Tackling the tax gap Contents

2HMRC’s plans to tackle the tax gap

The impact of COVID-19 on taxpayers’ compliance

12.The COVID-19 pandemic may increase the risks of non-payment of taxes and more people may operate in the deliberately hidden part of the economy.26 We asked HMRC about its assessment of the impact of the pandemic on the size of the tax gap and compliance yield. The Department told us that because of the level of uncertainty, it will take some time for the full impact of the pandemic to become apparent.27 Some outcomes of the pandemic, such as, the rise of digital transactions in most businesses and the move away from cash, may have a positive impact on the size of the tax gap.28 However, HMRC expects non-payment of taxes to be a significant issue, particularly because HMRC deferred the collection of a lot of the taxes due in order to support taxpayers. For example, HMRC offered all VAT-registered businesses the option to defer their payments of VAT that were due between 20 March and 30 June 2020 until 31 March next year. It confirmed to us that managing its debt balance in the future and the impact that will have on the tax gap will be one of its top priorities. HMRC has begun to prioritise contacting those taxpayers whose business affairs do not appear to have been significantly reduced due to the pandemic but nevertheless owe taxes to HMRC.29

13.During the pandemic, HMRC told us that it had to redeploy its resources from frontline activities, such as collection of tax, to work supporting taxpayers through the COVID support schemes. HMRC expects a reduction on compliance yield in 2020–21 compared with previous years.30 HMRC’s compliance yield dropped by 51% in the first quarter of 2020–21 compared to the same period in 2019–20 as it opened fewer inquiries and was more responsive to taxpayers’ needs. HMRC told us that it does not expect to make up for the loss of six months of normal activity by increasing the number of its investigations in the coming year.31 We asked the Department about the level of fraud and error in the COVID-19 support schemes, such as the furlough scheme. HMRC told us that to date it had received 8,000 notifications from employees highlighting potential non-compliance of employers with the terms of the Job Retention Scheme. HMRC is reviewing 27,000 “high-risk claims” and, after providing employers with the opportunity to correct their claims, it expects to investigate 10,000 of those 27,000 cases. Since the end of July, HMRC has had the powers to reclaim any grants that employers are not entitled to keep. HMRC told us that the error and fraud rate in the Job Retention Scheme claims could be between 5% and 10%. HMRC estimates up to £3.5 billion of furlough payments made by 16 August 2020 (£35.4 billion in total) may have been fraudulent or paid in error.32

14.HMRC explained to us that its overall approach to ensuring taxpayers’ compliance with the tax laws is predicated on promoting voluntary compliance through promoting trust in the tax system and supporting taxpayers that want to comply. It aims to deter those that may not want to comply by highlighting the risk of their detection and subjecting them to investigations and financial sanctions for non-compliance.33 The COVID-19 pandemic, by increasing fragility across the economy and in the financial affairs of taxpayers, has compelled HMRC to reconsider its processes for administering the tax system. HMRC told us that the assumptions that underpin its one-size-fits-all processes, namely that the vast majority of taxpayers can comply with their obligations and have the capability to do that, with a few exceptions that will need to be pursued for their non-compliance, may no longer hold true. For example, it has recently started issuing some penalties for people not filing tax returns because there has been a drop in the number filed by the taxpayers.34

Making Tax Digital

15.HMRC is implementing an ambitious initiative, Making Tax Digital, to help tackle error and failure to take reasonable care, particularly in the small business population. Small businesses accounted for the largest share of the tax gap (£13.4 billion; 43%) in 2018–19.35 They will be required to use accounting software to keep accurate and up-to-date records, and the software will produce filings that will feed into HMRC’s systems.36 HMRC has introduced Making Tax Digital for VAT.37 In July, the government announced an extension of the programme, throughout 2022 and 2023, to other taxpayers and tax types. The government plans to extend the programme, from April 2022, to all VAT payers and then from April 2023 to businesses and landlords with income over £10,000 per annum which are liable for Income Tax.38

16.We questioned the Department about the effectiveness of Making Tax Digital in closing the tax gap, particularly in tackling tax evasion. HMRC explained that the programme is not designed to tackle tax evasion by small businesses. Other solutions are required to address the risk of tax evasion. The aim of Making Tax Digital is to reduce the level of error and failure to take reasonable care, including failure to keep good records. HMRC told us that the Office for Budget Responsibility, which is independent of HMRC, has validated its estimates for the extent to which Making Tax Digital for VAT will reduce the VAT tax gap.39

