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UK tax gap remains at 4.8%

HM Revenue and Customs (HMRC) revealed in June that the estimated tax gap has stayed at 4.8% for the 2021–2022 tax year, the same as the revised figure for 2020–2021.

Published annually, the Measuring Tax Gaps report analyses the difference between the amount of tax HMRC expected to take and the amount of tax actually paid.

While the headline figure shows the tax gap hasn’t changed in percentage terms, in monetary terms, the difference has increased from £31 billion the year before to £35.8 billion in 2021–2022.

The tax gap percentage has likely remained stable despite the monetary difference because tax liabilities also rose from £643 billion the previous year to £739 billion, in turn likely due to inflation and fiscal drag.

Overall, the tax gap has been gradually falling over the years from 7.5% in 2005, as the government has continued to adjust policies to address the tax evasion, criminal activity, and general carelessness that contribute to it.

Here’s what the latest figures reveal about what’s causing the tax gap, and what this could mean for businesses and self-employed individuals.

What are the main causes of the tax gap?

When analysing the gap by tax type, Income Tax, National Insurance, and Capital Gains Tax all make up 35% of the total (£12.7 billion). Around 3% of these taxes went unpaid, a figure which is more or less stable, as it has fluctuated between 2.9%–3.6% since 2016–2017.

Corporation Tax makes up the next largest component of the total gap at 30% (£10.6 billion), with revised estimates based on new data showing that this 13% tax gap is at its highest since 2005
and has been steadily increasing since 2011–2012.

While the tax gap has increased for all other groups from 2020–2021, reflecting larger overall tax liabilities, Excise Duty is the only tax to show a reduction in both percentage terms and real terms – down from 7.7%
and £3.8 billion to 6.1% and £3.4 billion.

The VAT gap is up 0.4% and £1.3 billion
from the previous year, but it has decreased significantly since 2005–2006, falling from 14% and £11.9 billion down to 5.4% and £7.6 billion in 2021–2022.

Who is contributing to the tax gap?

When analysed by customer group, small businesses represent the largest component of the total at 56% (£20.2 billion). Criminals, large businesses, and mid-sized businesses follow with 11%
each (respectively £4.1 billion, £3.9 billion, and £3.8 billion).

Wealthy individuals are responsible for 5% (£1.7 billion) of the tax gap, while all other individuals contribute to the remaining 6% (£2.1 billion).

These figures mostly held steady from the previous year, with small percentage decreases for large businesses and criminals.

When it comes to behaviours contributing to the tax gap, failure to take reasonable care is the largest factor at 30%, followed by error at 15% and evasion at 13%.

Legal interpretation issues represent 12% of the tax gap, with criminal attacks following at 11% and non-payment at 9%. ‘Hidden economy’ makes up 6%, with avoidance representing the final 4%.

As criminal activities, if criminal attacks, hidden economy, and evasion are combined, then criminal activity matches lack of reasonable care at 30% of the tax gap.

The only behaviour with a year-on-year tax gap reduction is non-payment, which may be due to cashflows returning to normal after the COVID-19 pandemic, an increase in debt management enforcement, or both.

Small businesses have the largest share

The figures above show that small businesses are responsible for the largest share of the UK tax gap in 2021–2022 at 56%. This has increased for four consecutive years, rising by 16% and £7.4 billion
since 2017–2018.

There is a possibility that the rising tax gap for small businesses is a consequence of the economic effects of the pandemic followed by inflation.

There isn’t enough information yet to make any definitive conclusions, but smaller businesses could be declaring less income than they actually made or overclaiming deductions on expenses through electronic sales suppression.

Despite the figures also revealing an increasingly high level of non-compliance with Corporation Tax, the results of the latest annual report may encourage HMRC to increase tax investigations into small-to-medium businesses.

Small businesses who may have been getting away with tax avoidance over the years while HMRC was focusing on large businesses could now be investigated and caught out, so it may be time for them to get ahead of this and organise their taxes properly.

Make sure your business is tax compliant

HMRC publishes tax gap estimates every year to provide transparency, aiming to increase public trust in the UK tax system and highlight areas where improvement in supporting taxpayers to meet their obligations is a priority.

However, the concept of tax gap reports has been criticised, as some believe that HMRC uses this information to push agendas rather than reporting objectively – particularly pushing for the introduction of Making Tax Digital.

While MTD for VAT has been implemented in stages over several years, and is now compulsory for almost all VAT-registered businesses, the equivalent for self-employed individuals and landlords has been delayed for a few more years.

As the latest tax gap report has shone a spotlight on small business non-compliance, self-employed people and landlords may not want to wait to get started with Making Tax Digital for Income Tax Self-Assessment (ITSA).

Whether you are self-employed or run a small business, it’s crucial to ensure that your operations are tax compliant. Upfront savings in tax could soon turn into long-term losses from repaying fines on top of taxes owed when HMRC catches up.

Should you need help assessing your tax liabilities and getting to grips with digital tax returns, our accountants in Barnsley can provide a range of tax management services. Give gbac a call on 01226 298 298 or email us at info@gbac.co.uk to learn more.