A National Audit Office (NAO) study on tax fraud broadly supports HMRC’s efforts to close its £34bn tax gap, while gently questioning the quality of the data behind that strategy.
The NAO’s Tackling Tax Fraud report published today repeats the HMRC estimate that annual losses attributable to tax fraud amount to £16bn each year, nearly half of the £34bn tax gap.
In 2014-15 HMRC reported £26.6bn additional revenue from all its compliance work, including work to tackle tax fraud but also work to tackle other parts of the tax gap like error and tax avoidance.
The £34bn tax gap figure is the one HMRC has been quoting for most of the year, but what may alarm many accountants is way the tax department has positioned small businesses alongside organised crime as the biggest perpetrators of tax fraud.
According to the NAO report, HMRC identified three main areas where tax revenues are lost to fraud: £5.1bn criminal activity, £4.4bn evasion and £6.2bn hidden economy. Small businesses were linked to nine of the 21 biggest tax fraud risks, compared to organised crime, which was associated with eight of these risks. HMRC said these businesses are responsible for tax losses of £17bn, representing nearly half of its estimated tax gap.
HMRC cited small businesses failing to register for VAT when their turnover exceeds the threshold as an example of a tax fraud risk.
As a result of this conclusion, much of HMRC’s enforcement and compliance activity has targeted small businesses. This has drawn justified complaints from businesses, their advisers and MPs that the department is more interested in picking off smaller fry rather than tackling serious criminals and corporate tax evaders.
This strategy was reflected in a dramatic increase in prosecutions by HMRC to achieve a target of 1,000 a year by 2014/15. But the auditor noted, “The target had the effect of prompting the department to change its processes and make its investigations more efficient. This led it to focus on less complex cases, in particular a large number of prosecutions for people who had evaded income tax, VAT and tobacco duty.”
The NAO report also repeated long-running concerns about the quality of HMRC’s data. The department itself is “not able to say with confidence what proportion of the tax gap related to evasion is caused by these businesses”.
Just to recap, the £26.6bn “compliance yield” figure is based on a complex measure HMRC uses that combines tax recovered from civil and criminal investigations, the losses that interventions are likely to prevent in the future and estimates of the impact of anti-avoidance legislation.
“What HMRC measures has varied over time and caution is needed when making year‑on-year comparisons,” the report noted, harking back to its conclusion in that that HMRC had overestimated its compliance yield in 2013-14 by nearly £1bn. This year, however, based on the “partial evidence” available, the auditors were happy to accept that the tax department had exceeded its compliance yield target by £600m. In their estimate, between 30% and 40% of that total was generated by HMRC’s activities to tackle tax fraud.
In a summary of the data quality issues it encountered, the report commented, “We have found that HMRC does not always have the data and management information it needs to fully evaluate its activities, and that it relies on measurements of output as a proxy for evidence of effectiveness.”
These criticisms were echoed more widely in the press and elsewhere. Reacting to HMRC’s vague data, tax campaigner Richard Murphy said: “HMRC not only use a dire methodology, estimating evasion from tax returns received and not from macro-economic data, meaning that by definition they are bound to understate the scale of tax evasion, but even then the estimates they have made are so bad that they are at best ‘partial evidence’.”
Elsewhere in the profession ICPA chairman Tony Margaritelli has been flagging up HMRC’s dubious tax gap figures since the spring and pointing out the injustice of comments from HMRC business tax director Jim Harra chastising accountants who represent 70% of small businesses for permitting so much tax to escape HMRC’s net.
“We actually don’t have any control over whether our clients do or do not pay their bills at the correct time,” Margaritelli responded.
The Association of International Accountants echoed Margaritelli’s concerns in a discussion document about HMRC’s penalties. “In order to promote better client awareness HMRC should utilise the knowledge and experience of tax agents to help rather than undermine the work they do… This is an example of HMRC targeting the easier option rather than focusing on issues such as offshore banking facilities.”
The NAO study is a benchmark for continuing scrutiny of HMRC’s effectiveness in tackling fraud over the course of this Parliament.
“HMRC has started to take a more strategic view of its compliance business, but needs to go further,” the study concluded. “It has begun to shift the balance of its work, placing increasing emphasis on measures to prevent non-compliance rather than relying so much on investigating it afterwards.
“It is working to improve the way it collects and analyses data. For example, it has improved its assessment of tax risks, and is seeking to link this analysis more explicitly with the compliance yield it achieves and its decisions about where to deploy resources. Alongside these positive steps, we encourage HMRC to do more to strengthen the evidence that underpins its decisions, and to develop a clearer view of what would be the optimal balance of compliance activities based on sound data, analysis and judgement.”
The study also noted that the anti-fraud strategy is evolving alongside HMRC’s broader transformation programme. “A great deal of HMRC’s energy and focus over the next five years will be to automate its systems and migrate more taxpayers into digital channels in order to increase its efficiency and effectiveness,” the NAO authors noted.
“If successful, these measures will increase the amount of tax HMRC collects through its standard processes, allowing an increasing proportion of its expertise to be devoted to tackling those who deliberately break the rules. As we reported in July 2015, HMRC’s plans for change are ambitious and carry with them significant delivery risks.”