Insights

In the same way that businesses generate revenue projections to help them plan for the future, HMRC adopts a projected income approach to enable the Treasury to estimate public spending power. The ‘tax gap’ is an important metric in this and represents the difference between what the Treasury expects to receive in tax payments based on forecasts, and what it actually receives.

A negative tax gap means that HMRC estimates that it is losing tax revenue due to mistakes and deliberate fraud. It is an ongoing problem in every country globally and one reason why the UK government was so keen to introduce MTD (Making Tax Digital).  Making Tax Digital for income tax self-assessment (MTD ITSA) is regarded as being an especially useful way to minimise the tax gap.

How is the tax gap apportioned?

Estimates by HMRC show that the total tax gap in the UK is currently £35.8m and of this amount, 56% is due to tax underpayments by small business owners. It means that the small business community is potentially responsible for a total treasure revenue shortfall of £20bn.

Although the total tax gap figure has remained relatively constant over the past few years, the amount deemed to relate to small business tax payment shortfalls has increased by 15%. Five years ago, the proportion of tax gap due to small businesses (in the 2017-18 tax year) was 40%. In recent years the share of the tax gap relating to mid-sized businesses and large businesses is reducing; their share fell from 18% in 2017-18, to 11% in 2021-22.

The tax gap attributed to high net worth individuals is also growing. This was 9% in 2017-18 but is now estimated at 13%. This is possibly why the R&D tax credits scheme for SMEs has been tightened up so severely and why nudge letters are being used with individuals so frequently.

Why does the tax gap exist?

• Genuine mistakes on tax returns that are not detected;
• Deliberate attempts to defraud HMRC;
• Aggressive tax planning schemes.

Can MTD help close the tax gap?

Making Tax Digital (MTD) was designed to help close the tax gap because electronic record keeping together with the submission of quarterly returns and payments will reduce the likelihood of errors. Based on what has been seen with MTD for VAT, which came into operation 3 years ago, this looks likely because total VAT revenues have increased, but mistakes on tax returns remain a problem.

HMRC data shows that the VAT tax gap decreased from 14.4% in the 2008-09 tax year to 5.4% in 2021-22.  However, the proportion of missing revenues attributed to ‘failure to take reasonable care’ - a.k.a. mistakes and deliberate errors - was high - £10.7bn. What this shows is that despite efforts to simplify the tax system, it remains very confusing for taxpayers, and they are making costly mistakes. In spite of this, the tax gap is reducing which is a positive outcome.

Tax gaps for income tax, national insurance contributions and capital gains tax also decreased - from 4.5% in 2005-06 to 3.0% in 2021-22, whereas the corporation tax gap increased from 11.4% in 2005-06 to 13.3% in 2021-22.

A call for reduced tax complexity

Tax experts tend to agree that the tax system is too complex and this is often caused by tweaks being made to existing legislation to try and generate more income, rather than new rules being developed that are more straightforward.

As tax advisers, we welcome simplification and modernisation of tax laws to help reduce the tax gap. If you run a business and would like some tax advice, please contact us by emailing partners@rjp.cu.uk.