Small businesses responsible for 60% of tax gap

Sara White, Editor, Business & Accountancy Daily

Billions of pounds of tax remain uncollected as HMRC reports the tax gap has grown to £46.8bn, equivalent to 5.3%, with small businesses the worst offenders for yet another year.

Corporation tax is the biggest unpaid tax, at 40% of the total at £18.6bn, with the worst segment being small businesses, which dominate the tax gap and fail to pay taxes at an industrial scale.

The share of the tax gap attributed to small businesses has increased over the last five years, from 48% of the overall tax gap before the pandemic in 2019-20 to 60% in 2023-24, failing to pay a staggering £28.08bn in tax in 2023-24, revealed latest HMRC Tax Gap figures.

The £28.08bn small business figure is split between various taxes, but is mainly corporation tax. For example the HMRC Tax Gap data showed that they did not pay £14.7bn in corporation tax, a further £900m in PAYE and also £5.8bn from business taxpayers in self assessment.

This high incidence of non-compliance, errors and failure to pay by small businesses with turnover below £10m, was the same in 2022-23, highlighting a major problem with poor compliance by small and micro companies, personal service companies and sole traders, which needs to be prioritised by HMRC whether it is by providing more help to this segment of taxpayers or improving guidance so it is easier for small businesses to comply with the rules.

However, on the £5.8bn unpaid by business taxpayers in self assessment the ‘uncertainty rating’ for small business is marked as ‘medium’ risk, although it grows year on year.

For HMRC and the government, they are hoping Making Tax Digital (MTD) for Income Tax will be the panacea to the problem by ‘reducing errors’, but the jury is out on that and the results will not be seen for years. HMRC has estimated this extension of MTD will generate an additional £1.95bn in tax by 2029-30 tax year, although this will not dent the £28bn small business tax gap. 

The complexity of the tax system is a concern for many accountants, who warn that this inevitably leads to high levels of errors in small business tax returns.

Zena Hanks, partner at Saffery LLP, said: ‘Corporation tax continues to be far and away the biggest sticking point, as it has been for the past decade.

‘Specifically, it’s small businesses that continue to stand out, contributing 60% of the total tax gap which would suggest they are struggling the most with their annual compliance.

‘As HMRC continues to roll out Making Tax Digital, small businesses and sole traders are firmly within the compliance crosshairs, with HMRC able to point to the now record low VAT tax gap that’s been achieved since the implementation of MTD for VAT – though admittedly the VAT gap had long been on a downward trend. 

‘While it does involve some admin and expense to get reporting systems ready for MTD, any inconveniences should be outweighed by the advantages and efficiencies of a more intuitive reporting system improving compliance and the availability of real time information and reducing the likelihood of penalties and unexpected tax bills – benefitting both businesses and the public finances.’  

The rest of the business community accounts for 21% of the tax gap, while criminal evasion is at 5% and estimated non-payment by the wealthy is a further 5%.

Olivia Wiggett, associate director at RSM, said: ‘60% of the tax gap was attributed to small businesses, and phoenixism, where company insolvencies are contrived to evade tax or write off debts owed with the directors then setting up a new company, is likely to be a key contributor to this.

‘But the government is expected to be cracking down on this area with HMRC, Companies House and the Insolvency Service joining forces to deliver a plan to tackle those using contrived insolvencies to evade tax and avoid debts.’

But it is not only small businesses that are in the firing line.

Interestingly, HMRC has marked as a ‘very high’ uncertainty a £1.4bn tax hole identified due to non-payment of tax by large partnerships reporting under self assessment tax returns, indicating the level of uncertainty.

Despite talk of clamping down on tax avoidance, this is identified as only a tiny part of the tax gap at an estimated £200m, raising concerns the tax gap is likely significantly higher.

Another £3.9bn was lost through total PAYE, while the hidden economy, totalling £1.5bn lost tax, is split between £600m from culprits described as ‘ghosts’, and a further £900m from moonlighters taking cash payments and not disclosing income.

HMRC has made progress on VAT, with a sharp improvement in collection rates, with only 19% of tax gap now down to VAT, compared to an extraordinarily high 28% the previous year. However, this estill means £8.9bn of VAT went unpaid, and the improved figure only gets HMRC back to pre-covid levels after the tax authority eased off enforcement and compliance activity during the pandemic.

The overall tax gap was pretty much unchanged from the previous year’s final figure after various adjustments saw the final outcome being adjusted to £46.4bn, or 5.6% in 2022-23.

The tax gap estimate, the difference between what tax is expected to be paid and actually paid, was 5.3% for the 2023 to 2024 tax year, down from 5.6%. Over the years, this figure has improved from 6.9% in 2013-14, although the tax base was smaller so only £36.5bn of tax were left uncollected.

While £46.8bn was unpaid in 2023-24 tax year, HMRC collected £829.2bn, representing 94.7% of all tax due.

HMRC has been given an extra £1.7bn over the next four years to fund an additional 5,500 compliance and 2,400 debt management staff – to ensure more of the tax due is paid, to fund public services, but these new hires will take time to train to become highly productive and effective at such a specialist role.

Dawn Register, partner and head of private client services at BDO, said: ‘The decision to increase late payment penalties by 50% and invest in 500 additional compliance officers reflects the scale of the challenge HMRC faces.

‘With corporation tax compliance deteriorating and small business non-compliance rising, businesses should expect increased scrutiny from HMRC. The tax authority has stated that £1 spent on compliance delivers a £22 return on investment, making enhanced enforcement activity inevitable.’

The Treasury claims that measures to close the tax gap announced by chancellor Rachel Reeves at last autumn’s Budget and Spring Statement 2025 are expected to raise an extra £7.5bn in tax by clamping down on tax non-payment by the end of this parliament.