Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response to the Committee's Twenty-ninth Report of Session

Transcription

1 House of Commons Treasury Committee Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response to the Committee's Twenty-ninth Report of Session First Special Report of Session Ordered by the House of Commons to be printed 15 May 2012 HC 124 Published on 18 May 2012 by authority of the House of Commons London: The Stationery Office Limited 0.00

2 The Treasury Committee The Treasury Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of HM Treasury, HM Revenue and Customs and associated public bodies. Current membership Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Michael Fallon MP (Conservative, Sevenoaks) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Rt Hon Pat Mcfadden MP (Labour, Wolverhampton South West) Mr George Mudie MP (Labour, Leeds East) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and Thamesmead) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross) Powers The Committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No 152. These are available on the Internet via Publication The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at The Reports of the Committee, the formal minutes relating to that report, oral evidence taken and some or all written evidence are available in printed volume(s). Additional written evidence may be published on the internet only. Committee staff The current staff of the Committee are Chris Stanton (Clerk), Lydia Menzies (Second Clerk), Jay Sheth, Adam Wales, Dr Renée Friedman, Antonia Brown (on secondment from the Bank of England), Lara Joseph (on secondment from the FSA) and David Sewell (on secondment from the NAO) (Committee Specialists), Alison Game (Senior Committee Assistant), Steven Price and Lisa Stead (Committee Assistants) and James Abbott (Media Officer). Contacts All correspondence should be addressed to the Clerk of the Treasury Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is ; the Committee s address is treascom@parliament.uk

3 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 1 First Special Report The Treasury Committee published its Twenty-ninth Report of Session , Closing the tax gap: HMRC s record at ensuring tax compliance on 9 March 2012, as House of Commons Paper No The Government Response to this Report was received on 2 May 2012 and is published as an appendix below. The response from the Government is in plain text and the Committee s conclusions and recommendations are in bold text. Appendix 1: Government Response The Tax Gap 1. The tax gap can be a useful concept for assessing trends in the amount of possible unpaid tax. We are not, however, convinced that the process of calculating, publishing and publicising an aggregate figure for the tax gap is a sensible use of HMRC s limited resources. The aggregate tax gap figure is misleading and risks focusing HMRC on the wrong task as it only provides an order of magnitude. (Paragraph 16) The Government does not fully accept the recommendation. HMRC finds tax gap analysis useful in quantifying types and causes of non-compliance by tax regime and customer group. This informs deployment of resources and an assessment of long term trends. This, in turn, has allowed the Government to make strategic investment choices to tackle avoidance, evasion and criminal attacks to generate additional revenues of 7bn a year by HMRC does, however, accept that tax gap measures have limitations. They are, for example, not sufficiently accurate or timely to use for setting targets and performance measurement, and are not used for these purposes. The tax gap helps the department understand and explore the various causes of noncompliance, how they occur and how they can be addressed, whether through tailored assistance, simpler legislation, redesigned processes or targeted interventions. Calculating an aggregate figure allows HMRC to quantify, compare and prioritise its response to risk across the tax system and to benchmark performance against other fiscal authorities. Considerable resources go into tax gap analysis. However the various components of analysis, such as receipts forecasting, testing the accuracy of risk assessment and informing policy decision making, are required for other business reasons. The incremental cost of publishing an aggregate tax gap is therefore small. HMRC considers the additional resource is justified, given the uses that the tax gap is put to. HMRC continually reviews its processes in order to make them as efficient as possible. HMRC believes that an aggregate tax gap improves public understanding and allows HMRC to be better held to account. The Information Commissioner has held that HMRC s tax gap estimates are a matter of public interest and should therefore be published.

