HMRC and small business tax evasion
Niall Hearty of Rahman Ravelli considers HM Revenue and Customs’ big problem with small businesses
When it comes to tax evasion, the media focuses on the big numbers and the biggest names. Cases involving the largest companies, allegations of colossal amounts not being paid and the most sizeable penalties are the ones that, understandably, make the news.
Such cases can be great PR for HM Revenue and Customs (HMRC). It is seen to be clawing back large amounts and holding the big boys to account. Away from the news pages, however, it is equally important that HMRC is equally diligent when it comes to bringing action against the less high-profile companies, where less spectacular amounts are involved.
Such action is unlikely to generate headlines – but it remains a necessary HMRC function. HMRC’s approach to this more “bread and butter’’ side of its work, however, has now led to news coverage – and not the kind it would have wished for.
The National Audit Office (NAO) reported that HMRC has failed to prevent small businesses evading the payment of taxes totalling over £4.4 billion. This, says the NAO, is due to HMRC lacking a focused strategy for combating the various tax evasion schemes being used. It argues that HMRC’s general strategy for tackling evasion involving particular types of taxes and groups of taxpayers is not effective in all circumstances, which is why the non-payment statistics for small businesses are so high.
The solution, according to the NAO, is for HMRC to work more systematically across government. It cites the rapid increase in online businesses – and weaknesses in ensuring they are properly registered – as one area where a tighter approach is needed to reduce tax evasion. The NAO added that the fact that 42% of all companies incorporated last year were retailers suggests the retail sector may now pose the highest risk of tax fraud in need of urgent action.
The picture that the NAO paints is not one that makes pleasant viewing for HMRC. The tax authority could, in its defence, point to the tougher requirements introduced earlier this year that should make it more difficult to abuse the Companies House registration scheme for businesses. It could also emphasise the figures that show that tax evasion in general has stabilised in recent years; although last year’s figure of £5.5 billion lost to tax evasion is not something to be proud of.
With evasion still rising in the small business sector and the NAO pinpointing problems, the HMRC has issues that it must address. HMRC must, according to the NAO, tackle the problem of businesses that go into insolvency to shirk their tax debts only to reappear as new companies. Such so-called phoenix companies are responsible for more than £500 million a year in tax losses - and possibly more, according to the NAO. Yet of the 6,274 company directors disqualified in the past five years, only seven were struck off for this practice.
The challenge facing HMRC is how it addresses what appear to be blind spots in the way it works. Identifying tax evasion in smaller businesses – whether or not they are in the retail sector – may not produce individual cases that generate the headline-grabbing big numbers. But the NAO report shows that these cases add up to large amounts.
HMRC has the tools to resolve such cases. It now needs to decide how best to apply those tools. The small business sector is clearly an area where tax collection is far from perfect. The
HMRC may argue, with justification, that staffing and resources make it difficult for it to pursue each and every business in that sector. And it is clearly more cost effective for HMRC to target large businesses. But clearly something needs to change.
Due to restrictions in government funding generally across the board, HMRC could - as the NAO suggested - possibly benefit from working more closely with other government departments. Companies House, to take just one example, has invested in new initiatives such as developing software for ID verification to combat fraud under the Economic Crime and Corporate Transparency Act 2023. Greater collaboration with it may provide HMRC with the data or other means to tackle the ways small businesses sidestep their tax obligations, particularly when it comes to issues such as phoenix companies. There may even be the potential for HMRC to itself adopt a more digital approach to holding tax evaders to account.
At this stage, however, there does not appear to be a clear blueprint that HMRC can use immediately for tackling its small business problem. But in the UK, the difference between the expected amount of tax to be collected and what is actually collected – known as the tax gap – was £39.8 billion in 2022-23, according to HMRC. Some believe the actual figure is much larger. If small business tax evasion is accounting for more than a tenth of that figure, HMRC has to be seen to be addressing this sooner rather than later.
