Tax Gap ticks back up – no sign of MTD impact
‘Tax Gap’ figures published today show the gap increasing in both absolute terms and as a share of the tax that should be collected, after five years when the latter figure fell.
The tax gap is the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid. Today’s HMRC report1 looks at the estimated tax gap in 2019-20. The report puts the tax gap at an estimated £35 billion, which is 5.3 per cent of tax liabilities. It was 5.0 per cent in 2018-19, though it had proportionately fallen for the previous five years, from 7.1 per cent in 2013-14.
Today’s figures cover the first year of ‘Making Tax Digital’ (MTD), when compulsory digital record keeping and quarterly digital reporting for VAT were introduced by HMRC. HMRC stated that this would ‘reduce the amount of tax lost to avoidable errors’.2 However the amount of tax lost to both error and ‘failure to take reasonable care’ has increased significantly in the latest figures, as has the overall ‘VAT gap’ estimate.3
John Barnett, Chair of CIOT’s Technical Policy and Oversight Committee, said:
“After five consecutive years of a falling rate of tax gap, the slight uptick in 2019-20 can be seen as disappointing. However, the tax gap figures are always imprecise4 – last year’s numbers have themselves been revised upwards by a similar amount5 – so it would be wrong to read too much into this small increase at this stage.
“The figures suggest HMRC is still collecting about 95 per cent of tax due, which compares well internationally.”
Taxpayer mistakes / Making Tax Digital
The report puts tax lost due to taxpayers’ failure to take reasonable care in 2019-20 at £6.7 billion (1.0% of total theoretical liability) and tax lost due to taxpayer error at £3.7 billion (0.5%). The figures are up from £6.1 billion (0.9%) and £3.1 billion (0.4%) respectively in 2018-19.
John Barnett commented: “The findings in this report illustrate the complexity of the tax system. More than £10 billion of the tax gap relates to taxpayers not getting things right through what HMRC categorise as error or a failure to take reasonable care.
“Whilst we recognise that we are in the early days of Making Tax Digital (MTD)6 and the published tax gap data doesn’t allow a granular analysis, we are surprised to see such a significant increase in these elements of the tax gap. MTD is supposed to reduce the tax lost from these behaviours and bring in hundreds of millions of pounds of additional revenue. So far there is no clear sign that this is happening.
“These figures back up what CIOT have heard from our members – that Making Tax Digital is unlikely to reduce the amount of taxpayer error and may even in some situations be increasing it.7
“The theory behind digitalisation of the tax system is sound – and experience during the coronavirus has shown its merits. But HMRC must thoroughly assess the effectiveness of MTD, as well as whether the administrative burden it is imposing on business is reasonable, before they expand it further.
“Ministers must also stay focused on the need for simplification – a simple tax system, with clear rules and easy to navigate guidance will lead to fewer mistakes by both taxpayers and tax authorities.
“This is particularly true for small businesses. According to HMRC’s figures, small businesses account for over 40 per cent of the tax gap – though many of these are yet to be mandated into the MTD system.”
The report puts tax lost due to ‘legal interpretation’ in 2019-20 at £5.8 billion (0.9% of total theoretical liability). This is up from £5.0 billion (0.8%) in 2018-19.
John Barnett commented: “The legal interpretation part of the tax gap also increased to £5.8bn, its highest absolute amount for five years. So, ‘mistakes’ caused largely by the complexity of the system – error, failure to take reasonable care, and legal interpretation – now represent nearly half of the total tax gap.
“Legal interpretation is about tax which may or may not legally be due but the system is so complex that neither taxpayer nor HMRC yet know! Examples include the correct categorisation of an asset for allowances, the allocation of profits within a group of companies, or VAT liability of a particular supply. The £5.8bn figure makes the spurious assumption that HMRC’s view of the law is right in 100% of cases. We query why this category is part of the tax gap at all.
“This is another argument for a simpler tax system. If even HMRC are uncertain of the law to the tune of £5.8 billion what hope is there for the ordinary taxpayer faced with the same complexity in the tax system?”
From April 2022 this element of the tax gap will be targeted with a new requirement for large businesses to notify HMRC if they have adopted a tax treatment where the business believes that HMRC, or a tribunal or court, may not agree with their interpretation of the legislation, case law, or guidance.8
The report puts tax lost due to evasion in 2019-20 at £5.5 billion (0.8% of total theoretical liability), tax lost due to criminal attacks on the tax system at £5.2 billion (0.8%) and tax lost due to the hidden economy at £3.0 billion (0.4%).
John Barnett commented: “After substantial falls in evasion and criminal attacks since 2013, progress seems to have stalled and in absolute terms the amounts being stolen from the Exchequer by criminals appear to be going up. This suggests that while the Government’s actions in the early 2010s to put extra resources into identifying and tackling tax evasion and other illegal activity were successful they now need to think more imaginatively and make effective use of the latest techniques for spotting and tackling criminal activity.
“We would suggest that the main focus for HMRC should be on continued investment in data analytics to analyse the large amount of data they now have access to, and ensure that they have adequate numbers of compliance officers with the right kind of training to identify and target illegal activity.”
The report puts tax lost due to ‘non-payment’ (largely taxes written off as a result of insolvency) in 2019-20 at £4.0 billion (0.6% of total theoretical liability). This is marginally down on 2018-19 (£4.1 billion; 0.6% but up from £3.1 billion (0.5% at the time) in 2015-16.
John Barnett commented: “Non-payment reflects in large part the state of the economy, rather than anything HMRC can control. It increased sharply between 2006-7 and 2009-10, doubling both in absolute terms and as a share of the theoretical liability.
“These 2019-20 figures do not reflect the impact of the pandemic on business closures. The report includes an adjustment to account for tax payments deferred in March 2020 due to the pandemic. Next year’s presumably will do too. We will probably have to wait a number of years for the full impact of the pandemic to become clear, as the government’s economic support measures are wound down and we find out how much of the tax deferred in 2020 will ultimately go unpaid due to business failure.
“Also worth noting is that the government introduced changes in last year’s Finance Bill to give HMRC a higher priority in recovering debt that businesses owe when they become insolvent. They have predicted these will cut the tax gap by £150-200 million a year in a typical year. This change took effect in December 2020 so should start to be visible in the next set of tax gap numbers.”
The report puts tax lost due to avoidance in 2019-20 at £1.5 billion (0.2% of total theoretical liability). These numbers are both unchanged on 2018-19. The first tax gap figures (2005-6) put the ‘avoidance gap’ at £4.7 billion (1.1% of total theoretical liability).
John Barnett commented: “Tackling avoidance is the big success story of the government’s efforts to tackle the tax gap. The avoidance gap is less than a third of what it was 15 years ago, less than a fifth as a share of the total tax that should be collected.
“It is noteworthy that more than twice as much is lost to errors as to avoidance.”