevent them causing unnecessary compliance costs for
many UK businesses far removed from the fraud itself.
We recommend a further measure which
would also counter the fraud. The introduction of a credit limit
for input tax which would require businesses to notify HMRC in
advance of making abnormal input VAT claims. This would deter
the middlemen from becoming involved in the trade.
We believe that the only real solution
is the (re)introduction of the charging of VAT on cross-border
supplies within the EU, which would "close the gap".
Whilst we are aware of the political objections, operationally
we see the origin system, described in the main Missing Trader
and Intra-Community Fraud section below, as the longer-term solution
most likely to curtail the fraud.
4. We believe the Government should be considering
radical reforms to the PAYE system and in our comments on the
HM Treasury Discussion Paper Small companies, the self employed
and the tax system, published in December 2004, we put forward
the suggestion of a State Employment Service to which employers,
pension providers and employees could sign up. The service would
act as an effective portal which would deal with all the PAYE
requirements for the individuals involved. The proposal is described
in the Detailed Comments section below.
5. The Auditor General's report on HMRC's
2005-06 accounts highlights three areas of concern: attacks on
the tax credits system, tax credits overpayments, and tax credit
error and fraud.
Attacks on the tax credits system:
We understand of course that HMRC must protect the integrity
of the tax credits system and combat organised crime. We are not
in a position to comment on the nature or size of the risk or
the measures HMRC are taking to combat it.
However, we are concerned about the effect the
continued unavailability of the online service will have on claimants.
This is particularly important as the new requirements to notify
changes of circumstances mean that claimants have more things
to report in a tighter timescale. HMRC must ensure they offer
claimants a range of communication methods which best suit their
needs, including the ability to notify changes or ask questions
Tax credit overpayments: The
ICAEW broadly welcomed the measures announced by the Government
on 5 December 2005. These are being introduced in accordance with
the planned timetable although it is too early yet to say to what
extent they have reduced overpayments. As noted in the report
of the Auditor General, this will only become apparent in 2008
once 2006-07 awards have been finalised.
We commented in detail on the 5 December 2005
measures and the problems of overpayments in our evidence to the
Treasury Sub-Committee enquiry into the administration of tax
credits, but we would like to comment specifically on one of these
proposals. We do not support reducing the time allowed for mandatory
reporting of changes in circumstances from three months to one
month. While we can see that quicker reporting should help to
avoid overpayments, we are concerned that this requirement may
prove onerous and unrealistic for many claimants.
We are also concerned that the new rule whereby
changes can be notified within a month of the claimant "first
becomes aware of the change" (if this is later than one month
from the change itself) will give rise to problems of interpretation
Tax credit fraud and error: This
is clearly an area where HMRC needs to do more and better research
into the scale of the problem, beyond the research they have already
done based on 2003-04 awards and enquiries. and no doubt the Committee
will be questioning the HMRC representatives on its plans in this
Missing Trader Intra-Community Fraud
6. Missing Trader Intra-Community Fraud
(MTIC) is clearly the most serious criminal attack on the VAT
system since its introduction. The opportunity was created by
the Single Market VAT changes from 1 January 1993, which removed
VAT from intra-Community transactions between taxable persons.
The dangers were well-known to tax authorities, including the
UK, at that time, so the present position is somewhat self-inflicted.
7. It is difficult to estimate the extent
of the fraud, although unofficial estimates for the current year
range between £5-8 billion, with the official Government
estimate due to be announced in the Pre-Budget Report.
8. We have been pleased to work with HMRC
in their campaign warning businesses of the danger signs (so that
they do not inadvertently become involved with the fraud) and
have highlighted this aspect in our communications with our members.
We welcome recent press reports of a significant number of arrests
of alleged perpetrators.
The proposed reverse charge
9. We welcomed the proposed introduction
of the domestic reverse charge for certain goods, although we
see this very much as a temporary ameliorating measure rather
than a cure. Our main concerns are that the fraud will simply
switch to other goods and services not covered by the reverse
charge provisions, and that the proposed rules are "gold
plating" and place an excessive burden on too many businesses.
