Mind the gap!

As a tax geek, I find the Annual estimates by HMRC (“Measuring tax gaps”) of how much VAT HMRC Officers don’t manage to collect - and why - very interesting. One stat I look for is how much VAT HMRC thinks is lost to “artificial” avoidance schemes. As a result of both a raft of anti-avoidance legislation and changes to perceptions of what is acceptable behaviour, this estimate is now a relatively tiny figure- 0.07% of the theoretical VAT HMRC would expect to receive.

Much more significant are the sums lost to fraud, and the £2.2 billion VAT written off as bad debts.

But the two biggest sources of loss are analysed as “Failure to take reasonable care” and “legal interpretation”.

HMRC says the former “results from a customer's carelessness and/or negligence in adequately recording their transactions and/or in preparing their tax returns.”

Making Tax Digital is designed to reduce these losses, as a consequence of taxpayers keeping correct VAT records. I’d say that HMRC publishing clear guidance that taxpayers could easily access, and then rely upon, would have a major effect, too.

But the final category is perhaps the most interesting. “Legal interpretation losses arise where the customer’s and HMRC’s interpretation of the law and how it applies to the facts in a particular case result in a different tax outcome, and there is no avoidance”.

I wonder if HMRC is using the “persuasive power of numbers” here to discourage taxpayers from disagreeing with it. The correct tax outcome is that set out in law, there is no loss of tax unless the taxpayer’s position is legally wrong and is never corrected.

So why should HMRC suggest that, if all cases where a taxpayer disagrees with HMRC were resolved by the Courts, HMRC would receive a windfall? (Its estimate across all taxes, is £6.2 Billion a year. HMRC does not give a breakdown of this figure tax by tax.)

The VAT cases, where HMRC might expect to do well before the Courts, tend to fall into areas which are separately analysed components of the “Tax Gap”. It does have a good record in litigating avoidance and fraud cases. Likewise, if a taxpayer has been relying on a weak, untenable argument, (perhaps in the hope that HMRC will never discover the matter) HMRC may well treat this as “Failure to take reasonable care”, not least so it can argue for a penalty.

“Legal Interpretation” doesn’t include avoidance, fraud or carelessness. Just disagreements over how the law should be interpreted. You’d expect HMRC to win some, and lose some. HMRC should start at a disadvantage against a properly advised taxpayer, in that the taxpayer possesses the facts and has had time to analyse the law and apply it to those facts.

Of course, the whole exercise is a comparison between what HMRC thinks it could receive, and what it actually gets. If it underestimates the proportion of goods sold that are zero-rated, actual VAT receipts will be less than expected, and I assume the difference is chalked off to “legal interpretation.”

Legal Interpretation is then listed alongside negative behaviours such as fraud, avoidance and carelessness as a reason why the Exchequer gets less tax than HMRC estimate it should.

But “legal interpretation,” in the context of a taxpayer carefully reviewing the scope for zero-rating, or the scope for reclaiming input tax, etc. and then defending its position to HMRC, isn’t really a negative behaviour at all.

To discuss this or any other VAT issues, please contact Steve Chamberlain on 01225 472 800