02 May 2017
The difference between tax avoidance and tax evasion was once summed up by Chancellor of the Exchequer Denis Healey as “the thickness of a prison wall”. However, in more quantifiable terms, it appears that difference is growing: analysis of HMRC statistics from tax consultancy RSM shows that while tax avoidance is at its lowest level on record, the amount of tax revenue lost through evasion and the hidden economy is rising, amounting to £11.4bn per year. So what’s gone wrong – and right – for HMRC?
At the outset it is worth noting that HMRC calculates that the gap between expected tax take and actual tax take (the ‘tax gap’) is now at 6.5%, its lowest level ever, primarily due to major upgrades in HMRC’s digital capacity and new action on persistent, aggressive tax avoidance. Likewise, new powers such as the offence of failure to prevent tax evasion (embodied in the Criminal Finances Bill, which the Government intends to pass in the wash-up period before the dissolution of Parliament) are likely to give prosecutors additional ability to reduce the incentives of complicity with tax evasion.
Yet even in the last few years, prosecutions for tax evasion have increased. The shorter sentences that have accompanied this rise indicate that tax evasion proceedings are being launched against ‘smaller fish’ than before, rather than prosecutors focusing on high-profile and high-value cases. So if enforcement action is hitting a wider range of offenders, why isn’t this translating into an overall fall in evasion?
Jason Collins, head of tax at Pinsent Masons, told KYC360 that it was “difficult” to say why the figures for tax lost through evasion and the ‘hidden economy’ were going up (the latter is defined by HMRC in their tax gap analysis as “[u]ndeclared economic activity that involves what we call ‘ghosts’, whose entire income is unknown to HMRC, and ‘moonlighters’, who are known to us in relation to part of their income, but have other sources of income that HMRC does not know about.”) Mr Collins speculated that “more casual labour, cottage businesses and self-employment” were perhaps to blame for the increase in losses. The rise in self-employment versus normal employment arrangements, and its more complex tax arrangements, would seem to back this up: indeed, the first wave of HMRC’s new prosecutions for tax evasion tended to hit the self-employed, according to an analysis from Thomson Reuters.
George Bull, senior tax partner at RSM, writes in his analysis that the problem for HMRC is likely twofold. Firstly, tax avoidance, being legal, is easier to detect as it is already on record somewhere even if it hasn’t been flagged up to HMRC; secondly, there may not be the same electoral advantage in sweeping anti-evasion action as there is in hitting more tempting targets such as large multinationals who manage their tax affairs creatively. “By contrast, there is the strong suspicion that huge numbers of people are involved in low-level tax evasion and the hidden economy,” he writes, adding that “an effective crackdown would not only be difficult because of the sheer numbers of cases involved, but might turn affected voters against the government of the day.”
This is particularly true of the hidden economy. The prototypical example of evasion or ‘hidden economy’ practices that go unreported is the practice of paying tradesmen cash-in-hand to allow them to avoid paying income tax or VAT, thus reducing the cost of the service. This has created political controversy in the past, with Conservative and Labour figures both describing the practice as wrong, though taking significant criticism in the press over the prospect of action against it. However, some research from Italy indicates that there may in fact be political benefits to cracking down on widespread and visible tax evasion, pace Mr Bull’s argument, though it is notable that Italy’s tax system is far less efficient than the UK’s, with PricewaterhouseCoopers ranking it 126th against the UK’s 10th place on its ‘ease of paying taxes’ index. The Italian fruit is, so to speak, somewhat lower-hanging.
“HMRC would say that they are not powerless,” Mr Collins told us when asked how HMRC could go about reversing the upward trend in evasion and loss through the hidden economy. “They are ensuring big businesses are taking more responsibility for fraud in their markets and supply chains, such as with the new corporate offence [of failing to prevent tax evasion] and the new rules for online marketplaces. They probably need to do more to educate households about not engaging help without being comfortable it is being declared, and also to make the informal economy think they are more likely to be caught.”
As it stands, though, it’s still quite hard to explain the curious trend: the professionals we spoke to were all cautious about pointing to any one cause, and HMRC itself was unwilling to speculate in its analysis of the tax gap. Although the overall gap is shrinking, the striking relative increase in evasion may simply be a product of wider changes in the British economy over the last few years. In the lead-up to the general election, tax evasion and avoidance are likely to represent a significant battleground as the Treasury looks for a few extra billion pounds to help cushion the impact of the UK’s withdrawal from the European Union. This will not be an easy area of policy: dealing with widespread tax evasion practices will require a significant investment of resources, possibly with diminishing returns, both fiscal and political. The UK’s compliance rate is already among the highest in the world, and it seems likely that, if the analyses above are correct, some very significant changes either to the mechanisms of taxation enforcement or the structure of the British economy itself would have to occur for evasion to fall significantly.
Richard Nicholl (@rtrnicholl) is Legal Editor for a leading provider of corporate legal intelligence. He also works as a freelance political commentator and investigative journalist.
You can claim CPD minutes for reading this article, by signing up to our CPD WalletFREE CPD Wallet