Tax Gaps 2019-20

Lord Sikka Excerpts

Thursday 7th April 2022 Grand Committee

Asked by

[Lord Sikka]

To ask Her Majesty’s Government what assessment they have made of the HMRC report Measuring tax gaps 2021 edition - tax gap estimates for 2019 to 2020, published on 8 February.

[Lord Sikka (Lab)]

My Lords, it is a pleasure to bring this debate. I will raise three broad questions with the Minister: first, on the quality of HMRC’s analysis of the tax gap; secondly, on the composition of the tax gap; and, thirdly, on the administration of it.

What is the tax gap? It is a broad measure of non-compliance, defined by HMRC as the difference between the amount of tax that should, in theory, be paid to HMRC and what it actually collects. It says that the tax gap is around £35 billion a year or about 5.3% of the taxes that HMRC collects. In proportional terms, the tax gap has declined since 2010, though in absolute terms it has hovered at around £35 billion. That is assuming that one accepts HMRC’s methodology, which I do not. Even by its own standards, HMRC says that it has failed to collect nearly £400 billion in taxes since 2010. I will argue that that amount is not appropriate either.

HMRC attributes the tax gap to eight broad categories—what it calls taxpayer behaviours. These relate to criminal attacks, evasion, the hidden economy, avoidance, legal interpretation, non-payment, failure to take reasonable care, and error. This categorisation by HMRC of the tax gap does not connect with its priorities and legal duties. In court cases brought by HMRC, it frequently argues on three grounds. The first is fraud, the second is negligence and the third is honesty. But that is not how HMRC analyses the tax gap—that is entirely different.

The reason for the tax gap and putting a name to it is important because it frames how the issues are understood and the policy options that can be exercised. HMRC states that tax fraud is:

“Any deliberate omission, concealment or misinterpretation of information, or the false or deceptive presentation of information or circumstances in order to gain a tax advantage.”


That is a broad definition of fraud. If one applies that to the elements of the tax gap in the information published by HMRC, one can see that £15.2 billion of the tax gap is attributed to fraud. That raises serious questions about what is to be done about it. My first request to the Minister is this: can the Government please look at ways in in which to improve the analysis and presentation of the tax gap so that it links up with policy priorities and legal duties, rather than the departmental headings that HMRC uses at the moment?

Secondly, I have major concerns about HMRC’s methodology for estimating the tax gap. Typically, the HMRC estimate is based upon errors and omissions in tax returns, but we know that many individuals and companies do not file tax returns. Some 300,000 to 400,000 companies are struck off by Companies House every year for failure to file annual accounts, even though they may have traded and made profits—they just become invisible. Many companies are invited to file tax returns but do not do so. They may even have employees but do not make PAYE payments or pay national insurance. That, again, suggests that just a focus on tax returns will not help to estimate the tax gap. Many individuals do not file tax returns and escape consideration by HMRC’s tax gap model altogether. The number of tax audits undertaken by HMRC is not really that high either, so, again, it is extrapolating from a very small sample. In short, without going into a lot of technical details, the methodology for estimating the tax gap is highly questionable.

There are alternatives to HMRC’s tax gap model, and they estimate that the gap is somewhere between £58.6 billion and £122 billion a year. This suggests that, since 2010, between £400 billion and £1.5 trillion of taxes have not been collected. That is a vast sum. However, even these models do not fully capture the leakage of tax revenues. Let me provide three illustrations —I could do more, but we do not have the time.

I refer first to a well-known case. In 2005, the parent company of BHS paid a dividend of £1.3 billion, £1.2 billion of which went to Lady Green, its main shareholder. She is resident in Monaco, which does not levy any income tax. So the dividends were not taxed in the UK or in Monaco—they were not taxed anywhere. A UK resident recipient would have ended up paying at least £300 million in tax on that dividend. This is not an old or isolated example. Social care, water, train and many other companies pay dividends to offshore entities which are not taxed in the UK or anywhere else. This tax loss does not form any part of HMRC’s tax gap, and the Government have done absolutely nothing to curb this kind of tax avoidance.

My second example relates to the use of related-party transactions; again, the example is from BHS. In 2001, BHS sold some of its properties for £106 million to Carmen Properties Ltd, which is based in Jersey and controlled by Lady Green. Carmen then immediately leased the properties back, because BHS needed to use them. So from 2002 to 2015, BHS paid £153 million in rent to Carmen. These rents were tax deductible expenses in the UK and reduced BHS’s tax liability, but on the other side, in Jersey, they were simply not taxed and were paid over to Lady Green—a nice way to dodge taxes. This type of financial engineering is highly common among companies and results in tax avoidance adding up to billions of pounds. This does not form any part of the tax gap, and the Government have done nothing to check this form of avoidance either.

My third example has been the subject of the OECD’s base erosion and profit shifting—BEPS—project. It involves shifting profits from the UK to low or no-tax jurisdictions through intragroup transactions. Profits are shifted through interest payments on artificial loans, royalties and management fees, and now profit-sharing arrangements. Numerous companies are doing this. HMRC has done nothing to challenge this type of avoidance and has let off companies such as Starbucks, Microsoft, Boots, Facebook and many others. It entered into secret sweetheart deals with Google, Vodafone, Goldman Sachs and others, which then end up paying less. The cloak of confidentiality has prevented even the Public Accounts Committee investigating these deals.

HMRC’s report says:

“Some forms of base erosion and profit shifting … are included in the tax gap where they represent tax loss that we can address under UK law … The tax gap does not include BEPS arrangements that cannot be addressed under UK law and that will be tackled multilaterally through the OECD.”


This means that HMRC has absolutely no idea of the taxes lost due to profit shifting, and there is no estimate provided in the tax gap figures. My question to the Minister is this: can we have a more meaningful number for the tax gap, please?

I will say a few words about tax administration. HMRC staff do a heroic job. Dealing with the tax gap is very labour intensive, and investigating just one company like Google can tie down between 10 and 30 people for up to 22 months on average—that is an empirical number that I have just cited. In 2021, HMRC concluded 437 criminal investigations, compared to 864 the year before. Fraud investigations have also declined. In 2005, HMRC’s staff was 105,000; most recently, it was just under 62,000. I urge the Government to pay attention to HMRC’s resources, which have recently increased but are in real terms still well below the 2010 number.

Finally, can the Government be tougher on the tax avoidance industry? As far as I am aware, unless the Minister wishes to contradict me, not a single accounting firm whose tax avoidance schemes have been judged to be unlawful has ever been investigated, prosecuted or fined by the Government. Could the Minister explain why the Government are easy on the enablers? If they are easy, we cannot really address the tax gap.