4 2 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 2. We recognise that it is useful for HMRC s employees to have some idea of the difference between what HMRC should be collecting and what is collected, particularly in the case of criminal activity. However, in other areas it would be more useful for it to identify ambiguities in tax law rather than employ resources in calculating how much tax would be collected if everyone shared its interpretation of the law. Separate reports on how much tax was lost through criminal activity and areas where HMRC had encountered different interpretations of tax law would be a better use of resources. (Paragraph 17) The Government does not fully accept the recommendation. HMRC believes the aggregate tax gap analysis is a valuable tool in prioritising resources, as the Committee recommends, and agrees that the focus of work on tax gaps needs to be proportionate and help the best use of the resources available. HMRC does identify areas where there are different interpretations of tax law. Quantifying the scale of these issues helps set priorities for policy development and resource deployment. This allows the department to compare these priorities against tax losses resulting from other types of behaviour. There have been recommendations from both the Public Accounts Committee and the National Audit Office 1 to develop and use tax gap estimates in this way, and to publish the figures. In the interest of clarity HMRC thinks it makes sense to describe all of our tax gap estimates in one document so that a reader can understand more easily how the figures are calculated and the methodological issues which underpin them. 3. We would welcome further submissions from HMRC and tax experts both on how the tax gap calculation can be improved, and on whether it serves any useful purpose in HMRC s work. (Paragraph 18) HMRC has provided a submission to further explain (i) how the tax gap is useful, (ii) how it is calculated and how it can be improved, (iii) why publish an aggregate figure and (iv) how HMRC s estimate compares to others. This is included in Appendix 2. HMRC s Spending Review Settlement 4. HM Treasury has not adequately explained the criteria it used to make decisions about the re-allocation of funds to tax compliance. This makes it very difficult to scrutinise these decisions. HM Treasury should explain more fully how it decided to accept or reject HMRC s requests for additional funds and how it decided on the allocation of funds between functions. (Paragraph 24) HMRC s reinvestment package was agreed as part of the overall Spending Review process carried out in The details were set out by the Exchequer Secretary (XST) at the 1 Following the NAO 2003 report Tackling Fraud against the Inland Revenue PAC recommended The revenue should focus their work on making a reasonable estimate of the tax gap so they can judge the effort needed for a given reduction in losses. Following the NAO 2007 report Management of Large Business Corporation Tax PAC recommended The department does not have a robust measurement of the corporation tax gap it should develop such a measure and publish the result, with separate estimates for large businesses and small and medium sized businesses.

5 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 3 Treasury Select Committee (TSC) hearing on 11 May, and in a subsequent memorandum to the TSC on 15 June At the Spending Review, the Government announced 917m of investment for HMRC to address the tax gap and tackle tax avoidance and evasion, bringing in an additional 7bn a year in tax revenues by This investment would be funded from within HMRC s overall Departmental Expenditure Limit (DEL) allocation, prioritised from within 25% efficiency savings. Following the election, the Government made clear that one of its key aims was to do more to reduce the tax gap. Following the launch of the Spending Review in June 2010, HMRC were asked to set out a series of investment proposals to further reduce the tax gap. In considering the proposals, HMT had to consider individual proposals and the overall reinvestment package on the basis of: the robustness of the outline costs and benefits of each proposal; the fit with HMRC s overall strategy to maximise the collection of additional revenues due; the indirect impacts of different proposals, and HMRC s operational capacity and capability to deliver the reinvestment package alongside its other key objectives, so that HMT were satisfied that the 7bn of additional yield per annum was achievable without damaging performance in other key areas. As part of this process HMRC s Compliance Resource Allocation Model (CRAM) and other cost-benefit forecasts were used to estimate the impact of different projects. However the overall evaluation of these criteria was not just to identify which projects had the best return per 1 spent overall, but to ensure that the coverage across different sectors was consistent with increasing the deterrence effect of the whole package and improving the overall level of voluntary compliance. Although the overall scale and ambition of the reinvestment package was set out in the Spending Review, full businesses cases for individual proposals are scrutinised by HM Treasury as part of the overall assurance process. The Treasury regularly discusses overall performance of the reinvestment package with HMRC. Compliance Activity 5. By far the most efficient way of closing the tax gap is encouraging voluntary compliance. A process whereby taxpayers and HMRC work together to ensure that taxpayers voluntarily pay the correct amount of tax, sometimes following negotiation and agreement, is far less costly than the alternative. (Paragraph 28) The Government accepts the committee s conclusion. HMRC s existing customer-centric strategy, based on in-depth segmentation of its customers, provides explicit recognition that the majority of taxpayers are willing and able to get things right, and the department is transforming its business to make it as straightforward as possible for customers to comply

