UK claims tax gap has shrunk, but figures tell another story

Big businesses only accounted for 29%, or £9.7 billion ($12.8 billion), of the government’s £34 billion uncollected taxes for the year 2015-16, according to the latest tax gap figures – the difference between the tax amount collected and the total tax liability – released jointly by the Treasury and HMRC.

Overall, the figures showed that the tax gap has fallen from 7.9% in 2005-06 to 6% in 2015-16. However, the real term amounts of the tax gap have not declined at the same rate. The tax gap was £35 billion in 2005-06, but has only narrowed by £1 billion as of 2015-16, and has actually increased from the previous year.

Personal income tax, national insurance contributions and capital gains tax made up 40% of the tax gap share, costing the government £13.7 billion, while VAT losses amounted to £12.6 billion in 2015-16, or 37% of the tax gap share.

Of the £3.3 billion of corporation tax losses, which made up 10% of the tax gap pie, large businesses were only responsible for £1.4 billion, while small and medium-sized enterprises (SMEs) cost the government £1.9 billion in corporate tax losses.

However, some believe these figures are just too predictable.

“The very fact that it is now possible to say, with almost certain accuracy, that the UK tax gap will, according to HMRC, be a number falling between £30 and £35 billion is too predictable for the estimate to be entirely believable,” Richard Murphy, professor of practice in international political economy at City, University of London, wrote in a blog post.

“I have over time been deeply critical of HMRC’s tax gap estimates… The first issues relates to the credibility of these estimates. The chance that a pattern of behaviour such as this would, in value terms, be so consistently reliable over such an extended period is very low indeed,” Murphy wrote. “The second issue of credibility is that if this behaviour is so reliably predictable why has so little been done to address it? The claimed fall in the yield lost is noted, but does not answer that question. The risk is that HMRC is producing data that looks like Soviet style tractor production statistics. And that helps no one.”

Tax avoidance made up a surprisingly small portion of the tax gap – only 5%, which was the smallest tax gap by behaviour.

Avoidance accounted for £1.7 billion of the overall £34 billion gap, of which corporate tax avoidance accounted for a third (£0.6 billion), while personal taxes accounted for the majority (£1 billion).

Multinationals are often criticised for avoiding their UK tax liabilities and Chancellors state in each budget that they will tackle the storm of multinational tax avoidance, but the figures suggest ministers should be targeting individuals.

Andrew Hubbard, tax consultant at RSM in the UK, described the figures as a “complete caricature”.

“The central public narrative about tax over recent years is that there is massive tax leakage due to the aggressive avoidance activities by multinational companies, and if only that could be stopped the country would be in much better economic health,” Hubbard said. “But delving deeper into the figures we see that the gap attributable to avoidance by the largest businesses is … a very small proportion of the total tax gap ... We can debate whether or not this is due to increased HMRC compliance success or a move away from avoidance from the largest companies. In truth, it is probably a combination of the two. But it is clear that the public perception that ‘it is all the fault of multi-nationals’ has no rational basis.”

Jason Collins, partner and head of tax at Pinsent Masons, believes the figures show that large businesses have reacted to market and legal changes, where reputational risks are heavily associated with taxation and there is a need to be viewed as compliant.

Companies have improved their internal controls and many have also now have turned their back on marketed tax avoidance schemes. “The ‘magic money tree’ doesn’t exist for tax avoidance and Chancellors can’t keep promising to raise more money through targeting it,” Collins said, pointing out that the underpayment of VAT is a much bigger problem.

“The battle against avoidance has largely been won and we need to see a shift in the public debate to ensure that evasion in all its forms is seen by everybody as unacceptable,” added Hubbard.

One of the bigger problems in the tax gap is legal interpretation, which is highlighted in HMRC’s report as a key cause of underpaid taxes.

“Any kind of tax planning is now being scrutinised by HMRC to see if it can be challenged – no area is off limits for HMRC and this is reflected in the recent jump in the tax gap relating to legal interpretation,” said Collins.  

Legal interpretation refers to the taxpayers’ interpretation of the law and how it applies to the amount of tax owed, which often differs from HMRC’s understanding.

Although legal interpretation often helps to develop views of the law, the amount of tax not paid as a result of this has risen by 9%, from £5.5 billion in 2014-15 to £6 billion in 2015-16.

“HMRC is pushing the envelope in grey areas and muddying the water when it comes to enforcing its interpretation of the law,” Collins said. “The 9% increase may also reflect the fact that some large businesses are struggling to get certainty from their customer relationship managers at HMRC over complex new rules. This means more differences of opinion over legal interpretation are ending up as disputes rather than being resolved at an earlier stage.”

Collins believes that the tax gap for legal interpretation will rise further with major changes to the tax system looming.

With Brexit negotiations underway the banking sector is becoming nervous about how it will operate after the UK leaves the EU.

If foreign banks decide to shift their UK operations to other parts of Europe, it could leave a £17 billion black hole in the UK’s public finances, according to the Financial Times. A shift in this sector has the potential to suddenly widen the tax gap.

Despite the government’s positivity that the tax gap is narrowing and it is successfully tackling tax avoidance, the uncertainty in many of the underlying figures does not provide a full picture of what is going on.

But Hubbard believes it is the trends and make-up of the figures, rather than their absolute values, which matter. “The government and HMRC have, understandably, put a positive spin on the figures. I think that is justified so long as it means that future policy is based on intelligent analysis of what these figures actually say,” Hubbard said.

Let’s hope the government’s upcoming Autumn Budget on November 22 and the ongoing Brexit negotiations reflect the changes necessary to address the challenges identified in this year’s tax gap report.