Labour’s plan to close the tax gap
In response, Labour confirmed last week their intention to strengthen the proposed non-dom reforms, with the expectation of raising an extra £2.6bn over the course of the next Parliament. At the same time, Labour also pledged to raise an additional £5.1bn per year by reducing the tax gap. In their published plan, Labour outline how they would do so by providing additional funding to HMRC and by making legal and regulatory changes.
What is the tax gap?
The "tax gap" is the difference between the amount of tax that is owed and the amount of tax that is actually collected by HMRC. In the latest published data, for the 2021-22 tax year, the tax gap was recorded as £35.8bn, which is equivalent to 4.8% of the total theoretical tax liabilities. The tax gap as a percentage of theoretical tax liabilities has gradually fallen since 2013-14, when it stood at 7%. In real terms, the tax gap has varied between £30.8bn (2020-21) and £37.1bn (2013-14) over the last ten years.
Where are the gaps in the tax gap?
While the tax gap is a material amount in absolute terms, comparisons with other countries suggest that the UK’s tax gap is already considerably lower than many countries (with the caveat that such comparisons are difficult to make and few and far between).
Looking more closely at the components of the tax gap might, therefore, identify areas that Labour could be considering in order to raise funds.
The largest component of the tax gap by customer group are small businesses, who are responsible for 56% of the tax gap. The largest component of the tax gap by behaviour is a failure to take reasonable care (30%). The smallest element is tax avoidance (4%). Careless mistakes by small companies may therefore be a target but that requires considerable investment. By contrast, wealthy individuals (of which there are around 800,000) represent a little under 5% of the tax gap, which is almost the same as every other individual combined.
It is also worth noting that HMRC’s calculation of the tax gap does not include any offshore tax evasion. In July 2022, it was confirmed by the Treasury that HMRC planned to include offshore data in their tax gap reporting for 2021-22. When the 2021-22 report was published in June 2023, HMRC stated that they planned to publish offshore data in Autumn 2023. However, no offshore tax gap data has yet been published.
Offshore evasion by wealthy individuals could therefore be a potential area of interest for Labour, particularly given that the abolition of the non-dom rules (and the introduction of a new regime) might put a greater focus on offshore assets being brought onshore.
What are Labour planning to do?
In order to reduce the tax gap, Labour have said that they will provide additional funding to HMRC under an "invest-to-save" plan. This funding would then be used to improve HMRC’s ability to collect tax by, for example:
- increasing the number of compliance officers by 5,000 (thereby increasing HMRC’s capacity to undertake investigations);
- investing in digitisation and modernisation (including considering the potential role of AI); and
- ring-fencing a pot of "blockbuster" funding to be used on strategically important criminal cases for a deterrent effect.
Labour would also consider making legal and regulatory changes, such as:
- requiring a wider range of tax schemes to be reported to HMRC under the Disclosure of Tax Avoidance Schemes regime (DOTAS);
- introducing quarterly reporting on the volume and nature of criminal powers being deployed by HMRC; and
- exploring whether deferred prosecution agreements could be applied to individuals for tax evasion.
What are HMRC currently doing to close the tax gap?
HMRC currently undertake both “upstream” and “downstream” compliance work. In their upstream compliance work, HMRC look to prevent non-compliance before it has taken place by (for example) educating taxpayers so that they file on the correct basis and providing them with the support to do so.
In their downstream compliance work, HMRC identify and deal with non-compliance once it has occurred, for example, by carrying out compliance checks in order to check that companies and individuals are complying with the tax laws and paying the right amount of tax.
HMRC are aided in identifying potential non-compliance by hallmark based regimes such as DOTAS and DAC6 which require certain tax arrangements to be disclosed to HMRC.
What views have been expressed on HMRC’s activities?
In addition to considering what tax might be collected to close the tax gap and what Labour have said they will do, it may be instructive to consider what Labour have said about HMRC’s current approach.
It is, again, in the area of fraud that HMRC have faced some recent criticism.
Where fraud is suspected, HMRC’s most significant civil investigation tool is Code of Practice 9 (COP9). Under COP9, where HMRC suspect that an individual has committed tax fraud, the taxpayer is invited to make full disclosure of their actions, in return for an assurance that HMRC will not criminally investigate those disclosures.
In 2022/23, HMRC reported that 661 COP9 investigations were closed, yielding £89.2m in tax. That is material but negligible in the context of the wider tax gap. Even if investigations are expanded to include high-risk, but non-criminal, matters (under Code of Practice 8), those numbers increase but by less than double.
Criminal prosecutions can, of course, follow an HMRC investigation and the maximum prison term for tax fraud was increased from 7 years to 14 years earlier this year. However, in their announcement, Labour suggest that the rates of prosecutions have been low and this has led to a weakening in the deterrent effect of criminal sanctions.
This criticism reflects the comments from the Public Accounts Committee regarding the relatively small numbers of prosecutions resulting from its criminal investigations compared with pre-pandemic levels. HMRC’s criminal investigations resulted in 240 prosecutions in 2022-23 (2021-22: 236), considerably lower than the 691 prosecutions in 2019-20. The PAC expressed the concern that such low figures will not act as a suitable deterrent to crime.
There is a similar debate with regard to companies, which can also be held criminally liable for the offence of the failure to prevent the facilitation of tax evasion (under the Criminal Finances Act 2017); or for the failure to prevent fraud more generally (under the Economic Crime and Corporate Transparency Act 2023). Despite the provisions concerning the facilitation of tax evasion having been introduced seven years ago, there have been no prosecutions to date.
HMRC have argued that their approach has had the effect of changing behaviour (although it is hard to see that change in the tax gap). While no one has disagreed with the importance of that, there is an increasing call for action to be seen to be done.
What could this mean for the future?
Labour have reported that for every marginal £1 that HMRC spends on compliance activity, there is a return of £9 in additional tax revenue. The idea that investing in HMRC ultimately leads to increased revenue in tax collection is, of course, not a new or surprising concept.
In the Autumn Budget, Jeremy Hunt announced that HMRC would receive a further £163m to improve HMRC’s ability to manage tax debts; then with the Spring Budget came his announcement that HMRC would receive a further £140m.
However, while the tax gap has often been seen as a potential trove for funding, in more recent years, it has been hard to close significantly. While the tax gap has come down from a high water-mark of 7.5% in 2005/6, since 2015/16 it has hovered between 5.8% and 4.8%. Labour’s plan suggests a tax gap of around 4%.
Nonetheless, with both political parties viewing HMRC as an investment, that will likely mean higher numbers of tax investigations and, of course, a continued focus on avoidance.
As noted above, what might be a greater shift in emphasis is the focus on fraud and criminal investigations. Preparing a case to be referred for prosecution is costly and, with limited funds, HMRC’s strategy is to focus on cases that are sufficiently high value and high profile. However, with more funding, we may see a rise in tax-related criminal investigations and prosecutions. While that may include a first prosecution being brought under the 2017 or 2023 corporate offences, the suggestions above are that wealthy individuals may also become a focus. While it is always good advice that companies should monitor and update their compliance procedures, the comments from Labour (and others) mean there is a greater incentive on both companies and individuals to act in order to avoid becoming the deterrent for everyone else.
