Official Statistics

7. Tax gaps: Illustrative tax gap by behaviour

Published 18 December 2012

Introduction  

The tax gap is composed of a range of customer behaviours:   

• avoidance  

• criminal attacks  

• error  

• evasion  

• failure to take reasonable care  

• hidden economy  

• legal interpretation  

• non-payment  

The behavioural breakdown of the tax gap is estimated using management information, assumptions, expert judgement and historical data. The resulting estimates are subject to uncertainty which cannot be quantified. The estimates provide broad indicators of the behaviours contributing to the tax gap. They are illustrative and may not fully reflect how behaviours are changing over time.  

In ‘Measuring tax gaps 2023 edition’, we improved behavioural tax gap estimates by replacing historic fixed assumptions with customer behaviour data and expert operational insight. These updates do not extend back to 2005 to 2006 and only go back to 2019 to 2020. 

Avoidance  

Avoidance involves bending the tax rules to try to gain a tax advantage that Parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage. It involves operating within the letter but not the spirit of the law.  

Some forms of base erosion and profit shifting (BEPS) are included in the tax gap where they represent tax loss that we can address under UK law.  

The tax gap does not include BEPS arrangements that cannot be addressed under UK law and that will be tackled multilaterally through the OECD. The OECD defines BEPS as ‘tax planning strategies that exploit gaps and mismatches in tax rules to make profits disappear for tax purposes or to shift profits to locations where there is little or no real activity, but the taxes are low resulting in little or no overall corporate tax being paid’.  

The avoidance tax gap estimates reflect the laws that were in place at the time and do not include any subsequent changes to the tax law to prevent further use of avoidance.  

Tax avoidance is not the same as tax planning. Tax planning involves using tax reliefs for the purpose for which they were intended. For example, claiming tax relief on capital investment, saving in a tax-exempt ISA or saving for retirement by making contributions to a pension scheme are all forms of tax planning.  

Criminal attacks  

Organised criminal groups undertake co-ordinated and systematic attacks on the tax system. This includes smuggling goods such as alcohol or tobacco, VAT repayment fraud and VAT missing trader intra-community fraud.  

Error  

Errors result from mistakes made in preparing tax calculations, completing returns or in supplying other relevant information, despite the customer taking reasonable care.  

Evasion  

Tax evasion is an illegal activity where registered individuals or businesses deliberately omit, conceal or misrepresent information to reduce their tax liabilities.  

Failure to take reasonable care  

Failure to take reasonable care results from a customer’s carelessness and/or negligence in adequately recording their transactions and/or in preparing their tax returns. Judgments of ‘reasonable care’ should consider and reflect a customer’s knowledge, abilities, and circumstances.  

Hidden economy  

The term “hidden economy” refers to sources of taxable economic activity that are entirely hidden from HMRC. It includes businesses that are not registered for VAT, individuals who are employees in their legitimate occupation, but do not declare earnings from other sources of income (moonlighters) and individuals who do not declare any of their income to HMRC (ghosts).  

For tax gap behaviours, we treat the hidden economy and tax evasion as follows:  

• hidden economy — where an entire source of income is not declared  

• tax evasion — where a declared source of income is deliberately understated  

Legal interpretation  

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. Specifically, this includes the interpretation of legislation, case-law, or guidelines relating to the application of legislation or case-law. Examples include categorisation such as an asset for allowances or VAT liability of a supply, the accounting treatment of a transaction, or the methodology used to calculate the amount of tax due as in transfer pricing, or VAT partial exemption.  

Non-payment  

For tax gap purposes non-payment refers to tax that has been correctly declared or assessed but is not ultimately collected, typically because the taxpayer is unable to pay.  

For  VAT, Corporation Tax, and Income Tax, NICs, and Capital Gains Tax in Self Assessment and PAYE, for tax years since 2018 to 2019, non-payment is an estimate of eventual written off tax debt attributable to the year of tax debt creation. For years prior to 2018 to 2019, non-payment refers to the tax year in which tax debts are written off by HMRC and result in a permanent loss of tax.  

For all other taxes, non-payment is estimated using management information, assumptions and expert judgement combined with projections from historical data.