We set out these concerns in detail in our TAXREP 13/06 on the
Finance (No 2) Bill 2006, copied to the Committee. Further copies
are accessible at our website at http://www.icaew.co.uk/index.cfm?route=135941
10. The reverse charge measures require
the approval of the Commission and the Member States. Whilst the
Commission have approved for their part, we understand that some
Member States are not prepared to agree, so the introduction of
the provision (originally expected for 1 December 2006) has been
11. Whilst unfortunate, the delay will give
HMRC further time in which to address some of the operational
issues, such as:
the £1,000 de minimis
limit on transactions. Since, from reported cases, the normal
size of transactions involved in the fraud is in tens of thousands
of pounds, we question whether such a low limit is appropriate,
since it will affect (as a purchaser) the vast majority of businesses
in the country.
HMRC have yet to provide a definitive
list of the goods to be covered by the reverse charge, although
the UK's request to the European Commission was made in January
We consider that genuine retailers
should be excluded from the new reverse charge where they supply
goods to another taxable person. It would be difficult for fraudsters
to carry out MTIC fraud using a retail business.
12. At a time when there are many calls
for simplicity in the tax system, the detailed reverse charge
provisions will add considerable cost and complexity to the VAT
accounting for large numbers of UK businesses who have nothing
to do with the fraud. Businesses affected also need time to amend
their computer accounting systems, and the eight weeks proposed
by HMRC is unlikely to be sufficient.
A possible input tax "credit limit"
13. Once a business is VAT registered, it
can recover all the VAT it incurs on its costs without restriction,
subject to the normal rules. One feature in reported court cases
is that relatively small businesses, innocent or otherwise but
part of a fraudulent supply chain, have claimed input VAT on purchases
greatly in excess of their historic trading levels. The first
HMRC know of this is when the VAT return is submitted, often a
couple of months after the event.
14. A credit limit would impose a monetary
restriction on the input tax that each VAT-registered business
could claim in an accounting period. It would be set at an amount
that in the normal course of events the business would not reach,
with a fast clearance procedure for businesses to apply for an
increase for abnormal transactions, such as a property purchase.
The purpose would be to restrict the willingness of "middlemen"
(innocent or otherwise) to become involved and thus reduce the
scope of the fraudster to sell the goods and charge VAT. If the
middleman knew that he would not be able to recover the VAT automatically
through his VAT return, but at best would face a lengthy enquiry
from HMRC for exceeding his credit limit, he would be unwilling
to enter into the deal. It would, however, require HMRC to be
both prompt and efficient in dealing with requests for an increase;
otherwise they would be in breach of EC law.
The "origin system"
15. This is a much longer term solution,
and was favoured by the Commission when the current system, not
charging VAT in the country from which the goods are despatched,
was introduced in 1993. In its classic form, an origin system
would mean that a business selling goods to another business in
another Member State would charge VAT in the same way and at the
same rate as if it were a domestic transaction. The purchaser
would then be able to recover that VAT through his own VAT Return,
which may require Member States to have a clearing system between
them to deal with the money flows, though this would be a political
rather than a fiscal requirement. Whilst from an operational viewpoint
it would stop MTIC fraud, it would require Member States firstly
to set up new systems to exchange information and make refunds
to businesses promptly, and secondly it would need to be proof
against other possibilities of fraud. An origin system that required
businesses to account for output tax on intra-EC supplies, whilst
not permitting prompt input tax deduction, would have a negative
effect on cross-border trade, and could be seen as discriminatory.
Whilst we are aware of the political objections, operationally
we see the origin system as the longer-term solution most likely
to curtail the fraud.
16. Para 6.10 and 6.11 of the Statement
on Internal Control in the 2005-06 HMRC accounts states:
"The IR Statement on Internal Control for
2004-05 commented on weaknesses identified by reviews of PAYE
business, particularly where the system dealt with instances of
employees having more than one job. These weaknesses are estimated
to have led to overpaid tax of £295 million and underpaid
tax of £575 million.
The Department set up a Steering Group to prioritise
the recommendations from these reviews and is undertaking a number
of health checks and risk assessments across the range of PAYE
operations. In response to the recommendations made in these reviews,
the Department has taken steps to ensure staff better understand
the need to use all relevant sources of information when reviewing
liability, so that underpayments and overpayments of tax can be
identified and collected or repaid. All agreed recommendations
have either been fully actioned or plans to implement them are
17. The PAYE system has continued largely
unchanged in principle since it was first introduced. As a result
it has not sought to adapt to reflect modern working practices.
