This report is an update on one of the most important issues in the UK right now, which is the tax gap.
The tax gap is the difference between the money that the government should collect from the taxes owed in this country if everyone complied with the law and the amount of money the government does actually collect in tax.
In 2010 PCS was responsible for commissioning and publishing the most comprehensive calculation of the UK tax gap ever undertaken at that time.
The report by Tax Research UK, which estimated that the tax gap could be as big as £120 billion a year was criticised by the tax profession, by government ministers, by H M Revenue & Customs (HMRC) and by many large companies. However, what we have learned since 2010 is that this estimate of the tax gap has proved to be vastly more reliable as an indicator of the likely loss arising from the tax gap than any of those estimates produced by HMRC, who claimed the figure to be only £35 billion at their last count.
Things have moved on since 2010. As this report shows, the government has now admitted that tax avoidance in this country takes place on a scale that makes all their past estimates look ludicrously low. Indeed, so keen are they to admit that tax avoidance is prevalent that they might even be challenging Tax Research UK’s estimate as too low sometime soon! What this report also shows is that the government’s estimate of tax evasion is likely to wildly understate the scale of that problem and that Tax Research UK’s estimate is, once again, likely to be much more reliable.
This is incredibly important. If the tax gap is as big as £25 billion of tax avoidance a year, £70 billion of tax evasion a year and £25 billion of tax paid late at any point in time, then there is a vast sum of unpaid tax in our economy waiting to be collected if only there was the political will to do so. If it was decided to collect that tax, not only would we employ more people in HMRC, so helping tackle unemployment whilst providing people with meaningful and socially useful work, we would also prevent much of the programme of cuts that is now destroying our economy and which has forced us into a double-dip recession. What the existence of the tax gap proves is that we do have an economic choice about how to tackle the financial crisis and that the government has made the wrong one.
The result is that the tax gap is not now just an issue of obscure interest to tax technicians, it is taking centre stage in the political and economic debate about the future of our country, the prospects of employment for the people of the UK, the chances of providing people with their pensions, the provision of public services and the nature of the society we wish to live in and the type of companies that we wish to operate within it.
That is why we also make some practical suggestions in this report on how the tax gap could be tackled, almost immediately.
What is now clear is that there is real appetite for these changes. Just as PCS has with many NGOs and the TUC, called for the introduction of an international financial transaction tax which if introduced could raise additional billions, so has PCS played its part in drawing this whole issue of the tax gap to the public’s attention and in helping create an environment in which organisations like UK Uncut, the Occupy movement, the Tax Justice Network and others have been able to highlight the injustice that the tax gap causes. That injustice is, however, ongoing. That is why we hope you read and share this report.
Tackling the tax gap could change our lives.
That ‘tax gap’ has three major components:
The definition below of the tax gap was produced by the Large Business Services of HMRC in 2005 (supplied by HM Revenue & Customs to Tax Research LLP in 2005).
It is very clear from this that HMRC thought then, as we do now, that tax avoidance is part of the tax gap and that HMRC made clear then, although they have not done so since, that late payment is also part of the tax gap, as we still do. They also emphasised very clearly in this diagram that strong action to ensure compliance reduces the net tax gap, but not the gross tax gap.
All these perceptions are based on the very clear understanding that whilst fair tax planning within the spirit of the law to make use of the allowance and reliefs made available by parliament is absolutely acceptable, as the diagram makes clear, (and this is why tax law does provide many alternative ways to tax transactions that are there to reflect the complexities of modern commercial life) HMRC expect tax payers to be tax compliant.
For this purpose Tax Research UK has defined tax compliance as seeking to pay the right amount of tax (but no more) in the right place at the right time where right means that the economic substance of the transactions undertaken, coincides with the place and form in which they are reported for taxation purposes.
That HMRC agree with this is very obvious: they clearly differentiate the tax due by the letter of the law and that due in accordance with the spirit of the law (which is the sum resulting from being tax compliant) in the above diagram.
In practice there is only one definition relating to the tax gap that ever causes real difficulty. That is how to define tax avoidance. This was defined by Professor David Ulph when Director of the Analysis and Research Division of HMRC by contrasting it with tax planning as follows:
“Tax planning” is a taxpayer’s adjusting his real social, economic or organisational affairs to obtain the “best outcome” in response to the tax system. This did not necessarily mean paying the smallest possible amount of tax; if the price of earning additional profits was to pay additional tax this might still be advantageous.
“Tax avoidance”, in contrast, is using artificial or contrived methods of adjusting taxpayers’ social, economic or organisational affairs to reduce their tax liability in accordance with the law while not affecting the economic substance of the transactions.’
Tax Research UK agrees with that opinion.
Tax planning is tax compliant; the law is used as parliament intended. Tax avoidance involves tax law being used contrary to the will of parliament. Others try to define these matters differently, usually to suit their own tax purpose. We are happy to use a definition consistent with one HMRC themselves have used, if not always consistently.
We are living through a time of economic crisis. At the time of writing 2.7 million people are unemployed and many more face the prospect of becoming so. Economic growth has disappeared. And all of this is because tax revenues in the UK collapsed in the aftermath of the 2008 financial crash.
