HMRC's Annual Tax Gap Figures: Unveiling the Reality and Hidden Challenges
HMRC have just published their annual Tax Gap figures. This is the estimate between the amount of tax HMRC is expected to be paid and the actual amount it collects. In its report HMRC reveal that although £35.8bn of tax was not collected, this represents 4.8% of total tax liabilities and is the lowest ever.
At first glance it seems that HMRC are doing an excellent job at closing the tax gap. However, critics question the criteria and methodology HMRC use in computing the tax gap. Some of the figures are extrapolations based on enquiries HMRC have opened, but this is not necessarily accurate as you don’t know what you don’t know! Crucially, it is argued that HMRC do not include the number of people estimated as participating in the hidden economy. In a separate survey published earlier this month, HMRC note that this number has doubled since 2016 to almost 6 million – an equivalent of 8.8% of the UK adult population! For their part, HMRC accept that their figures may be flawed but claim that they are an informed and consistent estimate which helps HMRC strategically allocate their resources in collecting tax.
Interestingly, more than half of unpaid taxes are the fault of small businesses who evaded tax or made errors in their tax filings. HMRC recognise this and believe that their plans to ‘make tax digital’ and require businesses to report earnings quarterly will drastically increase the tax take from this sector. Unfortunately, HMRC have been forced to admit that the ‘making tax digital’ pilot was too complex and that full implementation of the programme is likely to cost much more than originally anticipated.
Three types of people involved in the hidden economy have been identified. The largest group (65%) are moonlighters who supplement their taxed income with cash work. Ghosts (35%) do not declare any earnings at all, and businesses who failed to register for VAT make up the rest.
Is HMRC deterring Tax Fraud?
HMRC run regular information campaigns to educate taxpayers about their obligations and the consequences of not paying the correct amount of tax. I was therefore surprised to read that 18% of those surveyed claimed that taxable income from renting property did not need to be declared! And 28% thought that if you were already paying tax, you did not need to tell HMRC about any other activities as long as the income earned did not take them into the next tax band. As for the consequences – 88% of respondents thought that if caught they would get fined, 32% thought they would go to prison and 30% expected to get away with a warning.
Yet, HMRC’s deterrence appears to be weakening. The Public Accounts Committee warned that whilst prior to the covid-19 pandemic, HMRC was prosecuting approximately 700 cases a year, this fell to 163 in 2020–21 and 236 in 2021–22, and that HMRC was not planning to restore the number of prosecutions back to pre-pandemic levels.
According to the Committee, HMRC considers that its criminal prosecution powers were best used to tackle the most serious and complex cases, rather than large volumes of smaller cases and that the publicity around high-profile convictions, as well as its use of other enforcement tools such as civil powers, is sufficient to maintain a credible deterrent.
HMRC drove this home recently when they published details of a decade-long investigation into Northern Ireland’s biggest-ever tax fraud case which resulted in prison sentences for the two ringleaders. HMRC even published footage of secretly recorded videos taken in the offices of their accountants, Allen Tully & Co!
Launch of the New COP9
As part of their wider efforts to clamp down on tax fraud, on 14 June 2023, HMRC published a ‘refreshed’ Code of Practice 9. This re-establishes COP9 as HMRC’s primary civil investigation tool in tackling tax fraud and clarifies the rules on how taxpayers can report fraud where they have failed to pay the correct tax.
COP9 is where, in appropriate cases, taxpayers have the opportunity, to admit tax fraud, pay the tax they owe and significant penalties, and HMRC will not pursue a criminal investigation into the behaviour they disclose.
Under COP9 the individual under investigation and HMRC will enter a contract whereby the individual commits to making a complete, accurate, open, and honest disclosure of all deliberate behaviour and all other irregularities in their tax affairs. In return, HMRC commits not to open a criminal investigation. This is called the Contractual Disclosure Facility (CDF).
Where the individual enters a CDF contract with HMRC and then fails to make a complete, accurate, open, and honest disclosure of the frauds bringing about a loss of tax, HMRC can launch a criminal investigation with a view to prosecution.
The new Code of Practice:
- restates the Code of Practice, so that the COP9 recipient fully understands that the Contractual Disclosure Facility (CDF) is an opportunity offered to them as an alternative to a criminal investigation; and
- resets the terms of the CDF contract to make sure the recipient is clear on exactly what they are signing up to, HMRC’s expectations throughout the investigation, and the serious consequences of their non-compliance.
In addition, a number of new sections have been added to the Code of Practice. These include:
- reinforcing the criminal underpin in COP9 by emphasizing the different circumstances when a COP9 case can escalate to a criminal investigation and ultimately to prosecution;
- clarify when COP9 can cover fraud in respect of HMRC functions not involving tax; and
- sets out what HMRC can do, if the COP9 recipient rescinds their admission of deliberate behaviour, after they have accepted the CDF offer.
The Public Accounts Committee quoted earlier concluded that “We cannot and must not arrive at a situation in the UK where it is easier to cheat the tax system than it is to comply with it,” I think HMRC has responded to this criticism by assessing the tools they have had their disposal to tackle tax fraud. To some extent, the COP9 facility was overused to the point where it no longer acted as the deterrent it once was. With this reset, HMRC appears to be emphasising the severity of a COP9 and highlighting its potential to escalate into a criminal prosecution.
Yedidya is a Partner at Raffingers, a top 100 accountancy practice that specialises in a strategic business, tax planning, and commercial solutions.