6 4 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response with their tax obligations. This strategy also recognises that many taxpayers need help to comply with their tax obligations, in particular when facing obligations for the first time. For example, the recent Small Medium Enterprises (SME) Budget Document [ sets out the ways in which both the tax policy and tax administration agendas look to make tax easier, quicker and simpler for SMEs, and this approach mirrors that HMRC would take with all mass-market customer groups. The Department already provides and promotes opportunities to customers to voluntarily correct their tax affairs on the best possible terms, including through negotiation and agreement. For example, HMRC Campaigns allow taxpayers to voluntarily put their tax affairs in order. HMRC has also introduced a new contractual disclosure facility (CDF), launched on 31 January 2012, following consultation with stakeholders. Under the new facility, HMRC can contact a taxpayer in writing to inform them that they are suspected of serious tax fraud and offer them the opportunity to enter into a contract to disclose that fraud within 60 days. In return HMRC will agree not to criminally investigate the tax frauds disclosed. Taxpayers are not under investigation, but those who want to admit to tax fraud may voluntarily request that HMRC consider a CDF arrangement. HMRC has discretion to decide which cases are dealt with civilly, and which are investigated with a view to criminal prosecution. Negotiated Time to Pay (TTP) arrangements for customers who find themselves in temporary payment difficulties are also available. 6. Simplifying the tax system should be a legislative priority for the Government in this Parliament. The Government should commit itself to setting a fixed, published timetable for deciding whether to accept recommendations from the OTS, and for producing draft legislation to implement the proposals it accepts. (Paragraph 30) The Government agrees that it is important to simplify the tax system. Its commitment to simplifying the tax system is reflected in the establishment of the independent Office of Tax Simplification (OTS) in July 2010 to make recommendations to the Chancellor on possible reforms. The Government has responded swiftly to the OTS s recommendations. For example, following the publication of the OTS review of tax reliefs in March 2011, the Government legislated to abolish seven of these reliefs in Finance Bill 2011 and launched a consultation in summer 2011 on the abolition of another 36, most of which are included in Finance Bill 2012 (the remainder will be abolished either through secondary legislation or the next available National Insurance Bill). The Government does not believe it is necessary to set a fixed timetable within which to accept recommendations from the OTS and produce draft legislation. 7. It is vital that those who wish to be compliant with tax law should be able to be so. HMRC has a responsibility to educate the public about their tax obligations and to ensure that information about tax is readily available in a variety of media. We recommend that HMRC commission a study to identify the biggest gaps in the public s understanding of their tax obligations and develop a strategy for addressing these. (Paragraph 32) The Government accepts this recommendation.

7 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 5 HMRC carries out extensive research into its customers and their needs and is increasingly providing targeted educational support through a range of channels, particularly on line. The quarterly customer experience survey and tax gap analysis help it to identify areas where customers are having most difficulty and to address the causes. HMRC is introducing new tools to help customers understand how much tax they have to pay and the Chancellor has recently announced the introduction of new tax statements from HMRC regularly undertakes research in order to understand how to interact most effectively with taxpayers and to provide information about tax. Recently they have undertaken research to track customers experience of the education services provided across a number of channels, and in 2012 plan to undertake work to gain a better understanding of the sources of errors amongst SMEs to test what approaches will most effectively reduce error. The Department has already successfully used their understanding to improve the information available to customers. For example, it has designed the Child Benefit form to make it simpler to complete, redesigned the flyer which explains the P2 (tax code notice) to make it easier to understand and launched My New Business to provide online help and support, especially for new businesses. During this SR period, the department will build on these successes and concentrate on specific processes and life events that they know cause the most difficulty for their customers and cost for HMRC, such as retirement, bereavement or moving jobs. It will also be launching a New Online Tax Registration Service, putting in place new calculators and interactive tools, improved guidance, intelligent iforms and simple-to-use processes for new policies. 8. HMRC should consider establishing a general disclosure facility to run alongside its targeted campaigns. The details of the facility should be easy for all taxpayers to access and understand. (Paragraph 34) The Government partially accepts the Committee s recommendation. It agrees that taxpayers should be provided with ways to come forward and disclose liabilities voluntarily at anytime. However, in considering a general disclosure facility, it is important to balance this with the need to ensure that the tax system remains fair for the honest majority who pay their taxes in full and on time, and that those who undertake to pay less than they should, do not gain an unfair advantage. Taxpayers are already able to come forward at any time. If they do, and provided the disclosure is full and accurate, they will benefit from the best possible terms available because they have volunteered to put their tax affairs in order. HMRC also offers more specialised routes for disclosure, including the contractual disclosure facility (CDF) and offshore disclosure facilities. Under the new CDF, taxpayers who want to admit to tax fraud may fill out a form to voluntarily request that HMRC consider their suitability for a CDF arrangement. They can do this by using a dedicated CDF section of the HMRC website that contains all the information, guidance and forms. There is also a dedicated CDF technical helpline to assist customers and their agents with any queries they may have about the CDF procedure. 9. We support HMRC s plan to invest more in prosecuting those evading tax, and urge it to consider how to publicise these to maximise their deterrent effect. (Paragraph 39)