The following graph (see page 7) which is based on Treasury data for actual or anticipated tax receipts and government spending, clearly demonstrates this issue:
What is important is that, as is obvious, income and spending were very closely aligned from 1997 to 2007. It was the crash, and nothing else, that forced them out of step. Additionally, it was not spending that went wrong; it was a lack of income that gave rise to the borrowing that the government has undertaken from 2008 onwards. That lack of income was, of course, missing tax. And that is precisely why the tax gap is so important now.
If only we had some or most of the tax not collected as a result of the tax avoidance, tax evasion and tax paid late that makes up the tax gap, then not only would we not need to borrow as much as we are but more importantly there would be a good argument against the cuts in public services that in themselves are crippling the economy, blighting our public services, forcing millions out of work and dashing the hopes of the young, the poor, the old, the disabled and many others. If an international financial transaction tax were also to be introduced, the income generated from that could also be put to good use.
To date the government has denied that this alternative economic agenda – one where cuts are not needed because tax could pay for the services we require – is possible. It is also out of step with other European governments where 14 countries actively support the introduction of an international financial transaction tax, but he UK government is vehement in its opposition. But slowly and surely as the reality of the cuts agenda dawns on people, as the NHS is dismantled, as people’s hopes of retiring in good health and in time to enjoy retirement literally disappear over the horizon and as they, their friends and families see their prospects fade before their eyes the importance of this agenda is becoming clear.
When even Max Hastings of the Daily Mail can say that tackling tax avoidance “is not the politics of envy, it is the economics of justice” then a big change in public perception is taking place. This report suggests just how big that change could be for the UK.
It’s important to say it, because it is not said often enough these days: the TUC and PCS working with the UK based think tanks the Tax Justice Network and Tax Research UK, have put the issue of tax avoidance on the UK political agenda.
The TUC’s February 2008 publication ‘The Missing Billions’ was seminal in this. I argued as author of that report, that UK tax avoidance was as much as £25 billion a year. No one had ever previously published such an estimate. Within a month the Treasury realised as a result of the reaction to that report that a new issue had arrived on the UK political agenda.
In March 2010 PCS and the Tax Justice Network published another Tax Research UK report “Tax Justice and Jobs: The business case for investing in staff at HM Revenue & Customs”. This took forward work on the tax gap by providing estimates for the two components of the tax gap that the TUC’s “The Missing Billions” did not address. In doing so it used the then current figure for tax paid late of £28 billion (which has since then seemed to settle on an average figure of about £25 billion). This was, of course, a straightforward estimate by HMRC, who are the only organisation that could have information on this. The scale of the issue had not, however, been publicly recognised before this report was issued.
More importantly, in this report a first estimate of tax evaded in the UK was made.
Based upon extrapolation of HMRC’s own data, particularly for the VAT and corporation tax gaps, Tax Research UK estimated that it was likely that 13.7% of all taxes in the UK were lost to tax evasion. Based on this calculation it was estimated that tax evasion in the UK might amount to £70 billion a year.
These three figures – of tax avoidance of £25 billion, tax evasion of £70 billion and tax unpaid of another £25 billion have to date been the only well known estimates of the tax gap in the UK barring those estimates published in response to these reports by HMRC.
As a result of trade union pressure on this issue HMRC have published estimates of the tax gap from 2009 onwards, now having updated their estimates in both 2010 and 2011.
To put the rapidly growing importance of this issue in perspective, in 2008 the tax gap was not on HMRC’s agenda but in their business plan for 2012 to 2015 published in April 2012 they say that their vision is:
We will close the tax gap, our customers will feel that the tax system is simple for them and even-handed, and we will be seen as a highly professional and efficient organisation.
From the tax gap being nowhere on HMRC’s agenda to being the number one issue that the organisation is all about, is quite a change. In that case assessing what they have to say on the issue is important.
HMRC’s 2009 estimate of the tax gap, supposedly for the tax year 2007-08 (but some of it using earlier data) suggested that the tax gap was £40 billion. The data for the following two years is reflected in this table, published in September 2011, which is the latest HMRC estimate.
It is, to be candid, hard to break this analysis down into the tax avoidance, tax evasion and late paid tax split of the tax gap that HMRC once defined it as, and which the union movement has used. However, other data in the report helps us do that, and in particular the pie chart.
Again, this is a little difficult to interpret but it can be reinterpreted like this:
Tax gap loss Amount
Tax evasion £4bn
Criminal attacks £6bn
Hidden economy £4bn
Failure to take care £4bn
Total tax evasion £20bn
Legal interpretation £5bn
Total tax avoidance £10bn
Total tax gap £35bn
That makes more sense of the numbers, which appear to be obfuscated in the HMRC presentation.
This data can then be compared with the union estimates in the following table:
Tax gap loss Union estimate £’bn HMRC estimate £’bn
Tax evasion 70 20
Tax avoidance 25 10
Non and late payment 25 4
Roundings – 1
Total tax gap 120 35
What is readily apparent is that the figures noted are very different.
The first thing to be said about the difference is that both estimates are just that – they are estimates. They are, therefore, not expected to be 100% accurate. However, these ones are so far apart that something has to explain the difference. Tax Research UK has argued that there are a number of reasons why the HMRC estimate of the tax gap is seriously understated.