Multiple sources of earned income
18. The results of the Government's Administration
Burdens Reduction Project have identified a number of instances
where the existing system fails to cope with modern working practices.
Volume 1 of the KPMG report into business burdens (see http://www.hmrc.gov.uk/news/admin-burdens.pdf
) estimates that there are about 17 million employees and an estimated
50 million employments in the UK. Paragraph 3.1 in Part 3 of the
Auditor General on the HMRC 2005-06 accounts puts the figure of
separate employments and pensions at 41 million. There are likely
to be a number of reasons for this apparent discrepancy.
19. 1. Multiple employments. It is common
for individuals to have more than one permanent job at the same
time. A cleaner may work an early shift for one company, in the
afternoon for another and then work an evening shift for a third
unrelated different company. The PAYE system is not sufficiently
responsive in such situations to collect the right amount of tax.
Let us suppose that the individual earns £5,000 per annum
from each employment.
20. In this illustration, three PAYE codes
would be issued. A variety of permutations is possible:
If these are three separate 503L
codes, a serious underpayment of tax will quickly arise at the
rate of around £100 per month. A person on this level of
income can ill afford the cash flow consequences of paying back
even hundreds of pounds in tax.
If the employers are sufficiently
methodical to follow the correct P46 procedure when employments
2 and 3 begin, the individual may find himself with a 503L code
from the first employment and a BR code for each of the others.
This will mean that basic rate tax is collected from employments
2 and 3, but without any benefit being obtained for the lower
rate tax band. An overpayment of tax will arise during the year
of approximately £250. Once again a person on a low income
can ill afford such cash flow consequences.
There is a solution under the PAYE
system, splitting the tax code between the three jobs, but this
usually takes time, knowledge and persistence to achieve. As such
employees are unlikely to have an accountant to advise them, it
is unlikely that they would know to ask HMRC to do this. Furthermore,
if the person gives up one of the jobs, they will then be back
to overpaying tax because 1/3 of the personal allowance is no
longer being used.
21. 2. Casual staff. The administration
required to take temporary staff onto the payroll for only short
periods leads many employers to bring such employees onto the
payroll as if they are permanent staff. They are then paid only
when they work. A nil payslip is produced for other months. The
P60 and year end paperwork will need to be produced as for real
full time staff. In the catering industry, for example, a casual
waiter will usually sign on with a number of agencies. Similarly
it is common for healthcare professionals to be apparently employed
by more than one employer simultaneously.
22. 3. Pensioners. This is an extension
of 1 above. Many widows and widowers will have more than one pension
source. It is quite normal to have one pension from the person's
own previous employment, another pension from the deceased spouse's
previous employment as well as the State pension. Others may receive
a pension and also be in employment. The State pension cannot
be paid through the PAYE system at all and is always taxed by
adjusting the PAYE code or under self assessment if the person
has no PAYE source of income. The other two pensions must be paid
separately through separate payrolls. This will almost always
cause an under or overpayment of tax (see multiple employments
above), but especially where the person's total income exceeds
the abatement ceiling (£24,594 for a single person in 2006-07).
23. Clearly, a system which is designed
around the proposition that everyone has a single job is going
to struggle to work properly
24. We have previously suggested in our
response, TAXREP 22/05, to the consultation Small companies, the
self-employed and the tax system, published by the Treasury at
the time of the Pre-Budget Report 2004, that a state employment
service (SES) could be used to deal with these problems.
25. Angie, Betty and Cathy each work between
15 and 25 hours a week for the Red Lion pub. Cathy also works
for an outside catering company, BBQ Ltd, which is unconnected
with the pub. The landlord knows that he can afford to employ
people as long as his total cost per hour per employee is £6.00.
BBQ Ltd knows that it can afford to employ people as long as the
total cost per hour per employee is £7.50.
26. Arthur is a pensioner who receives each
year an old age pension, an NHS pension and an occupational pension.
