A picture of the National Audit Office logo Report by the Comptroller and Auditor General HM Revenue & Customs Tackling the tax gap HC 372 SESSION 2019–2021 22 JULY 2020 We are the UK’s independent public spending watchdog. We support Parliament in holding government to account and we help improve public services through our high-quality audits. The National Audit Office (NAO) scrutinises public spending for Parliament and is independent of government and the civil service. We help Parliament hold government to account and we use our insights to help people who manage and govern public bodies improve public services. The Comptroller and Auditor General (C&AG), Gareth Davies, is an Officer of the House of Commons and leads the NAO. We audit the financial accounts of departments and other public bodies. We also examine and report on the value for money of how public money has been spent. In 2019, the NAO’s work led to a positive financial impact through reduced costs, improved service delivery, or other benefits to citizens, of £1.1 billion. HM Revenue & Customs Tackling the tax gap Report by the Comptroller and Auditor General Ordered by the House of Commons to be printed on 21 July 2020 This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act Gareth Davies Comptroller and Auditor General National Audit Office 15 July 2020 HC 372 | £10.00 This report examines the effectiveness of HM Revenue & Customs’ (HMRC’s) approach, in partnership with HM Treasury, in reducing the tax gap, the difference between the amount of tax theoretically owed and the amount collected. © National Audit Office 2020 The material featured in this document is subject to National Audit Office (NAO) copyright. 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The National Audit Office is not responsible for the future validity of the links. 004998 07/20 NAO Contents Key facts 4 Summary 5 Part One Understanding the scale of the tax gap 14 Part Two HMRC’s performance in closing the tax gap 29 Part Three HMRC’s plans to close the tax gap 42 Appendix One Our audit approach 53 Appendix Two Our evidence base 55 Appendix Three The National Audit Office study team Percentage tax gap by type of tax 57 consisted of: Appendix Four Araz Enayati Rad, Jennifer Glover, Marcus Popplewell and Lydia Reid, Case study assessment 58 under the direction of Andy Morrison, with assistance from Lucy Weston and Sam Winterflood. 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Please email us at www.nao.org.uk/contact-us Twitter: @NAOorguk 4 Key facts Tackling the tax gap Key facts £31bn 4.7% 1.1% HM Revenue & Customs’ HMRC’s estimate of the size reported percentage (HMRC’s) estimate of the size of the tax gap as a percentage point decrease in the annual of the tax gap in 2018-19. of total tax due in 2018-19 tax gap between 2015-16 The tax gap is the difference and 2018-19 between the amount of tax theoretically owed and the amount collected £34.1 billion yield from HMRC’s tax compliance activities in 2018-19 (increase of £7.5 billion since 2015-16) 7:1 the estimated amount of additional tax revenue from each pound HMRC spent making sure individual taxpayers complied with tax rules in 2018-19 44:1 the estimated amount of additional tax revenue from each pound HMRC spent making sure large businesses complied with tax rules in 2018-19 £4.6 billion estimated additional tax yield arising from HMRC initiatives to promote compliance and prevent non-compliance before a taxpayer submits a tax return between 2016-17 and 2018-19 33% reduction in the number of HMRC compliance enquiries and audits between 2016-17 and 2018-19 Tackling the tax gap Summary 5 Summary Introduction 1 HM Revenue & Customs (HMRC) is responsible for administering the UK’s tax system. One of its three departmental objectives is to “collect revenues due and bear down on avoidance and evasion”. HM Treasury leads on the design of the tax system. It agrees HMRC’s revenue and efficiency targets, and levels of funding. 2 HMRC reported record tax revenue of £627.9 billion in 2018-19, an increase of £22.1 billion (3.6%) on 2017-18. Tax administrations rely heavily on taxpayers reporting and paying their taxes in line with the rules. In 2018-19 HMRC received 90% of total tax owed this way. Inevitably some taxpayers make mistakes, others choose not to comply, and some cannot pay because of insolvency. In other cases, taxpayers interpret tax rules differently from HMRC, which can affect the amount of tax they pay, or construct artificial arrangements to avoid tax. HMRC’s most recent estimate of the difference between the amount of tax theoretically owed and the amount collected – known as the tax gap – was £31 billion in 2018-19, equivalent to 4.7% of the total tax owed. HMRC estimated that its compliance activities, which range from educating taxpayers to fraud investigations, increased tax revenue by £34.1 billion in 2018-19 (5.2% of total tax owed) against a target of £30 billion. 3 HMRC defines the tax gap as “the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid”. A wide range of factors affect the tax gap, some of which are outside the control of tax administrators. For example, the state of the economy, demographic changes (such as more people in self-employment) and the perceived fairness of tax policy can all affect how many voluntarily pay tax (voluntary compliance). Tax administrators can increase tax revenue by encouraging voluntary compliance and stopping non-compliance. This includes making the tax system easier to use, detecting mistakes when taxpayers submit their returns and catching deliberate attempts not to comply. 6 Summary Tackling the tax gap 4 HMRC considers “the best way to tackle non-compliance is to prevent it happening in the first place, while cracking down on the minority who do break the rules”. As such its strategy aims to: • promote compliance by designing it into systems and processes, enabling taxpayers to get things right from the outset; • prevent non-compliance by using data to spot mistakes, prevent fraudulent claims, personalise online services and automate tax calculations; and • respond to non-compliance by identifying and targeting the areas of greatest risk, and tackle those who deliberately try to cheat the system. 5 The National Audit Office and the Committee of Public Accounts have previously identified areas for improvement in HMRC’s approach to tackling the tax gap. For example: • We have noted that HMRC needs to consider the right balance between pre-emptive measures to promote tax compliance and those designed to identify and tackle non-compliance. We identified potential for HMRC to strengthen its understanding of the link between risks to revenue, the resources used, and the cost and return of different compliance activities. • We identified that the quality of service experienced by personal taxpayers may have an impact on tax compliance. HMRC has found that customers who have a more positive experience are more likely to think evasion is unacceptable. • The Committee of Public Accounts has repeatedly recommended that HMRC should set targets for reducing the tax gap. HMRC maintains its long-term strategic ambition is to drive down the tax gap and accepts that it is right to be assessed on movement in the tax gap over time. However it believes that reducing the tax gap is not a suitable annual performance target as the tax gap is affected by a range of factors outside its control; it cannot be measured in a timely way; and it cannot directly inform operational decisions such as where to allocate resources. Tackling the tax gap Summary 7 Scope of this report 6 This report looks at HMRC’s approach to tackling the tax gap. HMRC needs to understand the scale and trend of the tax gap, to gauge its performance in collecting tax revenue and to inform decisions about how to tackle non-compliance.