HM Revenue and Customs (HMRC) estimates that it is losing £5.2bn a year through tax evasion, and SMEs are responsible for just over half of it.
Let’s be clear what they are talking about.
Tax evasion is illegal. In effect, cheating the tax man.
In that respect it differs from the legal – if morally dubious – avoidance methods that have been used by the likes of Amazon and Starbucks to minimise their UK tax liabilities by channelling sales overseas.
HMRC is so concerned about tax evasion by small businesses that it commissioned the research consultancy Quadrangle to produce a report, Understanding Evasion by Small and Mid-Sized Businesses.
The researchers interviewed SMEs from a broad range of sectors that were engaging, or had previously engaged in, tax evasion.
Their aim was to identify the characteristics and attitudes of tax evaders, and the approaches that might change those behaviours.
The report highlights three types of evasion:
1. Understating turnover
Often associated with work that is paid cash in hand. Money is either pocketed for personal use or put back into the business.
This may take place at the request of the customer, to avoid paying VAT, or be driven by the business to reduce its tax bill.
One business told the researchers: “Well, I would say half of it [is work done off the books and income not declared]. It is 50%. It used to be a lot more.
“It has changed because, obviously, well, it was, I would say 80% of it, used to be cash-in-hand and that, but because of the way clients have got building companies, they need proper invoices now.”
2. Overstating costs
Costs are overstated by claiming for a range of personal expenses through the business. These might include vehicles, restaurant bills, hotels, flights, electrical goods or even domestic cleaning and gardening.
Costs may be overstated by taking business stock for personal use, for example household goods or building supplies to be used for home projects.
One businessman told the researchers: “I might put through a car bill that might belong to my wife, for example, I’ll put that through. I might put through a mobile phone bill that belongs to my daughter, I might do that. It’s all minor stuff, nothing major, but it’s stuff that will make a difference personally.”
3. Understating employee earnings
This may include not putting through certain members of staff through PAYE, perhaps family members, casual workers or part-time employees.
It could involve under-reporting hours worked – paying some shifts in cash ‘off the books’ to reduce the tax paid for employer and employee.
The researchers also found examples of businesses not reporting improvements to premises to avoid increases in business rates, and using offshore accounts to hide revenue from HMRC.
And they identified three principal reasons why SMEs evade tax.
For some, evasion was seen as the only way to keep the business afloat, for others the driver was to grow the business with evasion deemed necessary to support ambitions or business goals. A third group used the proceeds of evasion to fund a lifestyle that would otherwise be out of reach.
But almost all said they would not have not adopted evasion strategies if they perceived them to be risky.
The financial penalties can be up to 200% of the tax due but that’s just the start of it. Tax evasion is a serious offence that can land you in prison.
They thought there was little chance of being caught.
One said: “They [HMRC] haven’t got the manpower, and they haven’t got the knowledge to do it. They just can’t prove it!”
Another said: “Even dad’s buying cases of beer and wine and stuff at Christmas, okay we’ll keep some ourselves, but they’d never know that wasn’t for clients. They wouldn’t say, ‘Well who did you give that to?’.”
The businesses interviewed typically deemed the risks of evasion to be relatively small, manageable and offset by the likely rewards.
There was a feeling that HMRC focuses its efforts on larger concerns, a perception reinforced by media reports of high-profile prosecutions.
Such media reports also helped SMEs to justify their own evasion on the grounds that others were evading tax on a much more significant scale.
Most were aware that penalties are possible but few had any understanding of what they might be.
Rob Johnston, Chief Executive of Cumbria Chamber of Commerce, said: “We all know that the sort of practices identified in the report are widespread, but we’d caution any business against going down this route.
“The financial penalties can be up to 200% of the tax due but that’s just the start of it. Tax evasion is a serious offence that can land you in prison.
“HMRC have greater powers to seek information about your financial affairs than they have ever had, and they have geared up their prosecution department to pursue evaders.
“We know that HMRC referred 1,135 tax evasion cases to the Crown Prosecution Service in 2015-16, and 1,258 the year before.
“It’s a myth that these are all major fraudsters. Around a quarter of prosecutions relate to sums below £10,000.
“There is also the risk of reputational damage to you and your business. HMRC now publishes a list of deliberate tax defaulters, which the media can use to ‘name and shame’ transgressors.”
He added: “Another area HMRC is looking at is bogus self-employment, where businesses make staff self-employed to avoid paying employers’ National Insurance contributions, and to remove their obligations to pay the National Minimum Wage, holiday pay and pension contributions.
“The number of self-employed people has risen from 3m in 2000 to around 5m today, and not all of that growth is down to growth in the economy.
“We wouldn’t be surprised if the Chancellor announces measures to increase tax on the self-employed and clampdown on bogus self-employment when he delivers his first Autumn Budget on November 22.”© Cumbria Chamber of Commerce