Tackling the tax gap Contents

Conclusions and recommendations

1.HMRC is not sufficiently clear about levels of uncertainty when publicising the tax gap. It is misleading for HMRC to report the tax gap as a single figure. HMRC does not present the level of uncertainty associated with the tax gap estimate alongside the headline figure, such as in its Annual Report or tax gap press notice. HMRC highlights the uncertainties for around 42% of the tax gap using range estimates but it cannot do this for the remainder because of data limitations. Around 20% of the tax gap (by value) is estimated using experimental methods, which carry a greater degree of uncertainty than established methods. In July 2020, HMRC made substantial revisions to its previous estimates of the tax gap. For example, in 2019 it had reported that the tax gap increased by £5 billion between 2015–16 and 2017–18. Its most recent publication now estimates the tax gap reduced by £2 billion over the same period. HMRC also does not provide ranges of uncertainty for its reported compliance yield, despite this Committee’s recommendation in 2015 to that effect. In May 2019, the Office for Statistics Regulation praised HMRC’s tax gap statistics, in terms of coverage and usefulness, but said it should do more to reduce the level of uncertainty.

Recommendation: HMRC should state more clearly (for example in its Annual Report or tax gap press notice) that its tax gap figures are highly uncertain and subject to revision. It should report the known range and scale of uncertainty alongside its headline estimates of the tax gap and compliance yield for 2019–20 onwards. Where that is not possible, HMRC should explain the elements where it is too difficult to give the range and scale of uncertainty.

2.HMRC does not know the relative size of tax gaps in the four nations of the UK or across different industries. HMRC already publishes breakdowns of the tax gap by taxpayer group, tax type and behaviour. However, HMRC does not calculate or publish estimates of the tax gap for each of the four nations of the UK. We recognise the difficulties in doing so but HMRC ought to be able to produce reasonable estimates for the tax gaps in the four nations of the UK, particularly since the devolution of Income Tax powers to Scotland from 2016–17, and Wales from 2019–20. In addition, HMRC does not publish any tax gap analysis for different types of industry. For example, HMRC has not published an estimated tax gap for the construction industry despite introducing the construction industry scheme to deal with high levels of non-compliance.

Recommendation: HMRC should include analysis of the tax gaps for each industrial sector in its future publications of the tax gap. In its Treasury Minute response to this report, HMRC should also set out what the benefits and challenges are of doing a similar analysis about the tax gaps in the four nations of the UK.

3.HMRC does not include sophisticated and undesirable tax planning by the wealthy and large businesses in its estimates of the tax gap. HMRC’s tax gap measures the uncollected revenue due to taxpayers’ non-compliance with existing rules. HMRC does not assess the gap where taxpayers make lawful use of tax allowances and reliefs but which are not desirable from a policy perspective (sometimes referred to as the ‘policy gap’) although this is something that policy makers and Government often express concern about. We recognise that HMRC’s compliance team is focused on non-compliance with tax law and not the policy gap. But our Committee and its predecessors have long been concerned that the wealthy and large businesses can employ specialist tax advisers to engage in sophisticated tax planning arrangements which are not readily available to most taxpayers. These sophisticated practices are legal and HMRC can only challenge them through changes in tax law or multinational agreements. HMRC would need a separate calculation if it was to measure how much tax is not being paid as a result of tax planning that is effective and not illegal but that, from a policy point of view, might be undesirable, in addition to the compliance gap. This is something that Government may wish to assess and Government has changed the law to close this perceived policy gap in the past.

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

4.Although HMRC has yet to see the full effects of COVID-19 on taxpayer compliance, it is already estimating up to £3.5 billion of fraud and error in furlough payments and has seen a significant drop in compliance yield in the first quarter of 2020–21.1 HMRC’s COVID-19 support schemes have led to a major reprioritisation of its resources and it has needed to reduce compliance activity while under lockdown. This has adversely affected HMRC’s core compliance activities and led to a backlog of investigations. There has been a significant fall in HMRC’s compliance yield in Quarter one of 2020–21 compared to Quarter one in 2019–20. Total compliance yield fell by 51%. HMRC assumes that most taxpayers will comply and can pay the tax they owe. COVID-19 means HMRC needs to reassess these assumptions. HMRC has already adapted its approach to compliance by reducing contact with taxpayers under financial pressure and it is initially contacting those it considers most able to pay.

Recommendation: HMRC should, alongside its Treasury Minute response, write to us separately explaining in detail how it will change its compliance approach in light of COVID-19.

5.It is not clear that Making Tax Digital will help reduce the tax gap or taxpayer costs at a time when individual taxpayers and small businesses are under considerable pressure. HMRC’s primary objective for the ‘Making Tax Digital’ programme is to help reduce the tax gap attributable to small businesses caused by error and failure to take reasonable care. The effectiveness of the programme is not yet known but HMRC is confident that it will achieve its aims: improving compliance rates, increasing productivity of businesses and allowing HMRC to realise savings. HMRC tells us that the Office for Budget Responsibility supports its view that the programme will help to close the tax gap, but we are not convinced that for all businesses there will be the benefits to them or tax collection that HMRC envisages. For example, the findings of a survey of businesses and agents, carried out by the Chartered Institute of Taxation and the Association of Taxation Technicians during December 2019 and January 2020, raised doubts about the effectiveness of Making Tax Digital in reducing errors and increasing productivity as expected by the government. The survey findings also suggest costs to business of complying with the programme far exceed government estimates. The Making Tax Digital programme is a logical plan in a world where more and more activity is carried out digitally, but it will impose extra, and possibly unreasonable, costs on some individual taxpayers and small businesses, and may be disproportionate to the gain to HMRC. Some of these businesses may be less able to afford the changes since COVID-19.

Recommendation: HMRC should, as part of piloting future rounds of MTD, assess whether the administrative burden it is imposing on taxpayers is reasonable and affordable before proceeding with further national roll-outs.

6.HMRC’s plans to tackle the part of the tax gap attributable to small businesses are made more difficult by the need to help those businesses survive the impact of the COVID-19 pandemic. HMRC estimates that 43% of the tax gap in 2018–19 was attributable to small businesses (£13.4 billion). In response to COVID-19, HMRC paid out billions of pounds to support small businesses. In August 2020, HMRC published a document setting out how it will support taxpayers and the economy against the background of COVID-19. To support taxpayers, especially small businesses, and increase the efficiency of its compliance approach, HMRC is increasingly adopting a “one to many approach” in its compliance checks rather than the more traditional investigations of individual taxpayers. This may not provide the tailored support small businesses need through the pandemic and HMRC needs to adapt. The Committee is disappointed that, so long after the beginning of the pandemic, HMRC has still not made sufficient use of its data to identify small businesses which have been left out of previous support packages, and therefore maximise taxpayer eligibility for grant support.

Recommendation: HMRC should write to us within one month of this report explaining how it plans to balance its efforts to tackle the tax gap in small businesses with the support that those businesses will need to survive the impact of COVID-19.

Published: 16 October 2020