The first and most obvious reason is that whilst late paid tax was clearly recognised as a part of the tax gap in their diagrammatic representation of the definition included earlier in this report they have omitted it from their own published tax gap estimates and have only included tax not eventually actually paid. The difficulty with ignoring tax debt as part of the tax gap is that this is not helpful at a time when the government is borrowing about £120 billion a year, precisely because it is not collecting enough in tax.
Every pound of late paid tax is a pound borrowed and when the government have made the reduction in government borrowing their key economic objective to exclude tax paid late from the tax gap is completely nonsensical. This sum has to be included or very obviously the goal of collecting this sum, which is essential to HMRC’s objectives, will not receive the emphasis it deserves in the allocation of resources.
Secondly, and mainly with regard to tax avoidance, HMRC and Tax Research UK use very different methods of calculating the tax gap. HMRC, perhaps unsurprisingly, wants only to consider something as tax avoidance if it can do something about it. Tax Research UK, on the other hand, considers something to be tax avoidance if it believes something should be done about it. The following example helps explain the difference in approach.
For a number of years HMRC put great emphasis on trying to close down the use of limited companies by people claiming to be self employed when they were actually in what HMRC considered to be, a disguised employment. They were particularly offended that the resulting income within the company was then being paid out to the shareholders of that company by way of dividend. This activity could give rise to tax avoidance in two ways. The first was that national insurance on what was really earned income was avoided. This was because national insurance would have been due on the salary that HMRC thought should have been paid, as it would also have been if the income had been received by a self employed person in their own name.
National insurance is not however due on dividends paid. Secondly, in many cases a person who HMRC thought had not really generated the income enjoyed by the company could be a shareholder in it and have its income shared with them by payment of a dividend, resulting in many cases in families reducing their overall tax rates. However, in 2007 HMRC lost a case in the House of Lords that would have stopped this abuse if they had won it and since then they have largely backed off challenging it.
As a result tax avoidance using this mechanism does not appear to be in their tax gap estimate. That does not, however, mean the tax avoidance has stopped. It just means it is not going to be challenged at any time soon.
Tax Research UK has estimated that such structures and similar avoidance through companies by those who are self employed but “income shifting” to parties not really engaged in the trade may have cost at least £1.2 million in lost tax and national insurance in 2007, and that figure may well be rather more now. This loss is in Tax Research UK’s estimate of tax avoidance, but not HMRC’s. The result is widely differing views of just how much tax avoidance there is.
Secondly, and also with regard to tax avoidance, when calculating corporate tax gaps HMRC has started with the assumption that the tax returns it gets are right and avoidance only exists if on investigation of the return, an activity is found that they wish to challenge as avoidance. This is what is called a ‘bottom up’ approach, which is discussed in more depth below concerning tax evasion. Tax Research UK, on the other hand, started from the accounts of multinational companies and tried to estimate what part of their profit should reasonably be taxed in the UK to estimate a tax gap. Again, an example helps explain the difference. In April 2012 the Mail on Sunday looked at the accounts of five US internet giants – Apple, Google, Amazon, eBay and Facebook. What they found was that the companies’ American accounts suggested that they had between them total sales income of £12.2billion in Britain in 2010. The Mail then suggested, using a methodology pioneered by Tax Research UK, which on the basis of their global profit margins it would have implied they should have, if all things had been equal, declared profits in the UK of almost £2.5 billion. UK corporation tax on that sum at 28 per cent (as was due in 2010) would have given them a bill of £685 million.
Instead they paid just over £19 million between them in tax in 2010 at an average rate of 0.8 per cent.
It has to be stressed all this is legal because the companies in question, bill their sales to UK customers from outside the UK and their UK operations are simply service functions. The HMRC approach to tax avoidance would not pick up the difference of £666 million found in these cases. The Tax Research Uk approach would. Unsurprisingly the figures are very different as a result. The HMRC approach may be to approve what the companies do as being strictly correct but it is very obvious that very few people would think that outcome appropriate and reasonable. The result is that HMRC have dramatically understated tax avoidance in the UK.
Tax evasion is another problematic issue. By definition, those tax evading, do not willingly tell HMRC of their activities. This means there are, broadly speaking, two ways of identifying the amount evaded. Oddly HMRC use both, but incompatibly.
The first method is the one they use to estimate losses in indirect taxes. Indirect taxes are things like VAT, duties on tobacco and alcohol and fuel duties. Tax evasion on this type of tax is estimated by HMRC using a “top down” approach. This means the tax gap for each tax is estimated by subtracting tax paid from an estimate of the likely total tax due based on the UK’s GDP – or total national income. This total tax due is estimated using data sources on consumption that are independent of HMRC, most coming from the Office of National Statistics household and business surveys. With regards to VAT for example, (which makes up by far the largest part of indirect tax losses) the loss is estimated by comparing the net theoretical tax yield on the national income of the UK and actual VAT receipts. The difference between these amounts is known as the VAT gap. This approach is rational because it seeks to establish the likely total tax due independent of any data submitted to HMRC and then compares this with the data HMRC hold. The residual is a good estimate of the likely tax gap.
The same is not true of the basis used for estimating tax evasion with regard to direct taxes. As HMRC note:
At present tax gap estimates are available for the main sources of revenue loss in Income Tax, National Insurance Contributions, Capital Gains Tax and Corporation Tax.
