Small businesses evading tax leave HMRC billions out of pocket
The UK is losing billions of pounds a year in revenue due to tax evasion among small businesses, which can easily exploit weaknesses in government systems, according to a new National Audit Office (NAO) report on tax evasion in retail.
As well as raising public funds, reducing tax evasion encourages a level playing field between businesses by denying evaders an unfair competitive advantage.
According to HM Revenue and Customs (HMRC), while the overall level of tax evasion has stabilised in recent years, it has increased among small businesses. The tax authority has not estimated the scale of evasion by sector, but it has targeted campaigns at some high-risk retailers including takeaways and sweet shops.
HMRC also does not have a specific strategy to clamp down on tax evasion, which means it lacks a focus on, or explicit objective for, its performance in this area. Instead, its aim is to stop overall levels of non-compliance increasing.
This means there has been too little emphasis on some widespread forms of tax evasion in the retail sector like electronic sales suppression (ESS) and abuse of the insolvency process to avoid paying tax debts (known as phoenixism).
Although HMRC estimated that phoenixism accounted for 15% of its tax debt losses in 2022-23 (equivalent to more than £500m), the Insolvency Service disqualified only seven directors specifically for phoenixism between 2018-19 and 2023-24, out of a total of 6,274 disqualified directors.
HMRC has had success in raising more tax from online retail by making online marketplaces liable for Value Added Tax (VAT) on sales by overseas retailers, a move followed by other countries. It now estimates that it collects at least £1.5bn more in VAT a year – five times what it initially predicted.
However, significant gaps remain in checks around online retailers, and overseas companies can falsely present themselves as UK-based to evade VAT.
Weaknesses in company registration criteria present another significant risk. Since 2011, when online incorporations were introduced, it has been quick and easy to set up UK companies online from anywhere in the world, leaving the UK vulnerable to tax evasion from fraudulent businesses.
Government introduced tighter requirementsat Companies House from March 2024. But some new measures will not be in force until Companies House develops the necessary systems and capability, or until further secondary legislation is in place (e.g. verifying directors’ identities).
In 2022-23, there was a surge in company registrations ahead of these stricter rules being implemented. Of the registered companies declaring themselves as retailers, 42% were incorporated since January 2023 compared with 23% of companies in all sectors. This may indicate a potentially higher risk of fraud in the retail sector.
HMRC has also not yet used all the powers it has secured to tackle evasion in retail. It should evaluate the extent to which it is using these powers, establish what barriers it faces, and identify any gaps that limit the actions it can take.
Gareth Davies, head of the NAO, said: “Although tax evasion has been growing among small businesses, HMRC has so far lacked an effective strategic response.
“Its assessment of risks has given too little emphasis to widely used methods of evasion such as sales suppression and phoenixism. It has also failed to use new powers to tackle tax evasion.
“Tackling tax evasion is not a straightforward task. 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.”
