In 2022/23, HMRC have lost £5.5 billion of revenue. 81% (£4.4 million) of this loss was attributed to small businesses (companies, partnerships and sole traders). In the years since, tax evasion among small business has increased, although it does remain stable across other sizes of businesses.
According to the National Audit Office, HMRC does not have an effective strategic response to tax evasion. To prevent HMRC losing billions, it’s time to tackling tax evasion on the high street and online retail.
This blog will look at what is contributing to the HMRC’s tax loss across the high street and online retailers, what the government’s current approach is, and what might need to be improved to prevent this from continuing to occur.
So, let’s get started with looking at some of the biggest contributors to these huge losses.
Phoenixism
Phoenixism is a proves whereby companies are created and later artificially dissolved with the sole purpose of defaulting on their debts and avoiding their liability to tax. Their underlying trade continues under the guise of a newly created separate company, which leaves HMRC heavily out of pocket, with phoenixism repeatedly occurring for serial offenders.
The ease of setting up these companies on Companies House is unfortunately assisting phoenixism.
Electronic Sales Suppression
Sophisticated ESS software is allowing businesses to mis-report transactions either during or after the point of sale, producing a seemingly ‘legitimate’ audit trail while understanding income and hence tax playable.
VAT Misrepresentation
Similarly, online marketplaces struggle similarly with authentication and are becoming increasingly unable to accurately verify seller information and platforms are unintentionally allowing overseas businesses to divert their UK VAT liabilities. Online marketplaces make overseas businesses who are selling to the UK liable to UK VAT, which these sellers try to avoid by creating UK entities for the sole purpose of assigning UK VAT to them. Those who divert their UK VAT liabilities to their UK entities in full only suffer VAT once the new entity exceeds the £90,000 threshold.
These ‘UK entities’ have little to no real physical presence in the UK and so far VAT purposes cannot constitute a genuine UK establishment – the VAT liability remains with the overseas sellers! Again, the ease of creating UK companies is a key driver in the UK tax evasion.
The Current Approach
In Cardiff, HMRC deploy a one-to-many letter strategy, otherwise known as nudge letters. This involves writing to groups of businesses whose returns flagged a common issue (e.g. the same or similar address), and is therefore used to tackle the tax loss via VAT misrepresentation. However, the HMRC was criticised by the NAO for doing very little investigation into the mechanisms behind these under-declaration.
Many think that HMRC is lacking a strategic approach to tackle phoenixism and ESS. In fact, ESS appears to be challenged simply through publicity of HMRC’s data collection powers and fines for promoters and sellers of ‘offending’ software, and phoenixism only as a ‘tag on’ to pursuit of directors of failed companies.
This approach is generalist rather that strategic or focused, and often on a case-by-case basis, which is ultimately problematic. Focusing costly and resource intensive investigations into high end crime and using basic compliance investigations to tackle low value cases restricts resource for middle end cases where there may be larger, well-hidden frauds.
A Better Approach
To tackle phoenixism, HMRC have proposed changes to Companies House in an effort to make the process of registering a company more rigorous, for example, by better verification of the identity of directors.
A more effective way of targeting phoenixism is with the threat of criminal prosecution for abusive practices in this regard and by pursuing directors personally for their assets. Without this real deterrent, phoenixism will continue to be a problem and the 15% level of tax debt will only get worse. As many people point out, HMRC have finite resources and so it makes sense to make more use of the Contractual Disclosure Facility (CDF) where tax fraud is suspected from phoenixism, ESS and/or VAT misrepresentation.
NAO have highlighted that HMRC are missing connected cases due to the narrow and single-minded approach that is currently in place. The CDF would afford directors protection from criminal prosecution while rectifying their businesses’ tax affairs and settling any liabilities. An approach such as this might at least help to bridge some of the £5.5 billion tax gap.
In terms of VAT misrepresentation, a better approach might be for HMRC to target the platforms and marketplaces directly. If HMRC were to threaten the platforms that are ‘enabling’ evasion with ‘super’ penalties (perhaps even making platforms jointly and severally liable for tax evaded by their users), there might be a push from the marketplaces to increase their authentication processes; hence ensuring that the correct VAT is paid.
Overall it is clear that something has to be done to prevent or at least reduce the huge amount of money being lost due to tax evasion.
If you want to learn more about this, or need any financial support or advice, please feel free to contact me now.