The tax gap and Labour’s review of HMRC

Ed Miliband announced at the weekend that, if elected, Labour would open an “independent, root and branch review of the culture and practice of HMRC” in relation to tax evasion and aggressive tax avoidance.

Today the Financial Times reported that there was support for the idea of a review among tax experts who “thought HMRC had lost too many skilled people in the pursuit of efficiency”.

Miliband said: “What we are seeing is the growth of hugely complex and aggressive tax avoidance schemes, often based offshore. The sort of activity that has left the UK a £34bn hole in our nation’s finances.”

HMRC’s estimate of the total UK tax gap is £34bn. The Independent reported – correctly, if we’re using HMRC figures (emphasis added): “The use of offshore aggressive tax avoidance schemes … contributes to a £34bn gap in much-needed public funds.”

Last week, as the Commons public accounts committee was preparing to question HMRC officials in the wake of revelations in the HSBC tax scandal, the Commons Library tweeted HMRC’s graphic showing the tax authority’s latest estimate of the tax gap by behaviour –

taxgap

Source: HMRC, Measuring tax gaps 2014 edition

Eight categories

According to HMRC’s own estimates and definitions (see page 13) the estimated £34bn tax gap includes:

  • tax of roughly £4bn (12% of the gap) lost through evasion, and
  • tax of roughly £3bn (9% of the tax gap) lost through avoidance.

HMRC uses eight categories of behaviour for this purpose, and the definitions used are set out in page 15.

Tax evasion is “illegal activity, where registered individuals or businesses deliberately omit, conceal or misrepresent information so they can reduce their tax liabilities”.

Avoidance for this purpose is “exploiting the tax rules to gain a tax advantage that parliament never intended”.

Avoidance “often involves contrived, artificial transactions that serve little or no commercial purpose other than to produce a tax advantage [and] involves operating within the letter, but not the spirit of the law”.

HMRC points out that tax avoidance is “not the same as legitimate tax planning”.

HMRC also considers that base erosion and profit shifting (BEPS) by multinationals is not within the definition of avoidance for this purpose. “The OECD defines BEPS as tax planning strategies that exploit gaps and mismatches in tax rules to make profits disappear for tax purposes or to shift profits to locations where there is little or no real activity, but the taxes are low resulting in little or no overall corporate tax being paid,” it says.

Excluding BEPS may seem controversial – especially in the light of the “LuxLeaks” revelations – but HMRC has to work within current tax law, not the law that we might like to have.