HMRC has recently made good progress in tackling tax avoidance, but increased attention should now be given to tax evasion.
HMRC estimates that evasion contributes £5.2bn to the tax gap, about 51 per cent of which is due to small and medium sized enterprises (SMEs).
A recent report published by HMRC suggests that cracking down on evasion by SMEs is now becoming a priority.
Researchers interviewed 45 SMEs that had been found by HMRC to have deliberately evaded tax. The research sought to establish motivation, evasion methods and possible deterrents.
A variety of justifications were given for evasion. These included claims that the amounts in question were insignificant in comparison to big businesses. Others said ‘It’s normal practice in my industry’ or the optimistic ‘I pay enough tax already’. Sadly, one said ‘My business would go bust if I paid the correct tax’.
The report identified four categories of SME tax evaders.
Unthinking – Carrying out small opportunistic evasions, buying family shopping through the business, or doing occasional cash jobs. They tend to be one-person businesses with difficulty separating business and personal finances. Oddly, they see themselves as compliant.
Invested – Carrying out more focussed evasion, feeling the business would fail if they paid the correct tax. They tend to backdate invoices and understate cash income.
Lifestyle – These people deliberately push boundaries between business and personal finance. They pay for a standard of living they feel they deserve, but which their legitimate business profits do not justify. This type of evasion stretches from simple things like paying for a family meal on the company credit card to more extreme examples such as funding luxury holidays.
Systematic – These are structures often deliberately set up to aid evasion, sometimes using quite complex strategies. These evaders run a real risk of criminal investigation and potential prosecution.
All generally believed that they were unlikely to be caught, and, if caught, the consequences would be minimal.
The interviews also identified several possible strategies to help HMRC prevent SME tax evasion.
Firstly, and most effectively, increasing the perception that tax cheats will get caught. Then showing how severe the penalties could be and that prosecution was possible, even for ‘small’ evasions.
We have some concerns: there is a risk that innocent errors may be mistaken for evasion and punished excessively. While, as the report recognises, increased publicity about evasion may have the countereffect of normalising it.
This will be a hard balance for HMRC to achieve but we applaud its initiative by seeking real world solutions to real world problems.