8 6 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response The Government accepts the Committee s recommendation and is already targeting increased publicity of prosecutions to maximise their deterrent effect as part of the 7bn additional revenue per year by that HMRC is committed to deliver over this Spending Review period. HMRC intends to invest up to 2m per annum in paid marketing activity aimed at deterring evasion. This will help the department maximise the effect of its operational successes and encourage taxpayers to comply through effective external communication. The investment will include publicity surrounding successful criminal prosecutions. HMRC will also seek greater publicity for its civil investigation work. For example, those who are caught and penalised without making full disclosure may in future find their details being published on the HMRC website as well as being put into HMRC s Managing Deliberate Defaulters (MDD) programme. HMRC is also using strong publicity messages to drive the deterrent effect of taskforce activity. Taskforces target specific high risk evasion populations in geographic hotspots and trade sectors and feature one to one compliance activity, using civil and criminal sanctions. 10. It is important that those outside the tax system who wish to become compliant are not deterred from doing so by an unfounded fear that they may be prosecuted. HMRC should publish on its websites case studies of taxpayers who have not been compliant in the past but who have approached HMRC to settle the tax they owe. These should make clear that in the vast majority of cases the taxpayer s disclosure did not result in prosecution and should be understandable to the lay reader. (Paragraph 41) The Government agrees that it is important that those outside the tax system who wish to become compliant are not deterred from doing so, be that for fear of prosecution, or any other reason. HMRC is already addressing issues that might deter people from coming forward. For example, many people who have not voluntarily complied fear contacting HMRC even if they think they will not be prosecuted. This is because they do not know how much tax, interest and penalties they will have to pay. In many cases they wrongly believe this to be greater than it really is. To meet this concern HMRC now provides links to interactive calculators through its campaigns pages, which allow anyone to gain some idea of what their non compliance might cost them, in anonymity. HMRC also runs regular campaigns aimed at encouraging voluntary disclosure and making it clear to those who come forward the amount they may have to pay on top of the tax they owe, principally a monetary penalty. To date we have received over 53,000 voluntary disclosures. As part of continuing customer research and working with stakeholders, HMRC is looking at how effective case studies would be in encouraging customers to join the formal economy, and whether publishing these on our website is the best way of realising any beneficial effects. 11. We endorse HMRC s targeted approach to compliance. We welcome attempts to identify those outside the tax system but believe HMRC could do more to ensure it focuses upon them with as much rigour as it focuses on those already within it. We

9 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 7 recommend that HMRC reports separately in its annual report on its work on tackling those entirely outside the tax system. (Paragraph 49) The Government agrees with the Committee s recommendation. HMRC s customer centric strategy is based on in-depth understanding of each of their main customer groups, which has enabled them to develop a segmentation analysis for their customers: SMEs, Individuals, Large Businesses and Benefits & Credits claimants, as well as Organised Criminals. However, given that those entirely outside the tax system, by their very nature, are unwilling to interact with the department, it recognises that hidden economy businesses sit beyond their main customer segmentation analyses. HMRC remains committed to exploring what else it can find out about this difficult to reach group, who it believes contributes around 12% of the tax gap. The department is currently undertaking research to enable a better understanding of those who operate outside the tax system, and what potential levers could be utilised to change behaviours and discourage such activity. This will help the current work of developing a wider strategic approach to the Hidden Economy, to identify what meaningful initiatives could be adopted to complement current compliance activities devoted to tackling this sector. HMRC is happy to report on what it is doing to tackle those entirely outside the tax system, as appropriate, in its regular annual publications. 12. For offshore campaigns to be successful, those who do not take up the opportunity to disclose unpaid tax to HMRC should be prosecuted. These prosecutions should be well-publicised both to demonstrate to those who made the decision to come forward that they are not in a less favourable position than those who did not, and to encourage others to make disclosures where they have not already done so. (Paragraph 56) The Government partially accepts the recommendation. It agrees that it is important that those who do not take up the opportunity to disclose unpaid tax in the offshore schemes should be the subject of further action, including criminal prosecution. However, it believes that it is right that criminal prosecution should continue to be used selectively, with action for civil fraud as an alternative; in the case of offshore cases penalties for civil fraud can be as high as 200% of the tax owed and these are levied in addition to payment of all back taxes and interest. The Government also agrees that the consequences of non-disclosure should be wellpublicised. Publicity is already a key part of HMRC s broader strategy to change taxpayer behaviour by discouraging tax evaders from using offshore structures to hide their assets. The success of the offshore disclosure facilities is underpinned by an emphasis on the adverse consequences of failing to come forward. 13. The principle of the UK-Swiss agreement may turn out to be a step forward in reducing opportunities for individuals to avoid tax by concealing assets offshore. However, we are concerned that the rate of tax which will be withheld from anonymous Swiss bank accounts will be lower than the highest rate of income tax payable in the UK, and that the long delay before withholding begins will allow those with Swiss bank

