Corporation Tax gap due to increase?

The main rate of Corporation Tax is due to increase to 25% from 1 April 2023, which will be the highest rate for over a decade. Will the increased rate lead to more businesses seeking to mitigate their tax liability, thereby increasing the Corporation Tax gap percentage?

Last week HMRC released the latest tax gap data, this estimates that the Corporation Tax gap is around 9% of the overall Corporation Tax liability in 2020/21, or £5.6bn. The overall Corporation Tax gap has been reducing over the last 16 years, from 11.3% in 2005/06, albeit it has been relatively stable since 2014/15.

Between 2005/06 and 2014/15 the main rate of Corporation Tax fell from 30% to 21%. The main rate reduced even further to a historically low rate of 19% from 1 April 2017, which was announced in July 2015 as part of that year’s Summer Budget.

This suggests a trend that as the main rate of Corporation Tax has fallen, the tax gap percentage has also reduced. However, when the tax gap trend is considered for each category of business size, it shows a different story:

The large business Corporation Tax gap was 9% in 2005/06, and fell steadily to around 2% in 2017/18, a level it has remained at since. The reduction of the tax gap as the main rate decreased implies a correlation. However, HMRC’s focus on large businesses through Customer Compliance Managers, risk assessments and tax strategies as well as the Public Accounts Committee’s focus on tax avoidance by multinationals around 2013 have probably also influenced the fall for large businesses. The Corporation Tax rate increase will hit large businesses the hardest and we could see an increase in the tax gap as a result, undoing some of the good work done over the last decade.

The medium business Corporation Tax gap was 13% in 2005/06 and 10% 2020/21, but the trend is less clear. The rate has fluctuated around 10% throughout the 16-year period. There is no clear correlation between the reduction of the main rate of corporation tax and the tax gap.

The small business Corporation Tax gap decreased from 20% in 2005/06 to 9% in 2011/12, but despite the main rate continuing to fall the tax gap has been on the increase and is now at 19%. This category of business makes up a significant majority of the overall Corporation Tax gap and are amongst the worst offenders. The Corporation Tax rate increase is unlikely to have a significant impact. The tax gap is more likely to be due to the sheer complexity of the tax system and the difficulties faced by small business owners in reporting and paying the right amount of tax.

Although the overall tax gap suggests that there is a correlation between the tax gap and the main rate of Corporation Tax the trend by business size suggests this may not be the case. More needs to be done to help small businesses pay the right amount of tax at the right time, to narrow the tax gap. Unless action is taken, the forthcoming Corporation Tax rate increase could compound the problem, potentially reversing the progress made on the tax gap for large business and sending the overall tax gap in the wrong direction