Throughout lockdown, the Government has made significant financial contributions to UK businesses to help mitigate the economic impact of the pandemic by way of a £330bn war chest. Now that Britain is re-opening and adjusting to a new normal, HMRC will want to recoup as much of that initial outlay as possible through taxation.
Given this new commercial environment and to avoid large fines, it is critical that businesses remain on top of their tax liabilities. Joe Lennon, Partner at Wellers, discusses how HMRC is connecting the dots to close the tax gap following significant Government assistance during the COVID-19 pandemic.
How HMRC has gained more power over the years
The tax authority has been increasing in power since its inception in 2005. This is in a bid to close the ‘tax gap’ which refers to the difference between the amount of tax paid per year in the UK and the amount of tax that should be paid. The gap is a significant one too. For the 2018-19 financial year alone, the gap was estimated to be £31bn, according to the HMRC’s own tax gap report. That’s equal to 10 percent of the Government support given during the pandemic lost in tax revenue in one year.
In the past, it has been big businesses such as Starbucks and Amazon that have made headlines for avoidance measures they have taken with regards to paying tax in the UK. However, it’s actually small businesses that present the biggest problem, with the tax gap equating to an estimated £13.4bn. Unfortunately, that makes them a prime target for HMRC.
The body’s most significant increase in authority and power came 10 years ago when it introduced its software call ‘Connect’. This utilises multiple data sources to create a picture of a taxpayer’s lifestyle, in turn helping to identify those that aren’t paying enough tax, either through error, avoidance or evasion. For obvious reasons, HMRC won’t divulge all of its data sources, however, we do know that it includes tax returns, credit cards, social media, Land Registry reports, DVLA records, and even Google Street View. It even has the power to order big businesses like the aforementioned Starbucks and Amazon to hand over data that would help uncover businesses and individuals that could be evading tax.
The data collected is then used to paint a picture of how much tax should be paid by an individual or business and compares this to what is being paid, allowing HMRC to single-out areas where the two don’t match up.
In practice
Reading about the theoretical power that HMRC holds seems intimidating, almost like we are living in some sort of police state akin to the Geroge Orwell book, 1984. But does this power translate into reality? Well, it’s estimated that since the launch of Connect, which cost the Government £100m, HMRC has recouped £3bn in lost tax revenues, so it has more than paid for itself. However, this only represents 10 percent of the lost tax for the previous tax year and Connect has been in place for a decade.
Despite the tax gap remaining, HMRC has succeeded in dismantling key areas of tax avoidance. For example, the Ingenious Film Partners 2 LLP avoidance scheme. Used by England international footballers David Beckham and Wayne Rooney, amongst many others, participants now face a £520m tax bill after accusations of aggressive tax avoidance were made. Ingenious Film was involved in the funding of blockbusters such as Life of Pi and the Girl with the Pearl Earring, but the company has fought back protesting that their investors qualified for tax breaks under rules set by the previous government.
Tax avoidance and evasion
It is also becoming increasingly difficult to ‘hide’ money abroad as HMRC has started working closely with international partners to increase global tax transparency. This is where it is important to understand the difference between tax avoidance and tax evasion. Tax avoidance is when the rules of the tax system are stretched in a way the law hadn’t envisioned. Although a grey area, it is technically legal. In contrast, evasion is fraud. A decade ago, there were plenty of faraway islands offering secrecy to would-be evaders, and anyone with an offshore account could be fairly confident that HMRC wouldn’t find it, but that isn’t the case anymore and international tax authorities are increasingly collaborating in a global crack-down on tax evasion.
For small and medium-sized businesses, the significant tax gap is mainly put down to inaccurate reporting, however, HMRC is not naïve to think there isn’t deliberate evasion happening too. This could be seemingly innocent things like traders accepting cash-in-hand and not declaring the income, or owner-managers charging personal expenses to the company, but both examples are fraud.
PAYE audits
Smaller companies should also be wary of PAYE audits. HMRC is directing a lot of attention to these and with recent reporting that six million furloughed workers broke the rules to carry on working during the lockdown, this will become a critical area of investigation as it looks to give out fines to offending businesses. If an organisation is selected for an audit, the taxman will be checking for the following:
- The correct employee codes are being used
- PAYE deduction working sheets
- Cash payments
- Employee benefits
- Compliance with NIC regulations
These audit visits often result in inconsistencies being found, which will result in HMRC calculating the tax and NI lost from the previous six years.
Avoiding investigation
Keeping accurate records is the easiest way to avoid a tax investigation. Although a percentage of tax investigations each year are completely random, the majority are triggered by inaccuracies in reporting or by a tip-off. These inaccuracies could be an innocent mistake in a tax return, but with HMRC clamping down to recoup as much tax revenue as possible, it’s better to remove the risk by working closely with an accountant to avoid mistakes happening in the first place.
It’s also wise to avoid aggressive tax avoidance schemes. The risk is never worth the reward and tax investigations are not only costly, but they can take years to put to bed and will leave a mark on your record. Future-proofing for tax investigations is available through fee protection which will cover the cost of accountants’ fees should your business be investigated by HMRC.
More on small business tax and paying your taxes.
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