Direct tax gap estimates are produced using “bottom-up” methods. This means that components of the tax gap are estimated using departmental sources, such as surveys, administrative and operational data. The bottom-up method is less comprehensive than the top-down method used for indirect tax gap estimates because by its nature much of the gap arises from activities that are deliberately concealed. In addition because the bottom-up methods are based on compliance activity which can, in some cases, take years to complete the resulting tax gap estimates typically apply to earlier periods than those from the top-down methods.
It is extraordinary that by HMRC’s own admission their methodology is itself seriously incomplete and yet they have sought to defend the resulting estimates robustly. The biggest weakness is simple to identify: the method relies on data available to HMRC and yet it is readily apparent that a great deal of tax evasion will never result in data being available to that department precisely because the evasion is completely outside the tax system and entirely undetected by it. As a consequence the method used by HMRC must seriously under-estimate the loss of direct taxes compared to any method using a top down approach of the type used to calculate indirect tax losses. The consequence is thatthe HMRC method for estimating the tax gap for direct taxes such as income tax, corporation tax and national insurance must seriously underestimate the tax gap.
Tax Research UK, using data for VAT as the primary source, since this tax gap does appear properly estimated by HMRC and VAT covers more economic activity than most people realise, estimated that the total tax evasion gap was likely to be 13.7% of total taxes due based on averaged time series data. On that basis they suggested that UK tax evasion might amount to £70 billion a year. As is noted above, the HMRC estimate is very much smaller.
Battle lines on the tax gap intensified after the 2010 general election. Whereas Labour ministers in 2008 had asked for work to be undertaken on the tax gap to establish what its scale might be, Tory and Lib Dem ministers after May 2010 set out to resolutely defend HMRC’s estimate of the tax gap. For example, David Gauke, the Tory minister responsible for tax policy in the Treasury said the following in November 2010 when addressing an audience at Deloitte, the Big 4 firm of accountants that has offices in most of the world's major tax havens:
I know that when facing difficult decisions on public expenditure, some may have felt that the easiest way out would’ve been to rely much more on taxation – and, in particular, squeezing more from business.
A minority of commentators have fancifully suggested that this wouldn’t even involve raising rates. That all our problems could be solved by simply eliminating the tax gap – the difference between what is paid in tax and what should be paid.
I’ve seen some rather alarmist figures being put forward about the scale of the problem in the round, and I think it’s important that the public doesn’t get seduced by this wishful thinking.
It does no-one any good to exaggerate the scale of the tax gap, or generate confusion about its nature. Despite what some individuals may think, we can’t magic away our debts by collecting supposedly unpaid amounts of tax that, in reality, don’t even exist.
I’ve seen some external tax gap estimates of up to £120 billion – three times HMRC’s own figure – based on rather far-fetched assumptions.
These are particularly egregious in the area of corporate avoidance.
First, people’s rhetoric seeks to gloss over the relative proportion of the tax gap that is attributable to large business.
Second, their own estimates have looked at the statutory rate of Corporation Tax, and the effective rate, and classed the difference as avoidance. They’ve chosen to ignore the fact that much of the difference can be explained by double taxation relief, capital allowances, R&D tax credits, and other legitimate reliefs.
So yes, while we can’t afford to ignore the issues of evasion, fraud, or avoidance for that matter, our strategy for addressing these issues will be grounded in reality, not hearsay or creative accounting. Let us ensure that this is an informed debate, based on the facts.
It's an interesting view, but what is now clear is that the minister was ill advised to defend HMRC's position on the tax gap so robustly: much of what HMRC said is now very clearly wrong.
Positions on this issue were entrenched throughout 2011. The government stuck to David Gauke’s line. In the face of an onslaught on tax issues from UK Uncut, the Occupy movement, the union movement, the Tax Justice Network and others, the government persisted that it was right and everyone else was wrong. That was until a combination of evidence and public sentiment began to force change onto the government.
In the case of tax evasion what has changed is the evidence. In two new reports, one for the Tax Justice Network and one for the Socialist and Democrats grouping in the EU parliament, Tax Research UK showed that tax evasion is a massive problem worldwide.
The research used third party sources, including data on the size of the shadow economy in well over 100 countries in the world in a paper published by the World Bank. That paper suggested that the shadow economy in the UK represented 12.5% of GDP, a figure slightly smaller than Tax Research UK estimated in their paper on tax evasion for PCS in 2010. However, the Tax Justice Network version of the report suggested that the tax lost as a result was US$107.3 billion, or almost exactly £70 billion a year, which happened to be exactly the same number as the report by Tax Research UK for PCS had suggested. The European version of this research (using EU source data on the size of GDP and government spending) suggested the loss was a little lower at €94 billion – or about £65.8 billion a year. Both remain estimates, of course, but both are much larger than any estimate HMRC have ever suggested.
These reports have now been used as the basis for resolutions in the European Parliament on the impact of the tax gap.
What has also been presented is evidence as to how such tax gaps could arise. Tax Research UK has, again, been responsible for work on this issue. In a report in March 2011 they showed that the failure to administer small companies in the UK led to the extraordinary situation where 500,000 such companies literally disappeared off the official register in the year to March 2010, and only 66% of all companies asked to submit corporate tax returns in that year actually did so. The result was that, in Tax Research UK’s estimate, up to £16 billion of tax could have been lost. Again, this is an estimate, but whatever the right number, the scale is bound to be substantial. The point was a clear one: the failure to regulate and collect data allowed tax evasion to take place.
