Contractors, the gulf between what the tax gap is and what HMRC wants it to be, is huge
Originally thrust upon HMRC by the Public Accounts Committee under Lady Margaret Hodge, the annual calculation and publication of the ‘UK tax gap’ has shifted from unwelcome chore that HMRC tried to avoid, to gaining ever greater prominence in the external publication calendar, writes Graham Webber, tax director at WTT Consulting.
Question, claim, scrutinise
With the 2018/19 year being no different, it is important to ask whether the tax gap is an accurate representation of HMRC’s progress and development, or a catch-all justification for its continued accumulation of increasingly divisive collection powers.
The quantum of the gap is “falling”, HMRC claims because of their actions. Given the lack of independent verification or even any reliable explanation of how the value is compiled, this is a claim that requires a healthy degree of scepticism.
Nonetheless, it is a media-friendly and easily presented headline that is loved by the tabloid press and rarely enquired into even by those publishing outlets more considered in their reporting.
The gap’s importance, however, lies further in the detail and is worthy of further scrutiny.
Because trends matter
The tax gap in 2018/19 is 4.7%. Of what?
HMRC defines the tax gap as “the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid”. Given the impossibly subjective nature of “should be paid” and the fact that the measure ignores any view other than their own, HMRC themselves think that the trends matter more than the figure.
Nonetheless, 4.7% equates to £31 billion of unrecovered tax. This figure is slightly lower than earlier years but hardly sets a trend. There are also elements that make it up which have barely moved since the first measure was produced, remaining stubbornly static. Despite this, the figure is representative of just £1 billion more than is needed to cover new COVID-19 measures announced in chancellor Rishi Sunak’s mini-Budget. As a result, we expect to see HMRC using these headline figures to further increase their powers to refill the inevitable hole in the Treasury. Contractors, therefore, have grounds to beware the Revenue, even more so than they do already.
Let’s examine those figures further.
Tax gap by group
“Non-compliance” by “small business” accounts for 43% (£13.3bn) of the tax gap. The largest single contributor. Criminals and large business claim second and third position with £8.2bn between them, with individuals and the newly created ‘wealthy’ categories coming further down the list.
Criminal evasion of tax and the ‘black economy’ are by definition difficult to deal with and require a significant investment of time and money in order to challenge. Unsurprising therefore that the values here remain motionless.
HMRC will therefore continue to focus efforts for recovery on small business. This sector has the advantage (for HMRC) of being largely compliant with the law and willing to give HMRC the basic information (addresses) which permits targeted enquiry. In effect, this is ‘easy money’ if HMRC is prepared to deploy their 100+ powers granted since 2016, without mitigation, towards contractor limited companies and other small businesses.
Tax gap by behaviour
Taxpayers failing to take ‘reasonable care’ represents the largest single loss of tax revenue in this year’s estimate at £5.5bn. Adding to this £4.9bn for legal interpretation and £3.1bn for error, it is evident that £13.5bn has been lost to an overly complex tax system. Over 15% alone, lost to legal interpretation simply cannot be interpreted any other way. Compounded by recent statistics showing wait times of over 10 minutes for 47.7% of callers and with an average wait time of 9 minutes 17 seconds, HMRC must focus on customer service and resourcing to prevent this type of leakage.
HMRC could – and should – spend more time on the basics, and that would have a telling impact on the numbers. Instead, as any caller to HMRC will attest, even after waiting for the phone to be answered, the information obtained is rarely reliable. It’s not enough to answer the phone. HMRC needs to invest in its front-line officers knowing enough about tax to help.
Why does this ‘meaningless’ tax gap matter to HMRC?
HMRC considers that the published measure demonstrates ‘progress.’ The numbers however mean little. Nobody really knows until many years after the event what the denominator value actually is. If you don’t know how much could be collected, a value for how much is not pocketed is meaningless.
Unfortunately, although the Public Accounts Committee insisted on a measure, they left the detail to HMRC. No government agency is going to mark its own homework as “D – must do better.”
We also see HMRC taking the opportunity to use the measure as justification for seeking more powers.
Take for example the reforms to IR35, which may well be the biggest single threat to the contingent workforce since the original legislation’s introduction in 2000. Again, using the statistics here the claim is that tax could be collected in larger quantum if all contractors were taxed as though they were employees.
Smoke and Mirrors
HMRC can point to non-compliance by small-businesses (PSCs) as being the largest contributor to the gap and justify the introduction of further complex and confused legislation. If we assume that the denominator in the tax gap values includes this ‘fact’ but the nominator does not, great. HMRC can show the gap narrowing for a couple of years.
In reality, since 2015, avoidance by individuals has consistently represented the lowest form of loss in the tax gap and questions must therefore be asked as to why so much resource, legislation and lack of scrutiny is being applied to the contractor sector, when exponentially greater revenue is lost to the Revenue’s own poor customer service, evasion, and lack of legal interpretation, every year -- consistently.
The measure matters because it is a simple number that can be spun in many ways. Rises in the percentage will be seen and presented as failure. Reductions as success. Expect therefore a focus on the compliant and hope that the message to the non-compliant (‘hide and there is a decent chance of getting away with it’- £2.6bn) is not read by too many.
What next in 2019/20 and beyond?
The delay to the reform of IR35 will mean that the gap in this year, when reported, will be largely the same as we see in 2018/19. Once the new off-payroll rules come into effect however, we will see the gap narrow again as end-clients are unwilling to take any risks in getting it wrong.
HMRC will no doubt spin this as meaning that their reform of IR35 is a success. The truth is, however, that the prosperity of the UK will suffer as talent and expertise will be less willing to take on the roles and end-clients will have a shallower pool of people to choose from.
Unfortunately, reduction to GDP is not part of the tax gap and in any event the 2019/20 reporting period will also show the start of the coronavirus effect. While all reasonable people applaud efforts to prevent fraud in the government packages designed to help us all though the pandemic, experience says that HMRC is ill-equipped to react quickly or efficiently.
We see newspaper headlines of action being taken against those exploiting the pandemic measures. But look closer. Almost all of the cases are based on taxpayers coming forward and reporting possible abuse. Where is HMRC? Where is the sort of interventionist policy that Loan Charge contractors needed when schemes were rampant and which the whole country needs now? The tax gap, reporting 15 months after the event is useless in this context. The expected increase in the 2020/21 ‘gap’ will no doubt be explained away by the pandemic.
Final thoughts (includes Godot)
Expecting more official analysis of the gap's value, a better explanation, transparency in measures taken to close the gap further (other than more draconian powers), is all rather like waiting for Godot. Most tax professionals know this.
Individual taxpayers -- and unfortunately that likely includes contractors, will perhaps have more to concern themselves with, as the largely compliant find themselves targets based on a measure that has less and less credibility.
Nonetheless, politicians like the measure. It’s simple, easy to justify and hides a list of flaws. But as with all measures of this type, we encourage MPs to dig a little deeper in holding HMRC to account before the event, rather than some years after as a result of 99-page collection of estimates.