The National Audit Office (NAO) pulls no punches in its latest report, 'Tackling tax evasion in high street and online retail'. It concludes that HMRC are slow in preventing phoenixing, disguised residency and electronic sales suppression. Tax evasion is growing in the small business sector and whilst HMRC have identified issues, they've done almost nothing to prevent them.
The NAO’s report examines whether HMRC, with other relevant parts of government, are well-placed to tackle tax evasion on the high street and online retail.
As well as assessing HMRC’s overall approach to tax evasion in retail, the NAO examined specific risk areas in more depth, specifically:
- Overseas retailers evading VAT on online sales.
- Contrived insolvency and phoenixism.
- Electronic sales suppression.
The NAO says that HMRC has so far lacked an effective strategic response to tackle growing tax evasion among small businesses. HMRC can offer some good examples of localised campaigns targeting some retailers, i.e. targeting takeaways and Westminster’s sweet and souvenir shops, but HMRC has missed earlier opportunities to tackle others, potentially allowing their market share to grow.
Evasion from small businesses is increasing among those which include companies, Partnerships and Sole traders, going from £3.1 billion (66% of the evasion tax gap) in 2019-20 to £4.4 billion (81%) in 2022-23.
Highlights from the NAO's findings
Overseas retailers evading VAT on online sales
The NAO notes that retailers use a variety of methods to avoid Import VAT and Input VAT.
Online marketplaces are now liable for the VAT from overseas retailers. Marketplaces are also liable for the VAT on imported goods sold to consumers in consignments worth up to £135, regardless of where the seller is from. While the change has helped reduce non-compliance, overseas sellers can evade VAT by breaking imports into small consignments and falsely presenting themselves as UK-established for VAT purposes.
Fraudulent company registrations
- A staggering 42% of retail companies currently on the register were incorporated since January 2023.
- The surge in company formations in 2022-23 may have included an attempt to stockpile registered companies before Companies House implemented new checks.
- Until 2024, Companies House had limited powers to control or check the validity of information provided by registered companies, and companies have been able to register and dissolve before submitting a tax return. Stricter requirements introduced at Companies House in March 2024 should make fraudulent company registrations more difficult, but the changes will take time to implement and gaps remain. The Economic Crime and Corporate Transparency Act 2023 significantly changes the role of Companies House
- Separately, HMRC conduct checks on whether businesses registering for VAT are UK-established based on known indicators of risk, but does not verify this in most cases.
- HMRC and Companies House have discussed closer integration of systems to tighten registration requirements but estimate these will take five to 10 years to implement. HMRC and Companies House have explored opportunities from Companies House’s new powers.
False representation as a UK-based business
A significant strategic risk for tax evasion is overseas retailers evading VAT online in the retail sector. This type of evasion can take different forms, including both direct sales and those made through online marketplaces. For example, it can happen when an overseas retailer falsely represents itself as a UK-established business so online marketplaces do not apply the correct VAT liability.
- VAT non-compliance by overseas retailers selling goods and services online resulted in losses of around £700 million, of which around £300 million was deliberate evasion. HMRC’s best estimates indicate that £150 million of non-compliance may occur through online marketplaces, though the estimates are uncertain.
The NAO is also concerned about 'Phoenixism':
- When companies artificially declare themselves insolvent and set up a new company it is known as 'phoenixism'.
- While phoenixism has existed for many years, HMRC did not fully assess its scale until 2023. HMRC’s latest indicative estimate is that phoenixism accounted for 15% of its tax debt losses in 2022-23, which equates to more than £500 million.
- HMRC has made changes to improve how it manages fraud and evasion after missing earlier opportunities to tackle phoenixism and other tax evasion among London souvenir shops.
- The Insolvency Service disqualifies very few company directors specifically for phoenixism. It disqualified 6,274 directors between 2018-19 and 2023-24 and only seven of them were for phoenixism.