The inevitable conclusion from this new work is that the HMRC estimate that the shadow economy giving rise to tax evasion is, maybe, no more than 4% of the UK economy is simply wrong. Indeed, the World Bank data would suggest there is no country in the world with a shadow economy of less than 8% of their GDP. That indicates how wrong the HMRC estimate must be.
New evidence on the scale of tax avoidance n the UK has come from the most unexpected of sources, which is HM Treasury.
4.2.1. Abuse of the 50p tax rate
HMRC data, as interpreted and reported by the TUC, showed that the 50p tax rate was forecast to yield more than £6 billion in additional tax revenue unless tax avoidance reduced the sum in question.
What HMRC did, however, report was that the tax in question may have raised less than £1 billion in its first year of operation, and this is almost certainly because of what is called ‘forestalling’, which means that tax was avoided by shifting income from the 2010-11 tax year when the new tax rate applied, to 2009-10, when it did not apply but its forthcoming introduction was known about. There may also have been some reduced work effort as a result of the new tax – but as even the Institute for Fiscal Studies admit, this is very hard to be sure about given the scale of tax avoidance that occurred.
The Institute for Fiscal Studies point here is a very good one: apart from the fact that it is clear that dividends (in particular) were shifted from the 2010-11 tax year into 2009-10, the data on this issue, is ambiguous at best and the claim that the tax rate was unsuccessful cannot as a result be justified, and nor will it ever be since its abolition has now been announced, meaning that income recognition will now be delayed until it is abolished. What is clear though is that it has now been admitted that tax avoidance worth billions of pounds a year took place with regard to just this one issue. And yet, in their report on the tax gap in 2011, noted above, HMRC suggested that total tax avoidance for income tax, national insurance and capital gains tax combined was just £1.5 billion in all a year.
Suddenly the credibility of their estimate was shattered: HM Treasury had themselves admitted that the figures produced by their neighbours in HMRC were dramatically understated as PCS, Tax Research UK, the Tax Justice Network and others have always argued.
4.2.2 Abuse of tax reliefs
Having admitted that the tax gap was vastly bigger than they had previously said, HM Treasury then seemingly wanted to continue confessing their errors. When challenged on the tax abuse of rich tax payers that, according to George Osborne, justified a cap on donations a person could make to charity.
George Osborne then said that “he was shocked to discover that some of the wealthiest people in the country pay virtually no income tax”. Apparently he had been shown the anonymised tax returns of 20 wealthy people who between them had avoided some £145 million of tax and had effective tax rates of less than 10%.
This was an issue highlighted by the TUC as long ago as 2008 in its ‘Missing Billions’ report, and it was good to see that the issue had finally reached the government’s agenda but it was the admission of the sheer scale of the issue that was telling. If twenty people could avoid £145 million it was suddenly very obvious that all tax avoidance with regard to income tax, capital gains tax and national insurance could not be just £1.5 billion a year in total.
4.2.3 New evidence of corporate tax abuse
As is very apparent from the report already noted from the Mail on Sunday regarding US internet giants, corporate tax avoidance in the UK is vastly bigger than HMRC have ever admitted. And this story is not isolated: cases of tax loss to multinational corporations are now reported with such frequency that the loss to tax avoidance by such companies has to be vastly bigger than the £1 billion a year that HMRC currently admit to.
In summary, the credibility of HMRC’s estimates has now been shattered.
All this evidence can suggest only one thing, which is that the tax gap is vastly bigger than HMRC currently admits to.
As the Observer newspaper said in an editorial in April 2012:
The trigger for Osborne’s action [on tax avoidance in his March 2012 budget] is a confidential study that revealed Britain's 20 biggest tax avoiders legally reduce their income tax bills by £145m in a year.
Osborne was reportedly “shocked”, though as chancellor, and previously shadow chancellor, it is difficult to understand why.
As chancellor, for instance, he must have been aware of the excellent research conducted by tax specialist Richard Murphy. In 2008, in a paper for the TUC “The Missing Billions”, Murphy estimated that £25bn is lost annually as a result of tax avoidance; £13bn from individuals and £12bn from the 700 largest corporations. This undermines the integrity of a tax system that is vital for a modern democracy, especially when we are meant to be “all in this together”.
Popular sentiment has changed on this issue: it is both very obvious that the HMRC official estimate on tax avoidance is wrong, and that the claim by the Chancellor not to have known about this issue is also both wrong and indicates that he has wilfully ignored it to date.
With the UK Uncut movement, the Occupy movement, tax Research UK, the Tax Justice Network, a significant part of the union movement, and many more besides now clear that that the tax gap is a massive issue when it comes to addressing the current UK economic crisis, and with all those organisations and the people who support them realising that the tax gap is much bigger than is officially conceded, the narrative on this issue is changing.
Perhaps nothing can indicate this more clearly than the persistent interest of the Daily Mail in this issue as 2012 has progressed. As Max Hastings said in that newspaper in April 2012:
Democracy works only if there is general consent, or at least acquiescence.
This is placed under huge strain if ordinary citizens on modest incomes face frequent quibbles and niggles from Revenue & Customs about a few pounds, while the wealthy get away with murder.
This is not the politics of envy, it is the economics of justice. If companies and very rich individuals pay pathetically little tax, the burden falls upon the poor saps who cannot or choose not to hide their income and profits.
