Contractors are no strangers to the unwelcome attentions of HMRC and the Treasury attempting to extract additional taxes. But Chancellor George Osborne’s award of a £900m war chest to HMRC specifically to target tax evasion could mean renewed attention on contractors.
HMRC estimates there to be a £42bn a year ‘tax gap’ – the difference between what taxes UK PLC should be paying, and what HMRC is actually recovering via direct and indirect taxation. But this estimate has been challenged by Tax Research, which claims the tax gap could be as high as £125bn.
Worryingly for contractors, everyday and entirely legitimate tax mitigation measures, such as splitting dividends between spouses and paying low salaries and high dividends through limited companies, have been flagged by Tax Research as avoidance measures costing the Exchequer billions.
Could this signify a new cycle of HMRC investigations into contractors’ tax affairs on a scale last seen in the heyday of IR35?
Analysing the tax gap estimated by HMRC
HMRC estimates the total tax gap in indirect and direct taxation for the financial year 2008-2009 to be £42bn. This is 8.6% of what HMRC models predict should be the UK’s potential tax take, and falls into the following broad categories:
- VAT gap, £15.2bn or 16% of what should be collected
- Income tax, National Insurance Contributions and Capital Gains Tax, £14.5bn or 5.4% of what should be collected
- Corporation tax, £6.9bn or 13.9% of what should be collected
- Other direct/indirect taxes such as duty on fuel and drink, inheritance tax and so on make up the difference, to £42bn.
HMRC estimates the total tax gap in indirect and direct taxation for the financial year 2008-2009 to be £42bn
Large businesses, including many contractor clients, are thought to have reduced their tax liabilities through avoidance measure to the tune of £2.9bn of the £6.9bn total, while small to medium sized businesses, including contractor limited companies, should be paying an additional £2.6bn, according to HMRC.
On the personal taxation front, inaccurate self assessment accounts for £5.8bn, and tax avoidance is thought to account for £1.4bn of lost revenue to the Exchequer. ‘Ghosts’, who don’t declare any income, cost £1.3bn and moonlighters, who have a second income but don’t declare it, account for £1.8bn of the tax gap.
Of the £42bn total, HMRC estimates evasion, classed as illegal non-payment, to account for £7.4bn and avoidance, which is legal but termed ‘clever trickery’, costing £7.4bn. Of the estimated £7.4bn lost through avoidance, HMRC figures suggest £1.5bn is through offshore havens and £1.4bn through personal tax avoidance, the remainder being avoidance by companies.
But Tax Research claims the tax gap is vastly underestimated
Tax advisers and research organisation Tax Research has completed its own estimate of the tax gap. Using data from HMRC and other sources, the organisation claims the tax gap is significantly higher, and its estimates range from £70bn to £120bn.
To put this into context, Tax Research suggests that unpaid tax could account for between 40 to 68% of the current public sector spending deficit, while more strenuous efforts to collect the tax could considerably reduce government borrowing.
Tax Research suggests that unpaid tax could account for between 40 to 68% of the current public sector spending deficit
To reach its high figures, Tax Research’s version of ‘tax avoidance’ includes two common and entirely legal contractor practices: ‘income splitting between married couples and within civil partnerships’ and the ‘creation of artificial self employments through limited companies, where dividends are paid instead of salaries’.
In analysis by Tax Research published by Guardian.co.uk, income shifting between spouses and companies is thought to cost £3.2bn, with ‘other offshore tricks’ costing £08.bn. Contractors clearly contribute to both these totals.
What’s HMRC likely to do to contractors to narrow the tax gap?
With a budget of £900m specifically to target non-payment of tax granted by the Comprehensive Spending Review (CSR), and a stated Coalition policy of clamping down on tax evasion, there is an expectation that HMRC will have to come up with some very public successes.
Contractors have traditionally been viewed by the Treasury and HMRC as soft targets because, unlike big businesses, most contractors can’t afford armies of experts to defend them. That situation has improved with the wide range of investigation insurances now available and the efforts of organisations such as PCG, whose members receive investigation insurance as standard.
But if the figures from Tax Research are to be believed, and more importantly if they are acted on by HMRC, the Treasury and the politicians that drive these organisations, then limited company contractors, contractors sharing company ownerships with a spouse or civil partner and contractors using offshore solutions might want to check their investigation insurance is up to date.
Tax avoidance in its many forms remains legal, as are the efforts of taxpayers to mitigate their tax liabilities. Tax evasion is illegal and rightly so. But the boundaries are being blurred by politicians and the media. The result could be that contractors could find themselves under investigation and under pressure to fill the tax gap.