Tackling tax evasion on the high street and online retail

HMRC does not have an effective strategic response to tax evasion, according to the National Audit Office (NAO).

HMRC have lost £5.5 billion of revenue in 2022/23 with small businesses (companies, partnerships and sole traders) accounting for 81% of this loss at £4.4 billion. It is estimated that tax evasion among small business is increasing, while it remains stable across other sizes of business.

The NAO highlights the three main contributors to HMRC’s tax loss across the high street and online retail sectors:

1. Phoenixism

The ease of setting up companies on Companies House is assisting so called ‘Phoenixism’; a process whereby companies are created and later artificially dissolved with the sole purpose of defaulting on their debts and avoiding their liability to tax. Their underlying trade continues under the guise of a newly created separate company. This process leaves HMRC heavily out of pocket, with phoenixism repeatedly occurring for serial offenders.

2. Electronic Sales Suppression (ESS)

The use of technology including sophisticated ESS software is allowing businesses to mis-report transactions either during or after the point of sale, producing a seemingly ‘legitimate’ audit trail while understating income and hence tax payable.

3. VAT mis-representation

Online marketplaces struggle similarly with authentication; becoming increasingly unable to verify accurately seller information. These platforms are unintentionally allowing overseas businesses to divert their UK VAT liabilities.

Online marketplaces make overseas sellers who are selling to the UK liable for UK VAT. In efforts to avoid this liability, overseas sellers are creating UK entities for the sole purpose of assigning UK VAT to them. Overseas sellers divert their UK VAT liabilities to their UK entities in full, only suffering VAT once the new entity exceeds the £90,000 threshold.

Crucially, these ‘UK entities’ have little or no real physical presence in the UK and so for VAT purposes cannot constitute a genuine UK establishment. The VAT liability remains with the overseas sellers.

It seems clear that the ease of creating UK companies is a key driver in UK tax evasion.

Current approach

VAT misrepresentation was no better illustrated than when tens of thousands of overseas businesses falsely claimed to be UK established, simply by using the same registered address in Cardiff.

In the Cardiff case, HMRC deployed a one-to-many letter strategy (so called ‘nudge letters’), writing to groups of businesses whose returns flagged a common issue, (i.e. the same or similar addresses). HMRC used this approach to tackle the tax loss via VAT misrepresentation. Again, HMRC was criticised by the NAO for doing little investigation into the mechanisms behind these under-declarations.

A strategic approach to tackle phoenixism and ESS is generally lacking. ESS appears to be challenged simply through publicity of HMRC’s data collection powers and fines for promoters and sellers of ‘offending’ software, and phoenixism only as a ‘tag on’ to pursuit of directors of failed companies.

HMRC take a generalist rather than a strategic or focussed approach, often on a case-by-case basis. This is problematic. Generally, focusing costly and resource intensive investigations into high end crime and using basic compliance investigations to tackle low value cases restricts resource for middle end cases where there may be larger, well hidden tax frauds.

Crucially, the NAO found HMRC to be missing cases of phoenixism by discovering evasion in businesses and then stopping the investigation once the business became insolvent. With phoenix-ism accounting for 15%+ of tax debt lost in 2022/23, this calls for re-evaluation.

A better approach

Tackling phoenixism, HMRC have proposed changes to Companies House in an effort to make the process of registering a company more rigorous (i.e. by better verification of the identity of directors). However, key elements of this proposal are dependent on additional funding and legislative changes which could take years and present a major obstacle to change.

A more effective approach may be to target phoenixism with the threat of criminal prosecution for abusive practices in this regard and pursue directors personally for their assets. Without any real deterrent, phoenixism will continue to be a problem with the current 15% level of tax debt only getting worse. HMRC have finite resources and so it makes sense to make more use of the Contractual Disclosure Facility (CDF), where tax fraud is suspected from phoenixism, ESS and/or VAT misrepresentation.

The NAO highlighted that HMRC are missing connected cases due to the narrow and single-minded approach currently adopted. The CDF would afford directors protection from criminal prosecution while rectifying their businesses’ tax affairs and settling any liabilities. Such an approach might at least help to bridge some of the £5.5 billion tax gap.

For VAT misrepresentation, a better approach might be for HMRC to target the platforms and marketplaces directly. If HMRC were to threaten the platforms that are ‘enabling’ evasion with ‘super’ penalties (perhaps even making platforms jointly and severally liable for tax evaded by their users), there might be a push from the marketplaces to increase their authentication processes; hence ensuring that the correct VAT is paid.

How we can help

We can help you and your business understand your tax obligations, assist in bringing your affairs up to date and making tax disclosures where necessary.

For more information, get in touch with a member of Crowe's Tax Resolutions team or your usual Crowe contact.