Since the beginning of lockdown preserving the UK economy has been a top priority for the Government, which has been confirmed by its committed spending to bail-out British businesses, including the £330bn war chest unveiled by Chancellor, Rishi Sunak, back in April.

However, the Government will likely look to recoup as much of the money loaned and granted as possible through taxation. So, to avoid large fines, businesses must remain above board.

The rise of HMRC

Since HMRC’s inception back in 2005, it has slowly been gaining more and more power in order to close the ‘tax gap’. This refers to the difference between the amount of tax that should be paid in the UK by individuals and companies, and the actual amount paid. There’s a significant discrepancy too. For the 2018-19 financial year alone, the gap was estimated to be £31bn, according to HMRC’s tax gap report.

Its often the large conglomerates that make the headlines for avoiding tax, like Google, after it was reported that its UK unit paid just £6m to the Treasury back in 2011 despite a UK turnover of £395m. However, it’s actually small businesses that present the biggest problem, with the tax gap equating to an estimated £13.4bn last year alone. This makes them a prime target for HMRC.

HMRC’s most significant increase in power came a decade ago when it launched its software called ‘Connect’, which uses multiple data sources to paint a picture of a taxpayer’s lifestyle or an organisation’s books, to determine whether they are paying enough tax, either through error, avoidance, or evasion. HMRC won’t disclose all of its sources of data, but we do know it uses things such as tax returns, Land Registry reports, credit cards, DVLA records, social media, and Google Street View. The body even holds the power to order big businesses such as Amazon and Airbnb to hand over data that would help uncover would be tax-evaders.

By collecting this data, HMRC is able to plug gaps in the tax system by identifying areas where tax isn’t currently being paid but should be.

Theory in practice

On paper, the theoretical power and influence that HMRC holds does seem intimidating. But how does the theory translate into practice? It’s estimated that since the launch of Connect a decade ago, which cost the Government £100m, the body has recouped £3bn in lost tax revenues, so it has paid for itself 30 times over. However, this still only represents 10 percent of the tax gap for one year.

Although the overriding tax gap remains, Connect has been successful in dismantling some high-profile tax evasion schemes. This includes the Robert Fraser Group tax avoidance. Adopted by adventurer Bear Grylls and many others, the scheme was based on maritime treasure hunts and allowed participants to claim back losses on investments into ship-wreck salvage companies. It raised around £110m but was questioned by HMRC in 2011.

Anyone thinking of hiding their money abroad may also want to think twice. HMRC has started to work more closely with international partners to increase global tax transparency, but it is important to understand the difference between tax avoidance and tax evasion here.

Avoidance is when the law is interpreted in ways not originally envisioned, which although frowned upon, isn’t illegal. In contrast, evasion is fraud and carries heavy penalties, including prison time. A decade ago it was fairly easy to store money on faraway islands and be fairly confident that HMRC would never find it. That isn’t the case anymore and international tax authorities are increasingly collaborating in a global crackdown on tax evasion.

When it comes to small and medium-sized businesses, the tax gap is mainly put down to inaccurate reporting. However, evasion is still a problem. This could be seemingly innocent things like accepting cash-in-hand and not declaring the income, but it’s important to remember that this is still fraud.

SMEs should also be aware of PAYE audits. HMRC is directing a lot of attention to these and with recent reports suggesting that six million furloughed workers were asked to break the rules to carry on working by their employer, this will become a critical area of investigation as HMRC looks to fine offenders. If a business is selected for an audit, the taxman will be looking at the following areas:

• The correct employee codes are being used
• PAYE deduction working sheets
• Cash payments
• Employee benefits (including expenses)
• Compliance with NIC regulations

Audit visits often result in inconsistencies being found, for which HMRC will calculate lost tax and NI revenues for the previous six years.

Preventing investigation

The easiest way to avoid a tax investigation is to keep accurate and up to date records. Indeed, a percentage of tax investigations each year are random, but the majority are triggered by inaccuracies in reporting. Although these errors may be innocent mistakes, if they aren’t there in the first place, they can’t be a red flag.

It’s also best to avoid aggressive tax saving schemes. The risk is never worth the reward as investigations are costly and can take years to put to bed. In addition, any good accountant will be able to advise you on legal tax reliefs that you or your business could benefit from. If you want some added peace of mind, futureproofing for tax investigations is available through fee protection which for a small sum covers the cost of accountants’ fees should you find yourself being investigated by HMRC. To find out more about how to prepare your business for tax investigations, you can take a look at the Wellers website.