Small firms behind 80% of tax evasion

Tax evasion by small businesses is costing billions of pounds every year, the public spending watchdog has warned.

Small companies can “easily exploit weaknesses in government systems”, according to a new report on tax evasion in the retail industry from the National Audit Office.

HM Revenue & Customs estimated that overall, £5.5 billion was lost to deliberate tax evasion in the 2022-23 financial year, and 81 per cent of this was caused by small businesses.

The overall tax gap — the difference between tax owed and paid, including errors — has been reduced from 7.4 per cent in 2006 to 4.8 per cent last year. However, the share of the gap attributed to small business has increased over the past five years, from 44 per cent in 2018-19 to 60 per cent in 2022-23.

HMRC does not have a “specific strategy” to tackle the problem so “lacks a focus on its performance in this area”, the report warned.

The tax authority has placed too little emphasis on “widespread forms of tax evasion” in retail, the watchdog said, including abuses of the insolvency process by folding companies to avoid paying tax debts before immediately starting a new company.

This alone is estimated to cost HMRC more than £500 million in the 2022-23 financial year, yet the Insolvency Service disqualified only seven directors for the practice between 2018 and this year, out of a total of 6,274 disqualified directors.

The spending watchdog also cited “electronic sales suppression” as a big source of tax losses. This is where till systems are manipulated to hide or reduce true revenues, including via software specifically designed for this purpose. HMRC says it has powers to tackle this, and businesses involved in “making, supplying or promoting” such tools face fines of up to £50,000.

The report said HMRC had some success in tackling VAT evasion by making online marketplaces liable for VAT on sales by overseas retailers on their platforms, bringing in an additional £1.5 billion a year.

However, the audit office warned that there were still “significant gaps” in checks and overseas companies were still falsely presenting themselves as British-based to evade VAT.

The ease with which companies can be set up in the UK from anywhere in the world leaves the country “vulnerable to tax evasion from fraudulent businesses”. Stricter registration rules are being implemented to tackle this.

The report said HMRC has “not yet used all the powers it has secured to tackle evasion in retail”.

Gareth Davies, head of the spending watchdog, said: “Although tax evasion has been growing among small businesses, HMRC has so far lacked an effective response.

“Its assessment of risks has given too little emphasis to widely used methods of evasion. It has also failed to use new powers to tackle tax evasion.”

Davies said tackling the problem was “not straightforward” but added there were “real opportunities for HMRC to work more systematically across government to reduce it. Tighter controls and more compliance work could raise significant sums and improve value for money.”

A spokesman for HMRC said: “We generated a record £843.4 billion in tax revenues last year, paying for the vital public services everyone relies on. The UK has one of the lowest tax gaps reported in the world, but the government is committed to reducing it further.

“While the vast majority of businesses pay the tax that’s due, we will continue to use our civil and criminal powers against the determined minority who refuse to play by the rules.”

He said HMRC would work with bodies including the Insolvency Service and Companies House to tackle evasion in retail and online services.