Small Fish, Big Fry: HMRC's potential new approach to tax evasion

The National Audit Office (NAO) report: Tackling tax evasion in high street and online retail examines HMRC’s approach to tackling tax evasion, which forms part of the tax gap. For context, many commentators point to the fact that the tax gap grew from £32.4bn in 2018/19 to £39.8bn in 2022/23, while others note that, as a percentage of the total theoretical tax receipts (recently at an all-time high), it has slightly decreased over the same timeframe.

While HMRC has focused on preventing an increase in overall non-compliance, the NAO believes this broad approach has resulted in insufficient attention to prevalent forms of tax evasion by small businesses in the retail sector, such as electronic sales suppression (ESS) and "phoenixism" (where companies are declared insolvent and dissolved without paying their tax, before their business recommences in a new entity). For instance, despite phoenixism accounting for 15% of HMRC's tax debt losses, the Insolvency Service has so far disqualified only a negligible number of directors for this specific misconduct.

One of the underlying problems HMRC faces is that it is more cost effective, in terms of money recovered per investigation, to target large businesses. HMRC’s overall success is measured based on the return on the Treasury’s investment in the department, so it is not a surprise that the focus of its compliance activities tends to be on those investigations that are likely to be higher yielding.

However, if tax evasion by individuals and small businesses is not adequately addressed, it will likely persist and potentially escalate, creating a cascading effect that significantly undermines the tax system. Minor infractions, when left unchecked, can embolden individuals and businesses to engage in more substantial evasion activities. The cumulative impact of these seemingly individually insignificant losses is evidenced by the increasing proportion of tax evasion losses (estimated at 81% for 2022-23) being caused by small businesses.

Given that investigating small businesses is costly, a better use of public funds might be an investment in deterring future non-compliance. Just like speed cameras deter people from speeding, investing in measures that deter tax evasion could be a more cost-efficient solution.

Following the enactment of The Economic Crime and Corporate Transparency Act 2023, Companies House has already heavily invested in new initiatives such as developing software for ID verification to combat fraud. With HMRC reviewing its tax administration framework with a view to modernising and simplifying the UK tax system, it would seem timely for HMRC to adopt similar approaches.

HMRC's priorities are directed by government, so as mentioned in our previous article, the long-term fight against tax evasion necessitates a change in government strategy. Clearly, allocating more officers to focus on this problem area is one solution, but there must be greater efforts to use digital approaches to deter tax evasion by smaller businesses. An investment in technology in this area could bring great returns and incentivise taxpayers to ensure future compliance.