In a concerning trend for UK’s tax collectors, small businesses were found to be responsible for 56% of the tax gap in the last financial year, equating to a staggering £20.2bn, according to a report by law firm Pinsent Masons.
This figure has been on the rise for the past four years, with small businesses previously accounting for 40% (£12.8bn) of the tax gap in 2017/18.
The tax gap represents the discrepancy between the amount theoretically collectable by Her Majesty’s Revenue and Customs (HMRC) and what is actually amassed.
This shortfall can originate from several factors, including tax avoidance, evasion, and errors in filing.
Shifting Focus of HMRC
With HMRC intensifying its efforts to reduce unpaid tax from large businesses and affluent individuals, there’s been a consequential shift of focus towards small and medium-sized enterprises (SMEs).
However, investigations into these small businesses often stretch over long periods, leaving unresolved issues lingering for years.
The Persistence of Tax Avoidance in Small Businesses
In fact, some small businesses continue to employ tax avoidance schemes long after such practices have been largely eliminated among large businesses and high net worth individuals.
This persistent issue underscores the challenge of enforcing tax compliance within the small business sector.
Given this, small businesses that are not tax compliant should brace for closer scrutiny by HMRC in the coming years.
The Composition of the Tax Gap
A closer look at the government’s latest Measuring tax gaps report shows that small businesses constitute the largest proportion of the tax gap, followed by criminal activities (£4.1bn), large businesses (£3.9bn), and mid-sized businesses (£3.8bn).
Wealthy individuals and all other individuals account for 5% (£1.7bn) and 6% (£2.1bn) of the tax gap, respectively.
When broken down by type of tax, Income Tax, National Insurance contributions, and Capital Gains tax make up 35% of the tax gap.
On a positive note, the VAT gap has shown signs of shrinking, falling from 14% (£11.9bn) in 2005/6 to 5.4% (£7.6bn) in 2021/22.
Causes of the Tax Gap
The tax gap can be attributed to various behavioural factors.
Failures to take reasonable care (30%) and errors (15%) top the list, followed by evasion (13%), disagreements over legal interpretation (12%), criminal attacks (11%), and non-payment (9%), as indicated in the report.
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