A new report from the National Audit Office (NAO) has revealed that the UK is losing billions of pounds annually due to tax evasion, with small businesses accounting for the majority of lost revenue. The report highlights significant weaknesses in government systems and calls for a more robust strategy to tackle the issue.
According to HM Revenue and Customs (HMRC) estimates, £5.5 billion was lost to tax evasion in the 2022-23 fiscal year. Alarmingly, 81% of this evasion came from small businesses, a significant increase from 66% in 2019-20. The retail sector appears particularly vulnerable, with 42% of registered retail companies incorporated since January 2023, compared to just 23% across all sectors.
The NAO report highlights significant weaknesses in government systems that have left the UK vulnerable to tax evasion. Since 2011, it has been quick and easy to set up UK companies online from anywhere in the world, creating opportunities for fraudulent businesses. In 2022-23, there was a surge in company registrations ahead of stricter rules being implemented, with 801,000 new companies registered – 20% more than in 2019-20.
HMRC’s Strategy and Performance
HMRC’s approach to tackling the problem has come under scrutiny. The tax authority lacks a specific strategy to address tax evasion, instead focusing on preventing overall levels of non-compliance from increasing. This approach has led to insufficient emphasis on widespread forms of evasion in the retail sector, such as electronic sales suppression (ESS) and phoenixism.
The report notes that HMRC does not know how successful it is in tackling tax evasion. While it estimates that its compliance work reduces the tax gap to around half of what it would otherwise be, it doesn’t track how much of this reduction relates specifically to evasion.
“One of the more shocking findings from the NAO report is that HMRC doesn’t have a specific strategy for clamping down on tax evasion,” says Dawn Register, head of tax dispute resolution at accountancy and business advisory firm BDO.
“Given it’s costing the taxpayer some £5.5bn a year, this should be an immediate priority. Law-abiding businesses expect to see action against those who are flouting the rules so that they can compete on a level playing field.”
Online Retail and VAT Evasion
The report does highlight some successes, particularly in online retail. By making online marketplaces liable for Value Added Tax (VAT) on sales by overseas retailers in January 2021, HMRC now estimates it collects at least £1.5 billion more in VAT annually – five times its initial prediction.
However, significant gaps remain. Overseas companies can still falsely present themselves as UK-based to evade VAT. HMRC’s latest indicative estimate suggests that VAT evasion by overseas retailers selling goods or services online amounts to £300 million annually.
Recent Developments and Unused Powers
In March 2024, stricter requirements were introduced at Companies House to improve the reliability of information on the company register. These include new powers to check information for company registrations, request evidence, and remove inaccurate information. However, some measures, such as verifying directors’ identities, are not yet fully operational.
The report also notes that HMRC has not yet utilized all the powers it has been granted to tackle evasion in retail. For instance, HMRC has powers to require overseas businesses with no UK establishment to appoint a UK VAT representative but has not yet used these powers.
“The NAO report illustrates that HMRC is simply not using all the new powers at its disposal. HMRC has a vast array of both civil and criminal powers to tackle tax evasion. It should make full use of these powers, and then evaluate their effectiveness, before seeking further power,” says Register.
Phoenixism and Director Disqualifications
The report highlights the issue of phoenixism – where companies artificially declare insolvency to avoid paying debts, including tax, before reforming as essentially the same company.
HMRC estimates that phoenixism accounted for 15% of its tax debt losses in 2022-23, equivalent to more than £500 million. Despite this, the Insolvency Service disqualified only seven directors specifically for phoenixism between 2018-19 and 2023-24, out of a total of 6,274 disqualified directors.
Recommendations and Criticism
Gareth Davies, head of the NAO, criticized HMRC’s response to the growing problem: “Although tax evasion has been growing among small businesses, HMRC has so far lacked an effective strategic response. Its assessment of risks has given too little emphasis to widely used methods of evasion such as sales suppression and phoenixism.”
Davies emphasized the need for a more comprehensive approach: “Real opportunities exist for HMRC to work more systematically across government to reduce it. Tighter controls and more compliance work could raise significant sums and improve value for money.”
The NAO recommends that HMRC should take a leadership role in working with other relevant parts of government to develop a shared understanding of the drivers of tax evasion and a more joined-up approach to tackling it. It also suggests that HMRC should evaluate the extent to which it is using its range of investigatory and enforcement powers and identify any gaps that limit the actions it can take.
Register emphasised the need for a clear strategy: “HMRC should set out its strategy to specifically address tax evasion and improve its ability to understand how successful it is in tackling it, learning lessons to improve future compliance activity. That strategy should encompass the hidden economy too – as some taxpayers deliberately fail to file returns and pay tax completely.”
As the UK grapples with economic challenges, addressing tax evasion becomes increasingly crucial. Not only does it deprive the public purse of billions in revenue, but it also creates an unfair competitive advantage for businesses that don’t play by the rules. The NAO report serves as a wake-up call for HMRC and the government to develop a more robust, targeted approach to tackling tax evasion, particularly among small businesses in the retail sector.