Sales suppression
The NAO says that ‘Sales suppression’ is falsifying financial records to reduce taxable income. It is one of the most common forms of tax evasion.
HMRC splits sales suppression into two distinct types depending on whether it relates to cash or electronic transactions, and takes a different approach to each:
- Cash-facilitated suppression is a long-standing source of tax non-compliance, and can be difficult to trace because there is no audit trail. A business using this form of sales suppression may conduct some trade, such as paying staff or suppliers, ‘off book’ with cash to appear to be operating in line with its under-stated income levels.
- Electronic sales suppression (ESS) is a 'growing method' that uses third-party software to manipulate electronic sales data, either during or after the point of sale. A business using this approach will seek to hide or reduce the real value of transactions to reduce turnover and tax liabilities, while having what appears to be a legitimate audit trail.
Tackling ESS
- ESS can be relatively straightforward to perpetrate (for example, putting transactions through a cash register’s training mode), but more sophisticated methods are increasingly marketed to businesses. HMRC estimated in 2016 that a certain form of ESS may result in at least £100 million of tax losses.
- In 2019 HMRC conducted a full threat assessment, and its indicative estimate was that annual tax losses from all ESS could be at least £450 million. HMRC told the NAO that its estimates were based on small subsets of data and various assumptions that may not apply across the wider small business population.
- Sales suppression has increasingly involved the supply and use of ESS software to remove or reduce the recorded value of transactions. HMRC found in 2016 that a certain form of ESS may result in £100 million of tax losses.
- HMRC introduced an ESS strategy in 2019, which included objectives to improve its understanding of and response to ESS and a series of actions to meet those objectives. However, HMRC has not updated this strategy or kept its assessment of the risk up to date. More sophisticated electronic sales suppression methods are increasingly marketed to businesses. HMRC has not updated its estimate of the scale of tax losses since 2019, but plans to do so in December 2024
- Many Organisation for Economic Co-operation and Development (OECD) countries require businesses to use electronic cash registers or to regularly report transactions to the tax authority.
The NAO concludes that HMRC does not know how successful it is in tackling tax evasion, in aggregate or for particular taxpayer groups. HMRC estimates that its compliance work reduces the tax gap to around half the level it would otherwise be, but it does not track how much of this reduction relates to different types of non-compliant behaviour. HMRC calculates the ‘compliance yield’ from its work on individual strategic risks, but many such risks include multiple types of non-compliance. For example, VAT non-compliance by overseas sellers includes errors and failure to take reasonable care, as well as wilful evasion.
The NAO previously recommended that HMRC be more consistent in evaluating the effectiveness of compliance work, which could provide greater insight into its impact. While HMRC has increased how many evaluations it conducts, it does not use these to consider its overall impact in tackling tax evasion or feed lessons on what works well into its plans.
Useful guides on this topic
UK fails to embrace tax technology
The National Audit Office (NAO) compares measures adopted by other countries to reduce instances of VAT and sales fraud with the UK's approach. It reveals that the UK is seriously lagging in terms of its adoption of technological solutions.
TAAR: Distributions on winding up (anti-phoenixing rules)
When does the TAAR apply? Who does it affect? Can you apply for tax clearance? Do the rules affect striking off?
Is a fiscal till solution the way to prevent ESS?
Over 30 countries have created and implemented so-called 'Fiscal Till Systems' to crack down on tax fraud by Electronic Suppression of Sales (ESS), but the UK shows no sign of following suit. Is the slow-burning rollout of Making Tax Digital into a direct tax to blame?
Digital Platform Reporting
NEW: Our subscriber guide explains the new reporting rules for Online Market Places: What is Digital Platform reporting? What is a digital platform? What are the digital platform reporting obligations? Who is excluded from digital platform reporting?
Online marketplances: are your ready for tax changes?
From 1 January 2024, Online Digital Platform Operators that are Online Marketplaces have to register with HMRC and report details of people who sell goods and services to buyers from their platforms.
External links
NAO: Tackling tax evasion in high street and online retail
