Small firms responsible for most tax evasion in the UK according to NAO report

A new report by the National Audit Office (NAO) says that the UK’s small businesses are responsible for the ‘vast majority’ of tax evasion. In fact, of the £5.5bn tax lost due to evasion, an astonishing 81% is said to be caused by small firms.

The report – Tackling tax evasion in high street and online retail – concludes that “tax evasion has been growing among small businesses, and HMRC has so far lacked an effective strategic response.”

Report highlights the biggest tax scams

The NAO report highlights some specific things which may have contributed to the level of evasion among small firms:

Electronic sales suppression

Retailers artificially reduce transaction values through various methods, including producing dummy accounts and keeping tills in ‘training’ mode. (cost £450m in 22/23)

Phoenix companies

According to HMRC, ‘phoenixing’ describes

…the practice of carrying on the same business or trade successively through a series of companies where each becomes insolvent (cannot pay their debts) in turn.

In other words, a company will become insolvent to avoid paying its tax liabilities and debts and reform as the same company in all but name.

Unfortunately, the Insolvency Service requires a high burden of proof to prove that directors have acted improperly, and as a result, many phoenix companies have managed to operate without consequences.

Phoenixing may have cost the Treasury £500m in 22/23.

VAT non-compliance by overseas retailers

VAT avoidance by selling goods and services online resulted in around £300 million in losses due to deliberate evasion in 2021/22.

The NAO suggests:

The UK may be more attractive to tax evaders where it has fewer requirements than other countries.

Online incorporation

Since 2011, online incorporation has made company formation from any location worldwide easier, leaving the UK more vulnerable to fraudulent activity.

The report notes that Companies House changes from March 2024 should make fraudulent company incorporations more difficult. However, it will take time for the extra security measures to take effect on a large scale.

What can the tax authorities do to clamp down on tax evasion by small firms?

Gareth Davies, head of the NAO, says that HMRC has failed to respond effectively to the growing rates of tax evasion and adapt to changing risks so far.

Its assessment of risks has given too little emphasis to widely used methods of evasion such as sales suppression and phoenixism. It has also failed to use new powers to tackle tax evasion.

While it is not straightforward and has a limited budget, Davies says that HMRC could raise significantly more tax by working more closely with other parts of government (e.g., Companies House) and using its existing powers to clamp down on fraudsters.

HMRC has the power to require overseas firms with no UK base to appoint a UK VAT representative, for example, but it has yet to do so.

Similarly, despite its new powers to act, it has yet to penalise firms that have used ESS (electronic sales suppression).

Download the full report here