Tax gap soars to £40b, with small business in the firing line

As the latest tax gap report fuels the political fire, small businesses are copping the brunt of the blame.

by | 26 Jun, 2024

Stacks of folders and books with sticky note tabs on a table
  • HMRC’s latest report shows largest ever tax gap.
  • Small businesses blamed for the bulk of the gap, but mistakes rather than evasion are the most common cause.
  • Labour, the Conservatives and the Lib-Dems all promise action to reduce the gap.

According to this year’s tax gaps report from HMRC, while the current situation is less than ideal, it’s moving in the right direction.

The data says the tax gap for the 2022/23 tax year adds up to 4.8 per cent of total theoretical tax liabilities of £823.8 billion. That is £39.8 billion in absolute terms, a record high in terms of amount, if not proportion of theoretical liability.

Over the long term, HMRC says, there has been a “reduction in the tax gap as a proportion of theoretical liabilities: the tax gap reduced from 7.4 per cent in the tax year 2005 to 2006 to 4.8 per cent in the tax year 2022 to 2023”.

In the same period, the VAT tax gap fell from 13.5 per cent to 4.9 per cent.

However, it’s not all good news. Looking at corporation tax – the largest component of the tax gap by tax type – the gap increased from 11.4 per cent in 2005/06 to 13.9 per cent in 2022/23.

Worse still for small businesses is the fact that they are copping the blame for the bulk of this part of the revenue shortfall.

By customer group, small businesses are responsible for 60 per cent of the corporation tax gap, while “wealthy and individuals each make up a low proportion of the tax gap at five per cent each in 2022 to 2023”, the report said.

Around 32 per cent of corporation tax owed by small businesses remains unpaid, adding up to about £11 billion in lost tax revenue.

The overall share of the tax gap attributable to small businesses has grown dramatically over the past several years, from 44 per cent in 2018/19 to 60 per cent in 2022/23.

 

Blaming small business “white-van men”

“It’s clear that the main problem is with corporation tax, where small businesses have had a tax gap of almost 30 per cent for the last three years – up from around 17 per cent in the mid-2010s,” said a report by Taxwatch UK.

“No other major tax type has seen an increase in its tax gap figure of anything like these amounts.”

“Error and carelessness account for around 45 per cent of the tax gap, indicating that other, more serious, behaviours are involved for over 50 per cent of the gap – a sum of nearly £20 billion.”

Tax expert Richard Murphy, Professor of Accounting at Sheffield University Management School and director of Tax Research LLP and the Corporate Accountability Network, says some politicians are giving small businesses a free pass on tax errors.

The Labour party is targeting the wrong group by focussing on the wealthy, he told The Guardian.

“The tax abuse scandal is among white-van men,” he said. “But politicians don’t want to hear that, as white-van man lives in their constituency.”

It is important to note that HMRC says the concept of tax avoidance plays a relatively small role in the tax gap, with £500 million allocated to tax avoidance of income tax, NICs and Capital Gains Tax and £1.5 billion to the “hidden economy”.

Much of the overall tax gap caused by small businesses is believed to come down to small business owners making mistakes with their tax reporting – errors, as opposed to intentional avoidance.

 

It is no secret that there is work to be done by HMRC around better educating, assisting and being available to offer advice to small and medium businesses and their accountants.

That alone, will help them understand their various and sometimes complex tax obligations.

A report from Tax Policy Associates accuses HMRC of losing control of small business tax.

“If HMRC had closed the small business tax gap as effectively as it closed other tax gaps, HMRC would collect £15 billion more tax revenue each year,” it said.

What’s in store?

As we fast approach a general election, Labour is promising to target tax evasion.

“After 14 years in power, the government have lost any focus and energy in tackling tax compliance and avoidance, and they have weakened the deterrent effect of prosecutions and penalties, with falling numbers of criminal investigations for tax evasion,” says the Labour’s Plan To Close The Tax Gap report.

Labour’s plan includes:

  • Increasing staffing on compliance;
  • Lending greater resources to segments with greater complexity, including “upstream compliance activity … to improve compliance yields” for small businesses;
  • A focus on offshore tax compliance;
  • Improved quality of compliance checks;
  • Drawing on external resources, in the short term, to raise tax revenue; and
  • Improving customer service.

Similarly, the Conservative party says it aims to raise a further £6 billion annually by targeting tax avoidance and evasion and “hiring additional HMRC staff, investing in labour-saving technology such as AI, and focusing particularly on problem issues like umbrella companies and regulation of the tax advice market.”

Finally, the Lib Dems are promising an extra £1 billion of funding annually to HMRC, to improve customer support, boost compliance and target tax avoidance activity.

The good news for accountants is that the solution involves their skillsets, and that all parties are promising greater funding to HMRC. This is a recognition of the clear customer service issues that have made compliance difficult for many small business owners.

Whoever wins at the polls will have a greater focus on small business reporting to reverse the dramatic rise in incorrect returns during, and since, the Covid-19 pandemic.

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