How can HMRC estimate the overall tax gap at 5.1% but profess no idea about the offshore element?
Tax Investigations Partner, Andrew Park, questions how HMRC can estimate the overall tax gap to one decimal point, without knowing the extent of the offshore element, in IFA Magazine.
Andrew’s article was published in IFA Magazine, 5 July 2022, and can be found here.
HMRC’s latest 23 June 2022 publication on the extent of the “tax gap” announces with striking precision that for the fiscal year to 5 April 2021 the difference between the total amount of tax that should, in theory, be paid to HMRC and the amount actually paid is “5.1% of total theoretical tax liabilities” of £635bn. This is almost unchanged and fractionally lower than the 5.3% overall estimate the previous year.
The total is broken down into the estimated tax gaps for the respective taxes. However, when one dives further into the report one of the notable areas on which HMRC is silent (along with explicitly excluding Covid support fraud recoverable through the tax system) is the level of the tax gap relating to the overseas assets, activities and arrangements of UK taxpayers – including offshore tax abuse. Although a startling area of silence, this comes as no surprise further to recent efforts by the not-for-profit organisation Tax Policy Associates to use Freedom of Information requests to obtain details from HMRC of its estimates of the offshore tax gap. HMRC reportedly responded to that attempt by professing to have no current estimate of what the offshore tax gap might be.
The fact that there is an “offshore” tax gap is undeniable. Even before taking deliberate offshore abuse into account, HMRC is aware from automatic exchanges of financial information with other tax authorities of c. £850bn of overseas assets held by UK resident individuals yielding huge levels of overseas income and gains. Coupled with the UK’s often complex tax statutes and case law that creates substantial scope for innocent and careless omissions on tax returns or else honest failures to realise tax returns have to be submitted at all. Additionally, many international business structures similarly are often inadvertently non-compliant given all the complex anti-avoidance and profit shifting rules they are subject to.
For many decades, thousands of UK residents held secret investment accounts in so-called “tax havens” – in places and institutions where absolute client confidentiality and no local taxes for overseas residents ensured that if they wrongfully chose not to disclose those accounts to HMRC it was doubtful whether HMRC would ever become aware of them. Indeed, some such offshore investment portfolios were successfully passed down within families for generations with HMRC none the wiser that Income Tax, Capital Gains Tax and Inheritance Tax was going unreported. That world of blatant offshore tax evasion relying on offshore secrecy is now largely a thing of the past. A series of embarrassing data leaks from offshore financial institutions that began some 15 years ago at about the same time as the global financial crisis gave OECD governments all the ammunition they needed at a time of fiscal pain to coerce almost all the traditional offshore financial centres to dismantle their secrecy laws and to comply with new initiatives to automatically hand over financial information – firstly with the USA under its FATCA regime but then swiftly followed by the OECD’s CRS initiative – involving over 100 participant jurisdictions. In HMRC’s own words, there are now “no safe havens”. Initially, HMRC offered special terms for UK residents to come forward to disclose such accounts but as the automatic information began to flood in “carrots” were quickly followed with “sticks” as the special terms were withdrawn and HMRC was granted new legislation to punish offshore related tax irregularities with eyewatering tax geared penalties of up to 200% or more in the absence of a reasonable excuse.
Similarly, complex marketed tax avoidance arrangements have often relied upon the use of overseas companies and trusts in tax neutral jurisdictions. However, the days when taxpayers could rely upon contrived offshore arrangements to achieve artificial UK tax advantages are now all but over. Enhanced anti-avoidance legislation and a string of successes for HMRC in the courts as the judiciary have adopted a more purposive approach – for instance, the “Glasgow Rangers big tax case” ruling that transfers to offshore trusts for the benefit of players were disguised remuneration – have now forced or encouraged legions of UK residents and business enterprises to exit such arrangements and to eschew entering into aggressive new arrangements in future.
Only the foolhardy would now seek to wilfully conceal an offshore account on which they should be disclosing income and gains from HMRC or to enter into a contrived tax avoidance scheme involving an offshore structure. It is easy, therefore, to understand how HMRC must rightly believe that a significant part of the offshore tax gap is now all but closed. However, in being so successful in recent years in plucking the “low hanging fruit” it seems HMRC has lost track of the remaining more subtle non-compliance – whether inadvertent or deliberate.
To cope with the vast amounts of offshore data it now receives HMRC has become increasingly reliant on trawling it with computer algorithms looking for anomalies between the offshore date it receives on UK residents and their submitted UK tax returns – if they have submitted them at all. Where potential anomalies are detected HMRC’s computers then generate “nudge letters” to the individuals concerned querying whether they have undisclosed offshore income or gains and requesting that they disclose anything they might have omitted. Although this is very efficient in working through most of data whilst making minimal demands on HMRC’s constrained staff resources it is also inherently limited in what it can achieve. The more complex international arrangements are the more complex and human intensive is the tax analysis required to identify whether or not the parties concerned are truly tax compliant.
Nudge letters are frequently sent to taxpayers who are actually completely tax compliant – for instance because of timing differences between the UK tax year and calendar year information provided from overseas, because income or gains fall within exemption thresholds or because the taxpayers are non-domiciled. Meanwhile, many taxpayers who did make errors refuse to believe it – particularly if they took professional advice. Whereas some people who have knowingly undeclared are likely to take their chances that HMRC will not have the resources to investigate further – particularly if the amounts are relatively small or their issues pre-date 6 April 2017, are still assessable now and would fall foul of minimum 100% penalties for failing to take steps correct such matters by 30 September 2018 under the UK’s one-off Requirement to Correct measure.
The only way for HMRC to truly know the scale of the offshore tax gap is to randomly investigate a statistically meaningful number of individuals and businesses with international arrangements and to allocate sufficient human resources to interact with the parties concerned and their advisors in the depth needed to do a full tax audit. I would not wish a random and ultimately unmerited tax investigation on anyone – however, that is what HMRC would have to do on a greater scale to better get to grips with the remaining non-compliant minority.
In professing to have no current estimate of the scale of the offshore tax gap HMRC is effectively loudly proclaiming that it no longer has the necessary human resource to open sufficient investigations into offshore related matters to know what it still has to deal with. That cannot be in the general public interest.
As for how HMRC can boldly estimate the overall tax gap to one decimal point without having a proverbial “Scooby” about the extent of the offshore element? How indeed . . .