Labour Party Pledges to Close the UK’s Tax Gap: Implications for Business

The Labour Party has made bold promises to address the UK’s ‘tax gap’, a subject that has garnered increasing public attention. Following Labour's recent general election victory, efforts to tackle the gap have gained prominence. One proposed method for raising additional revenue includes committing further investment into HM Revenue and Customs (HMRC).

But what exactly is the tax gap? The ‘tax gap’ represents the disparity between the amount of tax owed to HMRC and the amount actually collected from taxpayers. Data published for the 2022-23 tax year, released just last month, reveals a tax gap of £39.8 billion ($50.8 billion), or 4.8% of the total theoretical tax liabilities of £823.8 billion for that year.

The data indicates that the tax gap numbers are consistent with the previous year. It is not large and complex businesses (responsible for 11%) or wealthy individuals (responsible for 5%) that contribute the most to the tax gap, but small businesses, which account for 60% of the gap. A significant portion of this is due to small businesses failing to take reasonable care, accounting for 30% of the gap. Despite the headlines, tax avoidance is the smallest component, contributing just 4%.

One notable omission in the tax gap data is the lack of information on offshore tax evasion or profit shifting, though such data has long been promised. HMRC receives significant data from other tax authorities through the Automatic Exchange of Information (AEOI). This data will inform any future estimate of the offshore tax gap and the necessary steps to recover such tax.

To reduce the tax gap, several policies could be introduced. Over the last two budgets, HMRC has been promised £303 million in additional funding to enhance its capacity to manage tax debts. Labour has pledged to raise £5.1 billion by reducing the tax gap, proposing an ‘invest-to-save’ plan to fund HMRC. This plan includes increasing the number of compliance officers and investing in HMRC's modernization.

These additional officers may be granted new powers. A consultation on the “tax administration framework” published in February 2024 offers the new government an opportunity to overhaul the investigatory framework. There might also be a focus on HMRC’s punitive powers, with the maximum prison term for tax fraud recently increased from seven years to 14 years and penalties for offshore tax matters also heightened.

Labour has emphasized its commitment to pursuing tax evasion, particularly offshore tax evasion. Any strategy targeting offshore tax will require information exchange with other tax jurisdictions, meaning businesses may see HMRC increasingly utilizing AEOI data and applying to overseas tax authorities for information.

Labour has also announced the creation of a ‘blockbuster’ funding pot for large criminal investigations, alongside legal and regulatory changes that would expand the scope of the disclosure of tax avoidance schemes, requiring businesses to provide more information about their tax arrangements. Newly installed Chancellor Rachel Reeves has vowed to “take on the tax dodgers to fund our NHS.” Labour also suggests that more prosecutions are necessary to establish a credible deterrent effect.

Concerns have been raised over the lack of prosecutions under the recent offenses of failing to prevent the facilitation of UK or foreign tax evasion (under the Criminal Finances Act 2017), or failing to prevent fraud more generally (under the Economic Crime and Corporate Transparency Act 2023).

For businesses, the increased scrutiny accompanying these measures will inevitably affect all, not just those ultimately sanctioned for avoidance and evasion. This scrutiny includes not only a business’s own affairs but also its interactions with others who may be under investigation. The next parliament might see the first prosecution under the 2017 or 2023 fraud offenses due to a business’s failure to prevent an offense by someone acting on its behalf.

Companies should ensure they have robust corporate processes to fully understand their tax arrangements and secure senior management buy-in for their tax strategy and positions. Clear reporting lines to senior management and protocols for escalating tax issues are essential. Businesses must ensure the facts informing their tax positions are properly understood, have a clear (and justifiable) basis for taking independent advice, and retain sufficient records.

For offshore structures, businesses should prepare for questions from HMRC and overseas tax authorities. These processes should also address broader tax risks when dealing with others. The 2017 and 2023 fraud offenses place greater responsibility on companies to monitor counterparties, especially those acting on their behalf. Businesses must demonstrate that they have implemented ‘reasonable prevention procedures’ to prevent tax evasion.

As these new policies loom, there is an even greater incentive for companies to act now, ensuring their tax risk management procedures are up to date.

By fLEXI tEAM