10 8 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response accounts to remove their assets before withholding is applied. We recommend that HMRC, when publicising the UK-Swiss tax agreement, explains clearly the reasons for the lower rates of tax being withheld from Swiss bank accounts. If there are to be similar agreements in future with other jurisdictions, the Government should seek agreement for the same effective tax rates that apply to UK taxpayers. (Paragraph 57) The Government accepts the Committee s recommendation. The agreement with Switzerland is part of HMRC s broader strategy to tackle offshore evasion. The withholding tax element of the agreement will operate in a similar way to tax deducted from interest arising on an ordinary UK bank account balance, but will actually be at a much higher rate and on a broader base (for example, it includes Capital Gains) than is the case for bank accounts in the UK. The effective rate of taxation on interest is higher than the 35% withheld under the European Union Saving Directive. Because of the link to the highest marginal rate of tax and because some reliefs and allowances available (in respect of Capital Gains Tax for example) cannot be taken into account, a person who chooses not to disclose may pay a higher effective rate of tax then they would otherwise do. As a result, the tax implications of not disclosing income and gains on funds held in a Swiss bank account are now very much less attractive. Combined with the money being received earlier than would be the case under Self Assessment, the withholding tax arrangements provide a fair outcome for the UK Exchequer and the taxpayer. HMRC will work to ensure that this reasoning is clear in publicity associated with the agreement. 14. Successfully implemented, automation can enable HMRC to process a far higher volume of cases than it would otherwise. However, we have already seen instances of automation either damaging HMRC s relationship with taxpayers or consuming resources with a high volume of appeals. Automated processes should be rigorously tested and piloted and reviewed externally before implementation. HMRC must also provide ready access to members of staff who can help if the automated process creates errors. (Paragraph 61) The Government notes the Committee s conclusions. Automation not only allows the department to process far higher volumes more cost-effectively than it would otherwise be able to do, but also with a far greater degree of consistency and accuracy. The Government agrees that significant automated processes should be both carefully designed and appropriately tested but does not believe that every automated process needs be piloted, or that every automated process needs to be subject to external review. The Government believes that HMRC s testing, piloting, review and assurance activities must not only be proportionate to the likely risk and impact but that they should also provide clear value for money taking due regard of the cost to the public purse. The Government does recognise that many automated changes, particularly those requiring or encouraging customers to file electronically online, also involve integration with automated systems used in business or by Agents. The Government s strategy here is to ensure that HMRC works with customers, and in particular with the Software Development industry, to provide support services, including test facilities. This means that automated changes made by HMRC are assured and validated externally so that things like, for example, payroll products marketed by Software Developers work successfully. The changes made following Lord Carter s review of

11 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 9 electronic services are embedded in the way HMRC undertakes changes of this type and are being utilised fully, for example, in delivering the Government s flagship programme to deliver PAYE Real Time Information. The Government recognises that, however extensive the preparation, planning and testing for automation, things will not always work as intended. When this happens, the Government agrees that HMRC needs to have appropriate contingency plans in place so that issues can be put right at the earliest opportunity. The department values immediate feedback from customers when things go wrong, so that it can put things right quickly, ensure lessons are learned for the future and that those affected can receive the appropriate help and support. Large Business Service and Large Tax Cases 15. HMRC should work closely with large businesses to ensure that they fulfil their tax obligations given the sums involved in a single large business s tax affairs. However, the processes by which large tax cases are settled must be in a relationship based on openness and transparency and it is vital that appropriate checks be in place so that other taxpayers can be sure that all taxpayers are receiving the same treatment from HMRC. We consider below how this could be achieved and the extent to which the most recent proposals from HMRC achieve this. (Paragraph 71) 16. Where settlements made between HMRC and its customers are particularly complex, this should not be an occasion to alter governance procedures, but a time when existing procedures should be applied most rigorously. When the new code of governance for tax dispute resolution is published, we expect it to encompass all eventualities and be followed meticulously. We recommend that HMRC publish its code of governance in draft for consultation before a final version is published to ensure that it is suitable for all eventualities. (Paragraph 75) The Government accepts the Committee s recommendation. HMRC s Litigation and Settlement Strategy (LSS) is the framework for resolving all disputes with taxpayers which are resolved under civil procedures. The code of governance which HMRC has committed to publishing will set out the governance arrangements to ensure that the LSS is applied in practice. It will cover the arrangements under which HMRC makes decisions in specific cases of all sizes and levels of complexity, and those under which HMRC decides its approach to issues arising in more than one case. The code will be published in draft to allow an opportunity for interested parties to comment. 17. Where settlements of tax disputes are sufficiently large or controversial that they are escalated to Commissioners for review, this review must be independent and expert. We therefore welcome HMRC s recent announcement that a new Commissioner with responsibility for assurance will be appointed to review such cases and that the person appointed will be an experienced tax professional. We recommend that HMRC s annual report on its tax settlement work include confirmation that all cases which were escalated to Commissioner level were subject to review by a Commissioner with technical tax knowledge. (Paragraph 78)

