Tax Gap steady despite pandemic

‘Tax Gap’ figures published today show the gap remaining steady as a share of the tax that should be collected. The gap was down £2 billion in absolute terms in 2020-21 but this is in line with a fall in the theoretical tax liability during a year when the coronavirus pandemic had a significant impact on the tax system.

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 2020-21, but also revises some figures for earlier years. The report puts the tax gap at an estimated £32 billion, which is 5.1 per cent of tax liabilities. It was also 5.1 per cent in 2019-20, though it had been on a downward trend over the previous six years, from 7.2 per cent in 2013-14.

John Barnett, Chair of CIOT’s Technical Policy and Oversight Committee, said:

“On the face of it the pandemic has not had a significant effect on the tax gap, though as HMRC themselves note, the estimates for 2020 to 2021 are subject to even more uncertainty than usual due to COVID-19.

“The figures suggest HMRC are still collecting about 95 per cent of tax due, which compares well internationally.”

CIOT has also commented on some of the individual components of the tax gap.

Taxpayer mistakes / Making Tax Digital

The report puts tax lost due to taxpayers’ failure to take reasonable care in 2020-21 at £6.1 billion (1.0% of total theoretical liability) and tax lost due to taxpayer error at £3.0 billion (0.5%). The figures were £6.1 billion (0.9%) and £3.5 billion (0.5%) respectively in 2019-20.

John Barnett commented: “The findings in this report illustrate the complexity of the tax system. More than £9 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.

“We now have figures for the first two years of ‘Making Tax Digital’ (MTD)² – the introduction of compulsory digital record keeping and quarterly digital reporting for VAT by HMRC. HMRC have said that this will ‘reduce the amount of tax lost to avoidable errors’.³

“It is hard to judge whether this is actually happening. In the first year of MTD (2019-20) the amount of tax estimated as being lost to taxpayer error rose from £3.1 billion to £3.5 billion. The following year it fell back to £3.0 billion. But given the extent to which tax gap figures get revised in succeeding years, as well as the particular circumstances in 2020-21, we will need further years of figures before we can judge whether this fall is a lasting trend.

“The theory behind digitalisation of the tax system is sound – and experience during the pandemic 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 get much more 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 48 per cent of the tax gap – though many of these are yet to be mandated into the MTD system.”

Legal interpretation

The report puts tax lost due to ‘legal interpretation’ in 2020-21 at £3.7 billion (0.6% of total theoretical liability). This is down from £5.6 billion (0.8%) in 2019-20.

John Barnett commented: “This looks a substantial fall in the legal interpretation part of the tax gap, though it follows a year when it rose significantly, so it is hard to know at this stage if this is a trend or a blip.

“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 £3.7 billion figure makes the spurious assumption that HMRC’s view of the law is right in 100 per cent 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 £3.7 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 is being 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.⁴

Criminal activity

The report puts tax lost due to evasion in 2020-21 at £4.8 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 £3.2 billion (0.5%).

John Barnett commented: “After substantial falls in evasion and criminal attacks since 2013, progress on evasion 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.”

Non payment

The report puts tax lost due to ‘non-payment’ (largely taxes written off as a result of insolvency) in 2020-21 at £4.9 billion (0.8% of total theoretical liability). This is slightly up on 2019-20 (£4.6 billion; 0.7%) and in absolute terms the highest loss in this area since the tax gap series started in 2005.

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, then dipped, but now appears to be on another upward trend.

“While the 2020-21 figures cover a period when the pandemic closed many businesses the year also saw economic support measures including not just furlough, the self-employed scheme and bounceback loans, but also temporary tax cuts and taxpayers being given more time to pay. The economic support measures undoubtedly helped many business survive the pandemic but the long-term situation is less clear. We will probably have to wait a number of years for the full impact of the pandemic to become clear, as we find out how much of the tax deferred in 2020-21 will ultimately go unpaid due to business failure.

“Also worth noting is that legislative changes to give HMRC a higher priority in recovering debt that businesses owe when they become insolvent took effect in December 2020. The government predicted these would cut the tax gap by £150-200 million a year in a typical year.”

Avoidance

The report puts tax lost due to avoidance in 2020-21 at £1.2 billion (0.2% of total theoretical liability). These numbers are both unchanged on 2019-20. The first tax gap figures (2005-6) put the ‘avoidance gap’ at £4.8 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 just a quarter 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.”