More work on implementation and administration of tax reliefs needed, UK public spending watchdog says

Amyas Morse, head of the National Audit Office (NAO), said that a new report by the body on the broad “landscape” of the 1,128 tax reliefs currently in operation for UK individuals and businesses was intended to “put Parliament in a position to consider whether the major elements in the management and responsiveness of the system of tax reliefs are working adequately or are in need of further attention”.

“Tax reliefs are a powerful, important and long-standing element in our public finance system,” he said. “However, their implementation is subject to less independent scrutiny than that of other instruments of public policy.”

However tax expert Heather Self of Pinsent Masons, the law firm behind Out-Law.com, said that the NAO’s data, while providing a “useful baseline summary”, should be “used with caution”.

“As the Treasury notes, tax reliefs reflect policy decisions and the mere use of a relief is therefore not a sign of tax avoidance behaviour,” she said.

“The report does not distinguish between reliefs which are an absolute cost, such as the personal allowance; and those which represent a deferral, such as capital allowances for businesses. This means that the quoted total cost is not just a comparison of apples and oranges, but a completely mixed fruit salad,” she said.

According to the NAO’s report, the annual cost of the UK’s tax reliefs to the Exchequer has increased from 16% of gross domestic product (GDP) in 2005 to 21% of GDP, or £101 billion, last year. The figure relates to the 180 reliefs known as ‘tax expenditures’ for which HM Revenue and Customs (HMRC) has estimated a cost. These reliefs are often designed to achieve particular policy objectives by incentivising certain behaviour through the tax system, as an alternative to public expenditure. Examples include the tax reliefs and credits used as an alternative to grant funding to encourage research and development activity by companies.

“The cost of tax reliefs - so far as this is measurable - appears to be growing at a time when public spending is reducing,” the NAO noted in its report. “Each tax relief has an administration cost and carries the risk that revenue will be lost through error, tax avoidance and fraud. For tax expenditures, there is also the opportunity cost of the revenue foregone as a result of the policy decision to offer a relief. Reliefs may also have both intended and unintended consequences, such as the distortion of markets.”

HMRC said that it objected to the costing of the reliefs because “it does not represent an amount of money which might be obtained by Government - due, for example, to interactions between the reliefs”.

The report considered how HMRC was “responding to the challenge” of administering tax reliefs and spotting and addressing potential abuse of tax rules. It has done so by hiring 100 more investigators and extra risk and intelligence staff to identify and deal with tax avoidance and evasion, and through better use of data to cross-reference taxpayer returns against registered avoidance schemes and other data sources. However, the NAO noted that monitoring arrangements varied across HMRC and very few evaluations of whether expenditure reliefs in particular were meeting their social and economic objectives were actually commissioned.

“The suggestion that HMRC should be more proactive in monitoring the performance of reliefs is a good one,” said tax expert Heather Self. “Too often, reliefs are repeatedly ‘tweaked’ as problems become apparent, leading to complexity and increased compliance burdens for taxpayers.”

However, Self said that she was concerned to see the NAO highlight the use of interest deductions from taxable profits as a means of “substantially reducing tax liabilities” where companies had used debt to fund major investment or acquisitions. She said that HMRC rules preventing the deduction of interest where there is a tax avoidance motive or where there is a ‘group mismatch’ on the treatment of deductions meant that this was not strictly a relief but rather a means of preventing firms from being hit with a heavy tax bill when they could least afford it due to investment, such as in infrastructure.

“The report highlights that the deduction of interest from taxable profits can substantially reduce tax liabilities,” she said. “However, it fails to acknowledge that financing costs are simply a commercial expense for any business. The UK already has anti-avoidance rules in this area, but the relatively generous overall regime for interest relief is a key part of the competitiveness of the UK tax system.”

As part of the 2014 Budget report, the government published a detailed summary of its priorities for tackling international tax avoidance and working with the OECD on its base erosion and profit shifting (BEPS) project. At the time, Self said that this report appeared to suggest that the UK government could backtrack on its position in relation to interest, with a comment that the UK “looks forward” to the identification of best practice in relation to interest.