12 10 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response The Government accepts the Committee s recommendation. As the Committee notes, HMRC intends the Commissioner appointed to the new assurance role to be an experienced tax professional. All significant tax disputes referred to the HMRC Commissioners for consideration under the new arrangements should in practice be considered by at least two Commissioners with tax expertise. 18. It would be unreasonable to expect that HMRC will never make mistakes. However, it is important that HMRC learns from those mistakes and that the public s confidence in HMRC is not unduly eroded when mistakes are made. In the case of the mistake that was made in 2010 relating to a settlement with a large corporate customer, HMRC should publish the lessons learned from this mistake and how it intends to prevent such a mistake being repeated. (Paragraph 81) The Government broadly accepts the Committee s recommendation. The new governance and assurance arrangements HMRC will be introducing will minimise the risks of mistakes being made. Lessons learned from resolved disputes will be included, in anonymised form, in the Annual Report. 19. We recommend that the assurance Commissioner appear before this Committee as a matter of course after the publication of the proposed annual report on the outcome of HMRC s dispute work. (Paragraph 84) The Government accepts the Committee s recommendation. The assurance Commissioner and HMRC s Accounting Officer will appear before the Committee to discuss the Annual Report, if the Committee so wishes. 20. We recommend that HMRC s proposed code of governance for tax dispute resolution be explicit that the same rules apply to settlement of tax disputes with its large corporate customers as apply to settlements with all other taxpayers. (Paragraph 85) The Government accepts the Committee s recommendation. The framework within which disputes between HMRC and taxpayers are resolved is set out in HMRC s Litigation and Settlements Strategy which applies to cases of all sizes resolved through civil procedures. The proposed code of governance will set this out clearly.

13 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 11 Appendix 2: Additional information about the Tax Gap Introduction In the report Closing the Tax Gap: HMRC s record at ensuring tax compliance the Treasury Committee raised a number of concerns about HMRC s measurement of the tax gap and use of the estimates. Measurement issues raised included the inaccuracy of the measure, the range of methods used to produce the calculations, the wide range of behaviours included and the difficulty of making meaningful comparisons from year to year. In addition the committee were concerned that use of the tax gap risks focussing HMRC away from ensuring that all taxpayers pay the correct amount of tax. These doubts lead to the following three recommendations on the tax gap: The tax gap can be a useful concept for assessing trends in the amount of possible unpaid tax. We are not, however, convinced that the process of calculating, publishing and publicising an aggregate figure for the tax gap is a sensible use of HMRC s limited resources. The aggregate tax gap figure is misleading and risks focusing HMRC on the wrong task as it only provides an order of magnitude (Paragraph 16) We recognise that it is useful for HMRC s employees to have some idea of the difference between what HMRC should be collecting and what is collected, particularly in the case of criminal activity. However, in other areas it would be more useful for it to identify ambiguities in tax law rather than employ resources in calculating how much tax would be collected if everyone shared its interpretation of the law. Separate reports on how much tax was lost through criminal activity and areas where HMRC had encountered different interpretations of tax law would be a better use of resources (Paragraph 17) We would welcome further submissions from HMRC and tax experts both on how the tax gap calculation can be improved, and on whether it serves any useful purpose in HMRC s work (Paragraph 18) HMRC welcomes the opportunity to send this submission on the tax gap. In this submission we have tried to explain, (i) how the tax gap is useful to us, (ii) how it is calculated and how it can be improved, (iii) why we publish an aggregate figure and (iv) how HMRC s estimate compares to others. Why does HMRC focus on the tax gap? Two of the fundamental aims of HMRC are to encourage, facilitate and increase voluntary compliance and to crack down on those who choose to be deliberately non-compliant. We believe that these two aims are encapsulated in the concept of the tax gap. By the tax gap we mean the difference between total revenues collected by HMRC in a year and the total revenues that we estimate that the tax system should generate. So measuring the size of the tax gap provides measures of the level of voluntary compliance and of HMRC s

