The recent report from the National Audit Office (NAO) reveals some troubling statistics regarding tax evasion in the UK, specifically highlighting HMRC’s struggle to combat this issue effectively. In the 2022-2023 fiscal year, it is estimated that HMRC lost a staggering £5.5 billion due to tax evasion. What stands out even more is the alarming increase in tax evasion by small businesses. According to the NAO, 81% of the total losses came from small businesses, a significant rise from 66% in 2019-2020. This trend is concerning, as it suggests that HMRC’s efforts to curb tax evasion within this sector are falling short.

One of the major criticisms raised by the NAO is HMRC’s lack of a specific, targeted strategy to tackle tax evasion, particularly in industries known to be high-risk. While HMRC does focus on some retailers, especially those considered to be high-risk, the lack of a broader, comprehensive approach has led to certain types of tax fraud being under-monitored. This includes issues like electronic sales suppression (ESS) and phoenixism.

Electronic Sales Suppression (ESS)

Electronic sales suppression involves businesses using sophisticated technology to manipulate sales records. Typically, retailers with point-of-sale systems or those that use electronic cash registers can use software to hide or delete transactions, thereby under-reporting their actual sales and reducing their taxable income. This kind of fraud can be difficult to detect, especially when businesses are adept at maintaining dual sets of records: one for the actual sales and one for tax reporting. HMRC has been criticized for not addressing this issue more aggressively, which has allowed some retailers to take advantage of loopholes and avoid paying the correct amount of tax.

Phoenixism

Another common form of tax evasion is phoenixism, where a company deliberately declares insolvency to avoid paying taxes, only to re-emerge as a new entity (often under the same management) without liabilities. By exploiting the insolvency process, these companies shed their tax debts, leaving HMRC empty-handed. This practice can be especially prevalent in sectors like construction, retail, and hospitality, where smaller businesses may be more inclined to use this strategy to avoid financial obligations. While the Insolvency Service and HMRC have some mechanisms to detect and prevent phoenixism, it’s clear that the current approach is not robust enough to deter companies from using this strategy repeatedly.

HMRC’s Approach

The NAO report suggests that HMRC’s current approach to tax evasion is somewhat piecemeal, focusing on certain high-profile or high-risk retailers but lacking the overarching strategic framework necessary to deal with tax fraud across the board. This includes not only the aforementioned fraud types but also other common methods of tax evasion among small businesses.

HMRC’s resources are often stretched thin, and its focus is divided between tax evasion, tax avoidance, and general compliance measures. Without a more specific strategy, such as one that includes updated technology to detect ESS or tighter regulations to prevent phoenixism, it will be difficult for HMRC to address the growing trend of tax evasion among small businesses.

Additionally, as the NAO report implies, the rise in small business tax evasion could reflect deeper systemic issues. Many small businesses may resort to tax evasion not solely out of intent to defraud the government, but also as a reaction to economic pressures, including rising costs, competition, and the perceived complexity of the tax system. This doesn’t excuse illegal behavior, but it does suggest that a more nuanced understanding of the root causes of tax evasion might help HMRC and policymakers devise more effective prevention strategies.

Conclusion

The findings from the NAO report should serve as a wake-up call for HMRC and policymakers. The rise in tax evasion by small businesses, particularly through tactics like electronic sales suppression and phoenixism, highlights the need for a more focused and updated strategy to tackle tax fraud. If left unchecked, the growing losses will continue to undermine the UK’s tax base, shifting the burden onto compliant taxpayers and reducing funding available for public services. HMRC must prioritize creating more targeted solutions to address these specific fraud mechanisms, whether through better technology, stronger enforcement, or more collaborative efforts with other agencies.