27. Let us suppose that the Government sets
up an SES. The system could be state funded, or participating
employers could pay a small fee. Each individual's details could
be transacted by a central agency with payments handled by a single
entity or there could be multiple, competing, agencies to provide
28. Any employer or pension provider can
register to use the scheme. Any employee can also register to
use the scheme. Each participant is given a registration number,
which could be the NI number for the individuals. We note that
large employers, if they also came on to such a system, would
suffer cash flow disadvantages as they currently deduct tax and
NIC and don't have to pay it over before the 19th of the following
29. In our illustration, all the above are
registered with the scheme.
30. Each pay period, weekly or monthly,
the landlord of the Red Lion, BBQ Ltd, the Government pension,
the NHS pension and the occupational pension pay the salaries/pensions
to the SES. The SES runs the payroll and makes a single net payment
to each of the individuals.
31. Benefits: The two small businesses are
relieved of all tax calculations, including the consideration
of employers' NIC. They each know exactly how much buying one
extra hour of labour will cost them. BBQ Ltd does not have to
keep completing forms P45/P46 as it uses casual staff. In cases
where there was doubt over whether a worker was employed or self
employed, normal rules would apply, although they could ask the
Revenue for assistance as they do now.
32. Employees with multiple employments
and pension sources receive the correct net income without endless
wrangling with HMRC over tax codes for different sources of income.
Use of the PAYE system as an alternative to self
33. We have seen a deliberate policy to
take as many people as possible out of self assessment with the
result that the PAYE system is used as an alternative. For example,
where the individual has other sources of untaxed income, such
as from rented property, or where there is a higher rate tax liability
on savings income, the amount of such income is estimated and
then an adjustment is made to the person's PAYE code. In many
cases this results in a negative figure for tax free income and
hence a "K code".
34. PAYE codes are not easy for the public
to understand and in particular, the notion of K codes, and adjustments
to collect underpaid tax from previous years, are notoriously
difficult to comprehend. When the system is extended to collect
tax on current sources of non-employment income, it simply increases
the probability of non comprehension by the taxpayer, so placing
the burden of identifying tax under or overpaid solely onto HMRC.
Concurrent Self employment and employment
35. It has become common for people to start
up small businesses whilst remaining employed. E-Bay trading and
car boot sales are popular ways of earning extra money. We have
seen the PAYE system being used to collect tax on such sources
of self employment income, as for investment income above.
36 We would also like to add that in this
last case, collecting tax using the PAYE system rather than the
self assessment system accelerates its payment by many months.
Although the taxpayer can object to this, it does pre-suppose
that he can understand what is happening in the first place.
37. The ICAEW submitted both written and
oral evidence to the Treasury Sub-Committee enquiry into the administration
of tax credits (Sixth Report of Session 2005-06). We are active
participants in HMRC's tax credit consultation groups.
38. This is an appropriate time to reflect
on the system of Child and Working Tax Credits, and on the problems
identified with the system and progress in tackling them. It is
nearly a year since the 2005 Pre-Budget Report (5 December 2005)
when the Paymaster General announced a package of proposals designed
to improve the tax credits system and address overpayment problems.
These changes are in the process of being rolled out. It is also
nearly a year since the tax credit e-portal was closed (on 2 December
2005) due to its vulnerability to fraud, and regrettably it remains
closed with no signs of it re-opening.
39. The Auditor General's report on HMRC's
2005-06 accounts highlighted three areas of concern to do with
tax credits: attacks on the tax credits system, tax credits overpayments,
and tax credit error and fraud. We comment on each in turn, with
reference to the comments we made at the time of the Sub-Committee's
enquiry into tax credit administration and to subsequent developments.
Attacks on the tax credits system
40. We understand of course that HMRC must
protect the integrity of the tax credits system and combat organised
crime. We are not in a position to comment on the nature or size
of the risk or the measures HMRC are taking to combat it.
Problems arising from closure of the e-portal
41. However, the loss of the online service
removes one of the main ways in which it was envisaged that tax
credit claimants would communicate with HMRC. In our view HMRC
should do more to inform claimants and their advisers of what
is happening with the e-portal and to provide alternative routes
for claimants to communicate with HMRC.