14 12 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response effectiveness in tackling non-compliance. We aim to reduce the tax gap by ensuring that our customers pay the tax that is due. Thinking about the tax gap forces the department to focus attention on the need to understand how non-compliance occurs and how the causes can be addressed whether through tailored assistance, simpler legislation, redesigned processes or targeted interventions. Measuring the tax gap helps us to understand whether increasing returns from compliance activity reflect improved effectiveness or merely a decrease in voluntary compliance. Recommendation One in the report of the TSC inquiry the Administration and effectiveness of HM Revenue and Customs says: assessing HMRC s operational performance at ensuring compliance is complex. Tax receipts are affected by numerous factors including changes to the law, economic performance, cultural attitudes to compliance and HMRC enforcement activity. We recommend that the Government commission a study to attempt to separate out the impact of these factors over time. This study is underway and understanding movements in the tax gap is central to this work. What do we use tax gap analysis for? HMRC are pioneers in tax gap measurement. We first measured Excise gaps in the late 1990s, and the VAT gap in 2002, and over time we have learnt several lessons about how to use tax gap analysis effectively. We have found that tax gap measures are not sufficiently accurate or timely enough to use for setting targets and performance measurement. But we have also found that tax gap analysis is a very useful tool, alongside others, that helps the department with strategic thinking and business planning in a number of ways. In particular, by giving an assessment of long term trends and by quantifying types and causes of non-compliance by tax regime and customer group. Tax gap analysis provides a long term health check to validate the strategic decisions taken by the department and our effectiveness in tackling major risks. We have found that it is not useful to compare cash tax gap estimates across years because they are affected by factors such as inflation and rates changes that make comparisons misleading. However, the tax gap expressed as a percentage of tax due is suitable for tracking trends and is sufficiently accurate to show the impact of key developments in recent years. For example, the data series for the percentage tax gap clearly shows how the department has dealt with waves of criminal attack on the VAT system, how the recession increased debt and the increasing return from compliance activity. The total as a percentage of liabilities also allows us to benchmark levels of compliance in the UK against the other countries who measure and publish tax gaps. To aid departmental business planning, tax gap analysis is being split into risks for each tax regime. This is not the only tool that is used to allocate resources we have some very sophisticated models that allow us to estimate the marginal impact of putting more or less resource on specific activities. But the tax gap analysis does provide helpful validation of the broad use of resources, which is an important check in the resource allocation process.

15 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 13 Tax gap analysis plays a key role in the design of departmental strategy, for example in shaping the investment proposition for the current Spending Review. Two specific contributions of tax gap analysis to the spending review process were: Identifying areas where the department should look to investigate investment propositions by looking at the main causes of the tax gap by customer group and behaviour and seeing how these are distributed across the taxpayer population. The tax gap analysis showed that our effectiveness in tackling large business risks was already very high and that we should focus upon finding means of tackling evasion and reducing error amongst SMEs where greatest losses occurred, and Testing the investment propositions that had been developed using a range of more detailed analysis and models. Tax gap analysis allowed us to assess whether the overall balance of the SR package was proportionate and whether it was sufficiently ambitious. Notwithstanding the concerns expressed by Treasury Committee tax gap analysis was used in exactly this way in paragraphs 19 and 21 of Closing the Tax Gap: HMRC s record at ensuring tax compliance to assess the scale and direction of the SR10 investment. In addition to these high level strategic and business planning roles there is a host of other practical uses for the various tax gap measures. The trend in the VAT gap is used by OBR as part of the VAT receipts forecasting process. The data gathered through random enquiry programmes is used to test and tune our risk assessment systems. And tax gap analysis has played an important role in specific policy decisions. For example, the decision to raise the three line account threshold on the SA return for self-employed taxpayers reducing taxpayer costs by 50m could be made because tax gap data demonstrated that the risks could be managed. Finally, on the basis of tax gap analysis we are able reassure the public that over 90% of liabilities are collected and that the great majority of UK taxpayers pay the tax that is due. This is important because the academic research strongly suggests that social norms perceptions of attitudes and behaviour amongst peers are an important driver of behaviour. Measurement Tax gap measurement is not an exact science. The estimates will never be precise and some care needs to be taken when comparing estimates for different taxes. However HMRC has developed robust and internationally recognised measures of the tax gaps for the main indirect and direct taxes. We are confident that these are the best possible from the information currently available. And whilst we are not able to calculate a measure of the precision of the tax gap estimate we do know that the estimates are sufficiently sensitive to be able to identify significant developments affecting taxpayer compliance in recent years. A top-down approach is used to estimate tax gaps for indirect taxes. This is because we can use data on consumption that is independently gathered by ONS to compute how much tax should have been paid and so calculate a gap by comparing against tax receipts. We do not believe that the data needed for a top-down estimate for direct tax gaps exists

