Small businesses are significantly contributing to tax evasion in the UK, according to a new report by the National Audit Office (NAO).
The report revealed that small companies exploit weaknesses in government systems, contributing to 81% of the £5.5 billion lost to deliberate tax evasion in the 2022-23 financial year. Despite the overall tax gap—the difference between tax owed and paid—reducing from 7.4% in 2006 to 4.8% in 2022-23, the share attributed to small businesses has increased sharply over the past five years, rising from 44% in 2018-19 to 60% in the latest figures. The NAO report criticised HM Revenue & Customs (HMRC) for lacking a targeted strategy to tackle tax evasion by small businesses, resulting in a lack of focus on performance in this area.
The report highlighted that HMRC has placed insufficient emphasis on widespread forms of tax evasion in the retail sector, including abuses of the insolvency process, where companies fold to avoid tax debts and immediately re-emerge as new entities. This practice alone cost HMRC over £500 million in 2022-23, yet the Insolvency Service disqualified only seven directors for such abuses between 2018 and this year, out of more than 6,200 disqualified directors.
The report also pointed to ‘electronic sales suppression’ as a significant source of tax loss, where businesses manipulate till systems to underreport revenues, often using specialised software. While HMRC has powers to address this, including fines of up to £50,000 for those making, supplying, or promoting these tools, the watchdog suggests these measures are underutilised.
HMRC has seen some success in tackling VAT evasion by making online marketplaces responsible for VAT on sales by overseas retailers, generating an additional £1.5 billion a year. However, the NAO warned of ongoing ‘significant gaps’ in checks, with some overseas companies falsely presenting themselves as UK-based to evade VAT.
The ease of setting up companies in the UK from anywhere in the world leaves the country vulnerable to tax evasion by fraudulent businesses, prompting stricter registration rules. Gareth Davies, head of the NAO, said: ‘Although tax evasion has been growing among small businesses, HMRC has so far lacked an effective response. Its assessment of risks has given too little emphasis to widely used methods of evasion. It has also failed to use new powers to tackle tax evasion.’
Davies acknowledged that tackling tax evasion is complex but emphasised the potential for HMRC to work more systematically across government to address the issue. He suggested that tighter controls and increased compliance efforts could yield substantial revenue and improve value for money.
An HMRC spokesman responded by highlighting that the agency generated a record £843.4 billion in tax revenues last year, funding vital public services. He stated, ‘The UK has one of the lowest tax gaps reported in the world, but the government is committed to reducing it further. While the vast majority of businesses pay the tax that’s due, we will continue to use our civil and criminal powers against the determined minority who refuse to play by the rules.’ HMRC plans to collaborate with bodies such as the Insolvency Service and Companies House to tackle tax evasion in the retail and online sectors, aiming to close the gaps identified by the NAO.
The NAO report underscores the urgent need for HMRC to develop a more effective strategy to combat tax evasion by small businesses. Enhanced measures and inter-agency cooperation could prove crucial in addressing this pervasive issue, ultimately safeguarding substantial public funds.