It seems that the case for the existence of the tax gap has been made. And it also seems that everyone appreciates that it is so big that action to address it is now essential. In that case it is to this issue that we turn next.
The honest answer to this question is that there is a great deal can be done to tackle both tax avoidance and tax evasion. A whole range of such actions were outlined in Tax Research UK’s report for PCS in 2010. The current need is, however, to establish priorities and as such we concentrate on just four issues here, all of which would, we believe, have a significant impact upon closing the tax gap.
A general anti-avoidance rule is an essential part of any effective tax system. That is because all tax regulation is written and it is an inevitable fact of life that words have uncertain meanings, however much we like to deny it and however hard Parliament works to try to define them in taxes acts.
That means all tax law is open to abuse if the only basis on which it can be interpreted is the strict meaning of words, which cannot be known until a judge has ruled on the issue. So, we need a better basis for interpretation and that is to look at the purpose of the law, and the intention of the taxpayer and then decide if the two coincide. If they do, then everything is fine. If they don't then quite clearly action needs to be taken.
Now, no one wants a general anti-avoidance rule that gives a tax authority complete right to decide when, if, and how somebody should pay tax. That could, very obviously, create just as much uncertainty as a literal application of the words in the taxes acts. However, thankfully we have a precedent for a general anti-avoidance rule the type we need which was, curiously, created by the House of Lords. In 1982 the House of Lords ruled upon a case and created what came to be known as the Ramsay principle.
For the Ramsay principle to apply there had to be:
Under the Ramsay principle the artificial step inserted for tax avoidance was ignored when calculating the tax due which effectively created a general anti-avoidance principle.
Unfortunately, the Ramsay principle was largely overturned in a subsequent decision of the House of Lords in 2001, and that is one reason why tax avoidance has become so rampant in the last decade. Now we need something like the Ramsay principle back, and a general anti-avoidance rule that would put it into UK law is now essential.
It is an unfortunate fact that the general anti-avoidance rule now being proposed by the government will not restore the Ramsay principle to UK law. Instead, as Graham Aaranson QC, the author of the report says:
I have concluded that introducing a broad spectrum general anti-avoidance rule would not be beneficial for the UK tax system. This would carry a real risk of undermining the ability of business and individuals to carry out sensible and responsible tax planning. Such tax planning is an entirely appropriate response to the complexities of a tax system such as the UK’s.
The result, as the Association of Revenue & Customs (part of the FDA) say is that:
The proposal, and the concept of “responsible” tax planning, may widen perceptions of what is responsible tax planning and so make it harder to tackle avoidance.
Like HMG, ARC wants to tackle avoidance (very conservatively estimated at £5bn each year). We recommend instead a wider GAAR, fully resourced and able to provide taxpayers with clearances so as to provide more and early certainty on how HMRC views transactions. A narrow GAAR may otherwise serve to legitimise what is currently held to be avoidance. In other words, under the guise of tackling avoidance, it may actually facilitate it.
It is a conclusion with which we agree. It is for that reason that a broadly based general anti-avoidance rule is essential if tax avoidance is to be properly tackled.
A recent and welcome development in tax debate has been the increased awareness of the impact of transparency upon tax avoidance. This view seems to be based upon the widespread belief that most people are embarrassed about being found to be tax avoiding. The result is that there is also broad agreement that the more information there is on public record about a tax payer’s affairs, the less chance there is that they will undertake tax avoidance activity.
Whilst it is almost certainly true that more tax avoidance and tax evasion is undertaken by people than companies, there are, by definition, many fewer large companies than there are individuals and each of those companies also pays (or should usually pay) a great deal more tax than any individual, and so also has a great deal more opportunity to tax avoid. As a consequence, demanding transparency from multinational companies who have greatest opportunity to use tax havens and their associated arrangements to avoid their tax obligations in the UK is the obvious place to start with a transparency agenda.
Large companies do, of course, have to prepare and publish their accounts, but those accounts do not at present include any indication at all on the scale of what a multinational company does in each and every country in which it operates. So we have no idea of what its sales are, what its profits are, how many people it employs or at what cost, and most importantly of all, how much tax it pays in each and every country in which it operates.
Country by country reporting by multinational companies would solve this problem. Those companies would then have to publish a profit and loss account showing all the above noted information for each and every country in which they operate. As a result we will know precisely what they do in the UK, how much tax they pay here and how much in addition that they don’t pay here because we will know how much of their profit is shifted into tax havens.
Nothing is likely to change multinational corporation behaviour more than this exposure of what they are doing, whilst the same disclosure will also undoubtedly help tax authorities, not just in the UK but worldwide, best identify those companies deserving of tax investigation to stop their abuse.
In this context it is important to note that there is an official proposal for a form of country-by-country reporting before the European Parliament at present, but it only relates to the extractive industries. This issue is therefore, something that is not now just on the fringes of debate. However, what we really need is country-by-country reporting for all multinational corporations.
It was encouraging to note that the European Parliament passed a resolution calling for this in April 2012. The OECD is also looking at this issue as is the International Accounting Standards Board. It is time to put pressure on all these bodies to introduce a comprehensive country-by country reporting requirement to reduce the tax avoidance activity of multinational corporations to the benefit of all.