16 14 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response for example the data on income and business profits that ONS use comes from HMRC. 2 So direct tax gaps use a bottom-up approach based on HMRC operational and intelligence data such as from random enquiries and risk registers. In both cases we calculate the net tax gap which is the tax gap arrived at after taking into account compliance work by HMRC. Top-down and bottom-up methods of measuring tax gaps are complementary. The former are better at capturing all forms of tax loss (whether they are known to the authorities or not), whereas the latter depend on HMRC s ability to identify tax loss. However, top down measures capture all forms of loss in a single estimate, so further assumptions have to be applied in order to produce estimates by types of behaviour and customer group. Bottomup methods do enable a more detailed breakdown of the causes of tax losses. Ideally, we would use both methods for each tax, but this is not always practical, or even possible. We are keen to improve our tax gap and compliance measurement. We have a comprehensive work programme in place to gather more data and develop new methodological approaches. The primary aims for future work are to develop, (i) a more granular understanding of the causes of tax loss and (ii) a robust evidence base describing the full impact of HMRC upon behaviour and tax receipts. There are a number of strands to this work: Developing a more granular view of the causes of non-compliance. For example, we are building upon our use of customer surveys and insight techniques to gather more detail on why customers make errors. This will lead to improvements in our processes that can prevent non-compliance occurring in the first place; Using innovative experimental and laboratory approaches to evaluate the impact of HMRC interventions upon customers understanding and behaviour; Improving our knowledge of people and businesses operating in the hidden economy through use of surveys and exploiting our investment in cutting edge data matching technology to routinely measure the percentage of non-registered taxpayers found on external data sources; Integrating tax gap measurement with the analysis of receipts, additional revenues generated by HMRC activity, economic and demographic trends and changes in customer attitudes, and Engaging with external experts on how we can improve our approach. Specifically, we are endeavouring to engage academics interest in the subject of tax gap estimation and design of laboratory experiments as part of the External Research Programme. Why aggregate and publish a tax gap figure? The Treasury Committee questioned the value of calculating the tax that would be collected if everyone were to share our interpretation of the law and then adding this figure to an estimate of losses from other behaviours to produce an aggregate estimate. There are 2 We periodically review this conclusion to check whether there are top down techniques for the direct taxes that we could use. Our latest review was published in August 2011.Seehttp://

17 Closing the tax gap: HMRC s record at ensuring tax compliance: Government Response 15 two main reasons why we do this. One is a product of how we use the estimates within HMRC and the other is a technical point that comes from the way in which we calculate the estimates. On the first point it is important to understand that the use of avoidance schemes and contentious issues around legal interpretation are tangible causes of loss of tax. The tax gap for avoidance comprises the tax lost through the use of avoidance schemes that HMRC was not able to successfully challenge. The tax gap for legal interpretation is primarily an estimate of the extent to which HMRC does not identify contentious tax issues, which if identified and tackled would have brought in additional tax. (This gap arises mainly amongst companies who are not large enough to have a HMRC customer relationship manager.) HMRC needs to both identify and quantify the scale of these issues in order to help set priorities for policy development and resource deployment. And we need to be able to compare these priorities against tax losses resulting from other types of behaviour. This informs the decisions about how much resource to deploy on large business and wealthy taxpayers compared to SMEs, Individuals and Criminal Gangs. Because the information is used in high level decision making we feel that we should be transparent about the figures we are using. We have been pressed by PAC and NAO to develop and use tax gap estimates in this way and to publish the figures. And the Information Commissioner has ruled that our estimates of tax gaps are a matter of public interest and so should be published because disclosure will facilitate public debate and enable the public to assess HMRC s performance. The key to the technical point is that our methodologies first estimate tax gaps by regime rather than by behaviour. So for example the VAT gap is estimated as one figure and we then apply judgments to produce analysis by behaviour. This means that the estimates by regime are more robust than other types of split and that in order to understand the component parts it is necessary to understand how the total for the regime is estimated. Therefore in the interest of clarity we think it makes sense to describe all of our tax gap estimates in one document so that a reader can more easily understand how the figures are calculated and the methodological issues involved. Finally we have to be aware that because the concept of a tax gap is of public interest others will calculate a total. The external work has tended to produce estimates that we think are misleadingly high. (See the annex for a detailed discussion of why we are convinced that our estimate of around 35bn is much more accurate than the Tax Research UK estimate of 120bn). We think that these estimates could be dangerous if not countered by HMRC s published estimates. Partly because they give a misleading view of HMRC s effectiveness and the amount of uncollected revenues. But also because they encourage the perception that deliberate non-compliance in the UK is the norm a perception which could encourage further non-compliance. We are confident that deliberate non-compliance is far from the norm and that it is important to demonstrate this by publishing our own estimate of the total tax gap. Annex: External calculations of the tax gap There is a huge difference between the 35bn tax gap calculated by HMRC and the 120bn figure for the tax gap quoted by Tax Research UK. The scale of the difference has caused confusion and concern. Part of the reason for the disparity is that the two estimates are not