42. We note that the message on the HMRC
website still describes the e-portal as "temporarily closed",
which is misleading and unhelpful since it has been closed for
nearly a year. There is currently no indication of when it might
43. The reduction (from 6 April 2007) in
the time allowed to report changes of circumstance from three
months to one month, plus the increase (from 1 November 2006)
in the number of changes which must be reported, will require
claimants to have more contact with HMRC than they do at the moment,
as there will be more things to report within a tighter timescale.
It is therefore incumbent on HMRC to provide claimants with a
range of user-friendly ways to do this, which best suit the needs
of the claimant.
44. Alternative routes for contacting HMRC,
which they suggest in their publications, are the Tax Credits
Helpline and post. However, many claimants would prefer face to
face contact. Although this is offered by HMRC, we are concerned
that the re-design of the system at Tax Enquiry Centres should
not affect people's ability to obtain face-to-face advice when
they need it.
45. It is likely that many claimants would
prefer email as a means of communication, and we strongly recommend
that HMRC should offer email as a way to notify changes or ask
questions about tax credits. It should be noted that HMRC already
offer such a service for Child Benefit. We understand that HMRC
are reviewing their policy on email communication generally, but
that there are no plans to introduce this in the meantime specifically
for tax credits.
46. We also have concerns about the post
as a method of contact, as experience shows that there are often
long delays in dealing with post at the Tax Credits Office. One
difficulty is that the volume of post at that office makes it
hard to spot urgent items; one solution would be to provide a
specific form for notifying changes, which could be easily spotted.
Tax credit overpayments
47. The ICAEW broadly welcomed the measures
announced by the Government on 5 December 2005. These are being
introduced in accordance with the planned timetable although it
is too early yet to say to what extent they have reduced overpayments.
As noted in the report of the Auditor General, this will only
become apparent in 2008 once 2006-07 awards have been finalised.
Notifying changes within one month
48. We would like to comment specifically
on one of the December 2005 proposals. We do not support the proposal
to reduce the time allowed for mandatory reporting of changes
in circumstances from three months to one month. The regulations
to achieve this are already in place in the Tax Credits (Claims
and Notifications) (Amendment) Regulations 2006, SI 2006/2689.
49. While we can see that quicker reporting
should help to avoid overpayments, we are concerned that this
requirement may prove onerous and unrealistic for many claimants.
There is a balance to be struck between making the system responsive
but at the same time ensuring that the requirements it imposes
on claimants are not so onerous that it becomes a burden to them.
50. For some changes of circumstances, one
month will be too short a time for reporting because it is difficult
to pinpoint exactly when they have occurred or because it is impossible
to know within one month if there has actually been a change.
To address this issue and in response to concerns expressed by
representative bodies, the regulations now include a rule whereby
changes can be notified within a month of the claimant "first
becomes aware of the change" (reg 5(b), SI 2006/2689) if
that is later than the date of the change. This is intended to
provide a solution to some of these practical problems but it
does introduce into the procedures a new date which may itself
be hard to pinpointthe date when the claimant became aware
of the change. Our concern is that in a penalty situation, HMRC
should not interpret this provision as meaning the date when they
think the claimant should have realised that a change had taken
51. We have prepared a more detailed briefing
which sets out our concerns about the new measures on changes
of circumstance which we will very happily make available to the
Committee if required.
Tax credit fraud and error
52. This is clearly an area where HMRC needs
to carry out more, and better, research into the scale of the
problem, beyond the research they have already done based on 2003-04
awards and enquiries. No doubt the Committee will be questioning
the HMRC representatives on its plans in this area.
Right of appeal and judicial review
53. As set out in our evidence to the Sub-Committee
in December 2005, our view is that there should be a right of
appeal against a decision by HMRC to recover a tax credit overpayment.
54. We also consider that claimants' access
to justice would be improved if the tax tribunals had a judicial
review function and could consider HMRC's decisions on matters
of tax and tax credits administration. In this context we are
pleased to note that the draft Tribunals, Courts and Enforcement
Bill provides judicial review powers for the Second-Tier tribunal
under the planned new structure. We would also advocate providing
such a power for the First-Tier tax tribunals.