A lot of tax avoidance is complicated. It takes time to investigate it, time to assess it, time to react to it and time to process and collect the resulting demand for additional tax due. All that time has to be undertaken by real people, sitting in real offices, doing a real days work on behalf of the UK. They are employed by HMRC and yet right now many more of the people employed by our tax authority are facing the risk of redundancy on top of the many thousands whose jobs have already been axed as part of a massive office closure programme.
In January 2012 HMRC announced that a further 9 offices would be closed during 2013/14 with another 17 proposed closures by 2014/15. Closing offices and cutting jobs will do further damage to local economies that need investment, not more cuts.
Having tax offices based in local communities also shows the importance and value of tax collection to our economy and the staff based in them are much more likely to possess the local knowledge required to ensure that tax is complied with. These offices also maintain a vital face to face service for people who cannot, or do not want to, use the internet or phone a call centre.
The government has said since 2010 that it is investing up to £900 million in additional funds to tackle tax avoidance over the lifetime of this parliament but that has to be set against the background of £3 billion of total cuts to the budget of MRC over the same period. The reality is that you cannot tackle tax avoidance and cut the resources available to address this issue at the same time and the facts are that in 2005 there were nearly 100,000 people working for HMRC; now there are about 64,000 and by 2015 there will be fewer than 55,000 if HMRC achieve its objectives as set out in its business plan for 2012–15.
All this is part of an absurd objective to save about £1 billion a year in costs which can only result in a significant increase in the UK tax gap over the coming years. The simple fact is that you don’t collect your debt by sacking your debt collectors.
As a result it is now essential that there is a change in attitude towards spending on staff at HMRC. These staff should not be seen as a cost, but should instead be seen as a revenue generation opportunity, with the people in question being gainfully employed to ensure that there is a level playing field for everyone in the UK so that no one gets an advantage by tax cheating to give them an unfair benefit over honest taxpayers.
One of the first objectives of any tax avoider is to get their income out of their hands, where it might be subject to income tax rates of up to 50% at present and potentially to national insurance charges as well, and into the hands of another person who will pay tax at a lower rate, and possibly with no national insurance paid. That obvious other person’ is a limited company, and anyone can form such a company in the UK for an outlay of less than £100.
Too often the creation of such a company then means that the income that an individual has earned is artificially split with someone else, or that income from what is really an employment that should be subject to national insurance, is converted into what looks like investment income paid in the form of dividends to which no national insurance applies. We now know that thousands of people are paid in this way by the government each year, and there will be tens, if not hundreds of thousands, of people paid in this way in the private sector each year as well. All of this is tax motivated.
Now no one would want to impede small companies that create real job opportunities and growth in the UK economy, but the number of companies that employ anyone but their owner is now, it seems very small. There are about 2.8 million companies in the UK at present and the vast majority of small limited companies are now owned by just one or two people, have a share capital of under £100, do not retain profit for investment in the business, and are basically the incorporated persona of their owner/manager. We need to recognise this fact and create appropriate structures for limited liability entities for use in the 21st-century economy when at present we are struggling with the legacy of a structure designed in the 19th century.
There are two resulting problems arising from the easy availability of such structures. The first is that tax is avoided. The second is that such companies can be created so easily and cheaply that their numbers have exploded with the result that the effectiveness of the regulation of them has declined and consequently the use of limited companies for tax evasion purposes has, undoubtedly, increased considerably.
The basis of the tax avoidance issue has been outlined above: companies are being used to artificially split income between people who do not appear to have necessarily earned it whilst national insurance is being widely avoided. The obvious solution to this problem is to require that the vast majority of small companies in the UK, who would be identified either by the size of their turnover or, as likely, by the value of their subscribed capital, should be taxed on what is called a ‘look-through’ basis. This means that it is not the company that pays the tax on the profits that are earned but that it is instead those who own the company that are taxed on those profits, with power then being given to HMRC to challenge the way in which such profits are apportioned if it seems that they are inconsistent with the ratios of actual work undertaken by the owners in question or the capital that they have made available to the company.
There would, of course, be a need to prevent UK companies being owned by offshore entities that would then result in no tax being paid in the UK. This change would, overall, achieve three important goals. Firstly, income earned by companies would be taxed as if it was earned in a self-employment so that national insurance would be paid as a result.
Secondly, the relationship between owners of the company, the company itself, and those who actually undertake the work within it would become substantially more transparent, and the opportunities for tax avoidance would be reduced.
Thirdly, the chance that companies could still hide their true ownership behind nominees who at present appear, in at least some cases, inadvertently or not, to help those responsible for the managing of those companies avoid their obligations to pay tax, would be largely eliminated because the nominee would have to pay tax instead under this proposal. Few nominees would be willing to do that!
This reform would increase corporate transparency in the small business sector, encourage the more responsible use of companies, create a level playing field between those people operating as companies and in self-employment in this sector and without a shadow of doubt reduce the scale of tax avoidance, and probably evasion, in our economy.
The second major reform that would help is with regards to the administration of small companies. As research has shown, more than 325,000 companies were ‘struck off’ the Register of Companies in the year to March 2010. These companies had failed to supply information required by law to the Registrar of Companies. They were not penalised as a result, and HMRC investigated only a relativity small number of those cases. That is unsurprising since research on HMRC’s management of the corporation tax system for small companies in that same year showed just how deficient that was. In that year 1,796,000 companies were asked to make a corporation tax return out of almost 2.6 million companies that were in existence. Of those asked to make a return just 1,183,000 actually did, meaning that less than 66% of all companies asked to make a corporation tax return in that year actually submitted one.
