Designing good compliance into the tax system

Why do people evade tax?

HM Revenue & Customs estimates the total UK tax gap, the difference between the tax collected and the amount that should be collected “in theory”, at £34bn. Just £1.7bn relates to avoidance (excluding international tax planning strategies such as profit shifting, which are being addressed slowly but multilaterally), and £6bn relates to interpretation of the law.

In contrast, criminal attacks account for around £5bn and evasion another £5bn, while £3.5bn is attributed to the “hidden economy”. If income is declared but understated, HMRC regards that as evasion. A source that is not declared at all is part of the hidden economy, including “ghosts” and “moonlighters”.

HMRC also estimates that individuals and small and medium-sized enterprises, account for £19bn – or 56% – of the tax gap. A recent Institute for Fiscal Studies report based on tax return audit data for the ten years to 2009 suggested that more than a third of self-assessment taxpayers under-reported tax liabilities. “This rises to almost 60% among the self-employed,” the report said.

How reliable are HMRC’s estimates? According to the Chartered Institute of Taxation, the impact of SMEs on the tax gap merits a more detailed explanation than HMRC provides. “Without more granularity on the nature of the impact on the tax gap, HMRC risks stigmatising SMEs, which could be unfair and does not seem calculated to improving whatever underlying behaviour is the cause of the problem. It is also unhelpful to the public’s understanding of tax,” CIOT tax policy director John Cullinane said on 12 January in response to a Commons public accounts committee report.

External influences

It does seem sensible, however, to find out as much as possible about what motivates people to evade tax. Research conducted for HMRC and published last September, based largely on 45 interviews with SMEs who “engage in tax evasion”, identified four distinct profiles of evader. The report gave an insight into external influences driving or reinforcing behaviour, including social norms and “media noise”. It suggested that some mainstream and social media coverage of tax issues reinforced a view that evasion is “low risk” – there was a perception that the odds are “stacked against HMRC” – or that there was “one rule for them and one for us”.

Separately, research on the nature and scale of the hidden economy, published by HMRC last October, found mixed opinions on whether it was acceptable not to declare small amounts, occasional income of any amount, or income from internet sales.

HMRC’s “promote, prevent, respond” compliance strategy is based on a belief that the best way to tackle non-compliance is to prevent it happening in the first place. It seeks to promote good compliance by “designing it into our systems and processes, enabling customers to get their affairs right from the outset”.

Sectors ‘vulnerable to evasion’

This approach underpins both the Making Tax Digital project, based on the assessment that digital records and reporting will make it harder for taxpayers to make mistakes, and a proposal to tackle the hidden economy by making compliance with certain tax obligations a condition of holding some licences. A second consultation on this “conditionality” initiative will close on 2 March.

The hidden economy “distorts fair competition and is linked to wider rule breaking and criminality, including money laundering, health and safety violations, failure to comply with employment rights and immigration offences,” according to HMRC’s consultation paper.

Most businesses require services from other businesses, or approvals and services from local or national government, HMRC notes. The proposals would integrate tax registration checks into some of the existing approvals, and HMRC suggests that this could lead to improved standards of compliance with non-tax regulations.

Sectors being considered for the proposed changes include those considered “vulnerable to hidden economy activity”. These are private security, taxis and private hire vehicles, houses in multiple occupation (HMO), scrap metal, and “retail and services”.

HMRC observes that the Security Industry Association exists to improve standards in the private security industry, a sector “affected by crime and tax evasion”. It believes that the impact of waste crime includes a landfill tax gap of £100m. In the scrap metal industry, while trading in cash has been banned since 2013, the government believes that applying conditionality to licences could strengthen regulation in the sector. Although overall standards of tax compliance in the licensed taxi and private hire industry are good, HMRC says, the government believes “the composition of the sector makes it vulnerable to evasion and hidden economy activity from a minority”.

Other measures

While avoidance continues to be the focus of public debate, several measures to tackle evasion have been enacted recently and there are more to follow, in addition to those already outlined. The government announced, at autumn budget 2017, progress on:

  • A crackdown on VAT evasion by extending powers that make online marketplaces “responsible for the unpaid VAT of their sellers”
  • A proposed requirement for designers of certain offshore structures to notify HMRC of those structures
  • An extension of assessment time limits for non-compliance relating to offshore income
  • A proposed VAT reverse charge to prevent VAT losses due to fraud in construction industry supply chains.

Finance (No2) Act 2017, enacted last November, sets out the framework for digital record-keeping and reporting. Much of the detailed rules behind the Making Tax Digital project, however, will be set out in regulations. The Act also has measures dealing with penalties for errors in taxpayers’ documents, a requirement to correct certain “offshore tax non-compliance”, and penalties for transactions connected with VAT fraud.

Standards for tax agents

Tax advisers who are members of AAT, or one of the other professional bodies that signed up to the updated guidance on Professional Conduct in Relation to Taxation, will be familiar with the guidance on tax evasion. For example, a member “must never be knowingly involved in tax evasion although, of course, it is appropriate to act for a client who is rectifying his tax affairs” (paragraph 9.6). The challenge of keeping on top of recent legislation, while seeking to protect a taxpayer’s rights in the face of increased HMRC powers, is a considerable one.

It is worth noting that HMRC’s standard for agents, updated on 4 January and based largely on the PCRT, is intended to clarify what is expected of agents, “particularly those who are not members of professional bodies”.

Andrew Goodall is a freelance tax writer and journalist.

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