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Small businesses are responsible for the vast majority of tax evasion in the UK but HM Revenue & Customs does not have a strategy to combat the problem, according to the parliamentary spending watchdog.
In a new report focused on tax evasion in the retail sector, the National Audit Office has highlighted scams by businesses that under-declare their income or artificially file for insolvency to avoid tax bills before relaunching as “phoenix” companies conducting the same business.
“Although tax evasion has been growing among small businesses, HMRC has so far lacked an effective strategic response,” said Gareth Davies, head of the NAO, which released its report on Monday.
The Labour party, which won power in July, has pledged to raise an extra £5bn a year for the public coffers by 2029-30 by tackling tax dodging.
HMRC estimates tax evasion by small businesses rose to £4.4bn in 2022-23, accounting for 81 per cent of the total compared to 66 per cent in 2019-20.
The tax authority has a strategy for tackling all forms of non-compliance, including those caused by taxpayer mistakes, but does not have a specific focus on tackling evasion.
“This means there has been too little emphasis on some widespread forms of tax evasion in the retail sector,” the NAO said.
The watchdog highlighted scams such as electronic sales suppression, where retailers use software to reduce the recorded value of transactions and present artificially low revenues. Other versions of the scam involve producing “dummy” sets of accounts or running tills in training mode to reduce taxable profits.
These scams cost the exchequer £450mn a year, according to a 2019 HMRC estimate. The authority estimated “phoenix” companies accounted for more than £500mn of tax losses in 2022-23 but the NAO noted the Insolvency Service had disqualified only seven directors for this practice in the past six years.
The introduction of online company incorporation in 2011 also made it “quick and easy to set up UK companies online from anywhere in the world, leaving the UK vulnerable to tax evasion from fraudulent businesses”, the report found.
A surge in new company registrations ahead of the introduction of tighter requirements at Companies House, the UK’s corporate registrar, “may indicate a potentially higher risk of fraud in the retail sector”, the NAO said.
VAT evasion by overseas retailers selling online costs about £300mn a year. But the NAO noted HMRC said it had collected an extra £1.5bn a year since 2021 changes making online marketplaces liable for VAT from overseas sellers.
The NAO report comes after official data last month showed the number of large UK businesses under investigation by HMRC for potential underpayment of tax has hit a five-year low.
“Tackling tax evasion is not a straightforward task,” Davies said. “But real opportunities exist 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.”
Paul Monaghan, chief executive of the Fair Tax Foundation, said: “For far too long, the discussion of tax avoidance in the UK has focused solely on multinational enterprises. Tax dodging by small business is likely to be at least, if not more, impactful.”
HMRC said it raised a record £843bn in tax revenues last year and works with the Insolvency Service and Companies House “to tackle evasion in retail and online services”.
“The UK has one of the lowest tax gaps reported in the world, but the government is committed to reducing it further,” it said. “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. Such action helped us protect £41.8bn in the past 12 months.”
Additional reporting by Emma Agyemang in Copenhagen
