Ignorance of tax rules bolsters the tax gap

HMRC have published their annual estimates of the 'tax gap'. Ignorance of tax law as in 'failure to take reasonable care' by small businesses is blamed for a large percentage of the tax gap primarily through a lack of Income Tax and Corporation Tax receipts. 

The tax gap is the theoretical difference between the tax gathered and the amount that could be generated if everyone was tax compliant. Measurement involves a combination of actual statistics and best estimates.

When it comes to the causes of the tax gap, the main factors are failure to take Reasonable care and criminal behaviour. The definitions used for each of the behaviours that contribute to the tax gap are as follows:

• Failure to take reasonable care
  • Failure to take reasonable care results from a customer’s carelessness and/or negligence in adequately recording their transactions and/or preparing their tax returns. Judgments of ‘reasonable care’ should consider and reflect a customer’s knowledge, abilities and circumstances.  
• Errors
  • Errors result from mistakes when Preparing tax calculations, completing returns or supplying other relevant information, despite the customer taking reasonable care. 
• Avoidance
  • Avoidance involves bending the tax rules to try and gain a tax advantage that Parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage. It may operate within the letter but not the spirit of the law.  
• Criminal behaviour 
  • Criminal behaviour is organised criminal groups undertake co-ordinated and systematic attacks on the tax system. This includes smuggling goods such as alcohol or tobacco, VAT repayment fraud and VAT missing trader intra-community fraud.
• Tax evasion
  • Tax evasion is an illegal activity where registered individuals or businesses deliberately omit, conceal or misrepresent information to reduce their tax liabilities.  
• Legal interpretation
  • Legal interpretation losses arise where the customer’s and HMRC’s interpretation of the law and how it applies to the facts in a particular case result in a different tax outcome, and there is no avoidance.

 Tax gap: by business type and size

Tax gap: by tax

The accuracy of the methodology used in making these calculations is rated. For example, the methodology for VAT is rated 'low', whereas for small businesses and Income Tax or Corporation Tax is rated 'Medium'. For large partnerships, it is rated 'high'.

Tax gap: by behaviour

Failure to take reasonable care is being careless: i.e. not taking the time and effort to get something right.

Taking reasonable care means that the taxpayer has taken whatever steps are appropriate in terms of their ability and competence to ensure that their tax returns are correct.

See Client guide: Reasonable Care and Tax Penalties

Further useful additional statistics - these are all from different government sources

Population

• UK Population 67m.

Small businesses sizes

• Of the 5.51 million businesses that were small (0 to 49 employees).
• 4.1m had no employees: turnover £.33m.
• 1.44m had employees: turnover £4.15m.

Companies

• Number of companies registered with Companies House 5.2 million.
• Number of companies actively trading 2.1.
• 1.9 million inactive.

Employees

• No of employees in UK 33m.
• Employment rate 74.5%.

Participation in the Hidden Economy

• It is estimated that 8.8% of the UK adult population was identified as participating in the Hidden Economy.
• The above would reduce to about 6.6% if the trading or property allowance were claimed.
• It is estimated that 4.7% have an income above the personal tax threshold.

Participation in the Hidden Economy by behaviour

• Moonlighters, whose Hidden Economy activity supplements declared activity (65% of the Hidden Economy population).
• Ghosts, who reported that they have not declared any of their sources of income (whether taxable or non-taxable) to HMRC (35%).
• Value Added Tax (VAT) non-registered, businesses that are assumed to have a turnover over the VAT threshold and are not registered with HMRC for VAT (4%).

Participation in the Hidden Economy by profile

• Participation in the Hidden Economy was highest among younger people (17% of people aged 18 to 24),
• People in full-time education (20%) or unemployed (16%),
• People in a more difficult financial situation (17% of those finding it very difficult).

Record-keeping

• Most participants in the Hidden Economy (91%) did not receive help or assistance with bookkeeping and tax affairs.
• 66% of Hidden Economy activities were done without records and 41% were paid in cash.
• 91% of those involved in the Hidden Economy did not participate in any regulatory activities such as having a business bank account or holding a professional or vocational qualification.

Useful guides on this topic

Client guide: Reasonable care and tax penalties
What triggers a tax penalty? What standard of care is expected from a taxpayer? What is reasonable care? When is an error careless?

Calculating Corporation Tax & Checklist
How do you calculate Corporation Tax? What is the small profits rate? How do you calculate Marginal Tax relief? How do you adjust for Associated Companies? What is meant by Control? What are Augmented profits?

Record-keeping & tax: What, how and until when?
How long do you need to keep your books and records for tax? Record-keeping for Income Tax (IT), PAYE, Capital Gains Tax (CGT), VAT and Corporation Tax (CT). What if you lose your records?