The Tax Gap

HMRC released their latest report on the tax gap in June. The tax gap is the perceived difference between how much tax revenue should be paid, in accordance with relevant rules and regulations, and how much tax is actually paid.

The latest report reflects on the 2017/18 tax year. The conclusions are that the tax gap has been reduced to 5.6%, which is down from 7.2% in 2005/06 when HMRC started gathering data. However, this still equates to £35 billion, which is actually the highest figure it has been since they commenced collating data in 2005/06.

These figures are of interest to me as it gives a little insight into what HMRC are focusing on, as the analysis will provide specific areas to target for improvement.

Clearly the tax gap will include those who simply have not paid up – but this contributes only £3.9 billion to the shortfall. Of more specific interest is the fact nearly £10 billion comes from mistakes, which are then sub-categorised between legal interpretation and error. In addition to this, £5.3 billion is lost to evasion (income deliberately not being reported), and £1.8 billion to avoidance, where taxpayers seek to gain an advantage that was not intended to be given by Parliament.

Also of interest is other aspects of categorisation of the tax gap – £12.9 billion comes from income tax, NIC and CGT, £12.5 billion from VAT and £5.2 billion from corporation tax.

Then by ‘customer’ group, the biggest category comes from small businesses, which contributes £14 billion, compared with £7.7 billion from large businesses.

I take a couple of things from this – firstly, the public’s perception of things, which is mainly derived from the media, is that the main problem lies with large corporate entities or wealthy individuals, may not be entirely accurate.

Secondly though it helps to understand what the government is trying to achieve with Making Tax Digital (MTD). In particular why there is a focus on VAT and small businesses.

Clients with VAT registered businesses with chargeable turnover in excess of £85,000 per annum are just about to submit their first returns under MTD regulations. Hopefully anyone affected by this has already taken steps to ensure they have the requisite technology to handle the submissions. If not, I would recommend seeking advice ASAP, as otherwise things are likely to get rather hectic in the coming months.

This data though also confirms why MTD for income tax will follow in due course. Had everything gone in accordance with the government’s original plans, MTD for income tax would already be here. But partly due to the technological challenge, and no doubt partly due to resources and attention being focused on other areas of national interest, MTD for income tax has been placed on the back burner. Presently, we are expected MTD for income tax in April 2021; it will happen because it is perceived to be a key strategy behind closing the tax gap.

Finally on this subject, just a reminder that the powers that be consider a big reason for the amount of tax that is lost due to errors is as a result of poor record keeping. In my opinion, the authorities will more and more use technology to help them spot problem areas, in particular small business who are not complying with the new regulations, and these small businesses will consequently have a far higher chance of receiving a detailed investigation into their affairs.

There are always two sides to a story like this, and mainly as a cause of the complexity of our tax system there are also plenty of taxpayers who have been paying more than is required by the legislation, mainly because of mistakes typically borne out of failing to understand the regulations, or simply failing to claim reliefs that are there to help and assist; this point works both ways.

With the objective of providing some balance, I now want to focus on areas whereby taxpayers can often inadvertently end up paying more tax than necessary by missing out on claims for reliefs and allowances.

  • If you make a loss when selling an asset, claim the loss, and this loss can then be carried forward to be offset against gains arising in a future year. The loss has to be claimed within 4 years of the end of the tax year in which it was suffered. It can then be carried forward indefinitely.
  • If you make losses on shares in a trading company, you could qualify for income tax relief.
  • If you are making losses while self employed, particularly at the beginning or the end of your self employment, there are generous rules for offsetting the losses against other income from earlier periods which can often be overlooked
  • If you are employed and self employed the chances are self assessment might overcharge your Class 4 NIC liability.
  • Utilise the annual ISA and pension allowances to maximise tax breaks.
  • Married couples where at least one of the couple were born before 5 April 1935 can claim an additional allowance.
  • Married couples transferable allowance can be claimed where one person is a basic rate taxpayer and the other does not make full use of their allowance.
  • Married couples should also make sure that ownership of investment income generating assets is divided in a way that ensures each person fully utilises the Personal Savings Allowance and Dividends Allowance, where possible.
  • Persons registered with their local council as blind (or with sight that is severely impaired can claim an additional tax free allowance.
  • Fixed rate expense deductions – these can apply typically to those in employment who are expected to supply their own equipment and acquire and launder special clothing and uniforms.
  • Averaging – those in certain occupations with variable annual profitability (such as farmers) can average their results over 5 year periods. This helps to reduce exposure to higher tax rates in good years and can prevent tax free allowances being wasted in poorer years.
  • Rent a room relief – Home owners can receive up to £7,500 tax free rent a year from live in lodgers.
  • The trading allowance – claim the £1,000 trading allowance if you have a modest source of self employment or property income, if your allowable expenses amount to less than £1,000.
  • Gift relief – If you are a higher rate taxpayer, keep a track on gift aid charitable donations you make as you can claim relief against the higher rate tax that you pay.
  • CGT annual exemption – this is now worth £12,000 and should be claimed by anyone with a decent portfolio of stocks and shares. For periods of administration, it is available for the first 3 tax years.
  • Estates can also claim some of the costs of administering the estate against CGT.
  • Trivial benefits – Employers can (subject to conditions) provide staff with tax free benefits, up to the value of £50 a time.
  • Preserve entitlement to allowances where possible – as entitlement to child benefit is withdrawn when income exceeds £50,000, and entitlement to the tax free allowance is restricted when income exceeds £100,000, those who can control how and when they receive taxable income need to keep these thresholds in mind.