Two things are very obvious as a result of this combined finding. The first is that it is incredibly easy to avoid regulation on the management of companies including regulation on the filing of accounts on public record. The Registrar of Companies simply does not have enough resources to enforce the law on small companies who choose to neglect their obligation to file the information required of them. That is in part because of the ludicrously low annual registration fee that each company has to pay, which is just £14 a year.
Secondly, HMRC are also unable to effectively enforce regulations for companies. Their predicament is so bad that one in three companies in the UK completely ignores its obligation to file a corporation tax return. The loss resulting to the government each year has been estimated to be as high as £16 billion (ibid).
This is, of course, part of the tax gap. This issue can be tackled in three ways. Firstly, the Registrar of Companies needs a significant increase in the number of staff it employs to ensure that small company law is effectively enforced. If the annual fee payable by all companies has to increase as a result, so be it. That would allow more staff to be employed. It is an unfortunate fact that in response to these inadequacies in its administration, Companies House has reduced its staff by about 25% in the last two years. This can only exacerbate the problem.
Secondly, and very obviously, HMRC needs more staff to ensure that small companies pay the tax that they owe. This is an obvious role for the extra staff whose employment has already been suggested in this report.
Thirdly, these abuses happen because HMRC does not have the information it needs to track down those perpetrating them. It is an astonishing fact that anyone can now form a company in the UK without ever having to sign physical document to accept responsibility for the company in question. It is also quite extraordinary that a company can be quite legally set up very easily and also very quickly at only modest cost, with nominee directors, nominee shareholders and a nominee company secretary and can additionally use a nominee address to hide the real location from which it trades. If those nominees are outside the UK (and that is easy to arrange, bar the address) there is almost no way in which this barrier to identifying those who are really undertaking a trade can be permeated and yet this is permitted under UK law. What is very obviously needed is a change in the information powers available to both the Registrar of Companies and HMRC to ensure that the obligations created by law with which companies should comply can be imposed upon them and their officers.
That information power can be simply created. A company is, of course, only of any interest for tax purposes if it trades. It is almost impossible for a company to trade if it does not have a bank account. Despite this fact, at present, no bank has to advise HMRC when it opens a bank account for a UK company. Banks to have to advise HMRC when they pay interest to any individual taxpayer in the UK, but there is no similar information provision on them to advise when they provide banking facilities to a company, and this has to change.
What is needed is a legal requirement that any bank operating in the UK must advise both HMRC and the Registrar of Companies if they open or close a bank account for a UK company. This would immediately notify both departments which companies were likely to be trading. They could then focus their efforts on those companies to ensure they filed their accounts and paid their tax. This would result in better-targeted use of resources that would save cost.
That would not, however, prevent some companies ignoring the requests for information sent to them by HMRC. To get round this problem HMRC should have the right to approach any bank operating an account for a customer that has refused to answer a demand for information for more than three months, to ask that bank for the information they hold on who really runs that company and from what address. Banks are required to hold this information for money laundering purposes. That way HMRC could then track down those who were really using companies to avoid or evade their responsibilities to pay tax and so considerably increase the chance of recovering the tax due.
The mere existence of these laws would help prevent the use of companies for that purpose in a great many cases. As such it is almost impossible to see why any government would refuse to enact this legislation in the face of the evidence, that the administration of companies in the UK is failing very dramatically at enormous cost to society as a whole.
The message in this and in every other case that we highlight is that tax avoidance and tax evasion take place because there is a lack of political will to address them. They do not happen unavoidably; the means to address these abuses of our law exist if only there was a willingness to allocate the resources to collect the tax due, to enforce the laws that apply and to create a level playing field for all honest businesses that would result from doing so.
We’re not asking for something unreasonable when was say the time has come to tackle the tax gap. All we are asking for is that the law be upheld for the benefit of everyone in the United Kingdom, and that is the minimum that we think people should expect from their government.
But what this also means is that there is an alternative to a programme of austerity and cuts. The reality is that the government does have a choice if it needs to close the deficit. It could collect the tax due but not paid at present which, in total comes to maybe £95 billion pounds a year plus £25 billion of tax outstanding at any point of time, or £120 billion in all. It may just be coincidence that the annual deficit is near enough also £120 billion a year at present, but if it is, it’s a sufficient coincidence to point out just how significant the tax gap is.
We’ll never entirely close the tax gap, but trying to do so now, could, completely change our fortunes, and provide hope to people in this country where at present there is little but despair. That’s why it is essential we try to close the tax gap, now.
Richard Murphy (54) is a UK chartered accountant. Having been senior partner of a practicing firm of accountants and director of a number of companies he shifted towards a research focus for his work when he helped found the Tax Justice Network in 2002. He now directs Tax Research UK and writes, broadcasts and blogs extensively. He has been a visiting or research fellow at a number of UK universities and is joint author of ‘Tax Havens, The True Story of Globalisation’, Cornell University Press 2010 and sole author of ‘The Courageous State’, Searching Finance, 2011. He is now working on a new book – ‘The Joy of Tax’.