17.We also received written evidence from the Chartered Institute of Taxation, which highlighted the findings of a survey of businesses and agents with an interest in the programme that they had carried out jointly with the Association of Taxation Technicians during December 2019 and January 2020.40 The findings of the survey suggested that the costs of Making Tax Digital compliance had far exceeded government estimates. While HMRC had estimated the average transition costs to be £109 per VAT-registered business, less than 10% of respondents estimated their or their clients’ costs at or below that amount, with 45% estimating costs between £109 and £500, and some 12% estimating costs over £5,000.41

Small businesses

18.Small businesses accounted for the largest share of the tax gap in 2018–19.42 The tax gap attributable to small businesses was 43% (£13.4 billion) of the total tax gap in 2018–19 and has remained fairly stable as a percentage of the total tax gap for a number of years. Furthermore, the small business population is constantly growing. HMRC told us that it had grown by about 50% in the last 20 years, and therefore the tax gap is likely to get larger.43 HMRC explained to us that this is why increasingly its strategy is to focus on helping small businesses to get their tax right and make it harder for them to get it wrong. The Department told us that a ‘one-to-one’ approach to ensuring the compliance of all 5.7 million small business is not feasible. It needs to restrict its one-to-one interactions with small businesses to cases of tax evasion, and use more ‘one-to-many’ solutions, such as campaigns targeting specific sectors, for the other aspects of the tax gap.44 We asked HMRC why it had reduced resources allocated to pursuing small businesses for taxes unpaid when small businesses make up the largest share of the tax gap. It told us that its one-to-many activities allow it to reach more businesses with fewer of its staff.45

19.We asked HMRC whether it is doing enough to tackle small businesses that operate in the hidden economy and deliberately evade their responsibilities. HMRC told us that about 8,000 of its staff concentrate on ensuring compliance in the small business sector, including those businesses active in the hidden economy. It explained that the large number of small businesses and the fast changes in the make-up of the sector compromise the effectiveness of HMRC’s one-to-one enforcement actions in deterring small businesses from non-compliance. The Department told us that, from a strategic point of view, to reduce the tax gap HMRC has to consider making more use of third-party data to enable it to identify incorrect filings, and introduce more third-party withholding, as in the case of pay-as-you-earn income tax.46

20.We were interested to hear about how HMRC will support the small businesses as they have to deal with new and unprecedented challenges posed by the COVID-19 pandemic. HMRC recognised the impact of COVID-19 in increasing the fragility of businesses, particularly small businesses.47 It set up and administered a number of schemes, such as the job retention scheme, the self-employed income support scheme and “Eat Out to Help Out”, to support the economy and taxpayers. We asked HMRC why it had not used its data and sophisticated data analytics systems to identify all of the taxpayers, including small business owners whose only source of income is the profit from their companies, that were entitled to support from the COVID-19 support schemes. HMRC told us that its data analytics system, called CONNECT, which enables it to join up the activities of taxpayers across different legal entities is only used to identify risks of non-compliance, usually after the event, when HMRC has obtained enough data. The system could not be used, “at scale and at speed”, to operate the payments of grants to people based on linking different entities together.48 HMRC also told us that to support taxpayers it has avoided investigations into businesses that it believes are struggling as a going concern. In the case of already opened inquiries, it only takes action when statutory deadlines for reclaiming taxes unpaid are about to expire or the business has the capacity to engage with HMRC.49 HMRC has also deferred tax payments, for example, for VAT and self-assessment income tax, and offered taxpayers who have had difficulty in paying their taxes during the pandemic time to pay.50 In August 2020, HMRC published a policy paper that set out how it plans to continue to support taxpayers and the economy.

26 C&AG’s Report, para 9

27 Q 1

28 Qq 22, 61

29 Qq 1–2

30 Qq 3, 47, 51

31 Qq 52–53; HMRC quarterly performance report: April to June 2020, available at: www.gov.uk/government/publications/hmrc-quarterly-performance-report-april-to-june-2020

32 Qq 10–13

33 Q 17

34 Q 47

35 Qq 20, 45; C&AG’s Report, Appendix Four

36 Qq 20–21, 69

37 C&AG’s Report, paras 1.11, 3.4

38 Qq 20, 67; HM Revenue & Customs and HM Treasury, Building a trusted, modern tax administration system, 21 July 2020

39 Qq 66–67

40 TTG003 - Chartered Institute of Taxation para 4.21

42 C&AG’s Report, para 1.5

43 Qq 18, 20, 45; C&AG’s Report, Figure 3

44 Qq 18, 20, 41, 47

45 Q 45

46 Q 21

47 Qq 3, 10, 14, 47

48 Qq 33–34, 51

49 Qq 47, 52

50 Q 2

Published: 16 October 2020