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'Tax gap' due to ‘legal interpretation’ jumps 9% to £6bn

The amount of tax the UK's HM Revenue & Customs (HMRC) thinks is being underpaid due to ‘legal interpretation’ has increased by 9% over the last year to £6bn, up from £5.5bn in 2014/15 according to 'tax gap' figures released by the tax authority.27 Oct 2017

“Any kind of tax planning is now being scrutinised by HMRC to see if it can be challenged - no area is off limits for HMRC and this is reflected in the recent jump in the tax gap relating to legal interpretation,” said Jason Collins, a tax expert at Pinsent Masons, the law firm behind Out-Law.com.

“HMRC is pushing the envelope in grey areas and muddying the water when it comes to enforcing its interpretation of the law,” he said.

Underpayment due to ‘legal interpretation’ is recorded by HMRC when the taxpayers’ interpretation of the law and how it applies to the amount of tax owed, differs to its own, often developing view of the law.

The tax gap data is the difference between the amount of tax that should, in theory, be collected by HMRC against what is actually collected. For 2015/16, the tax gap was £34bn, up from £33bn in 2014/15. As a percentage of total tax liabilities this has declined slightly to 6% from 6.1% in 2014/15.

“The 9% increase may also reflect the fact that some large businesses are struggling to get certainty from their customer relationship managers at HMRC over complex new rules. This means more differences of opinion over legal interpretation are ending up as disputes rather than being resolved at an earlier stage” Collins said.

There have been significant changes to the UK tax system over recent years, including the introduction of diverted profits tax in 2015. This is leading to an increase in transfer pricing investigations, according to separate figures obtained by Pinsent Masons.

In addition, a new restriction on corporation tax deductions for interest payments takes effect from April this year.

“The tax gap for legal interpretation is likely to rise further with major changes to the tax system looming” Jason Collins said.

The figures show that the amount of the tax gap thought to be attributable to avoidance has declined slightly over last year at £1.7bn, as opposed to £1.8bn for 2014-15. The 2014-15 figure  was revised down from the £2.2bn figure published last year.

Jason Collins said: “The ‘magic money tree’ doesn’t exist for tax avoidance and Chancellors can’t keep promising to raise more money through targeting it.”

Although HMRC estimates the VAT gap to be £12.6bn, its lowest level since 2010/11, this makes up 37% of the total tax gap.

"The underpayment of VAT is a much bigger problem than avoidance and no doubt we'll see HMRC turn more attention to it - and using the new criminal offence directed at big companies which don't do enough to prevent fraud in their markets and supply chains” Collins said.

From 30 September 2017 it is a criminal offence in the UK if a business fails to prevent its employees or any person associated with it from facilitating tax evasion.

The tax gap figures show that in 2015/16, large businesses accounted for £9.7bn (29%) of the overall tax gap, whilst SMEs accounted for £15.5bn (46%).

“Large businesses have reacted to pressures from HMRC by improving their internal controls and many have also now have turned their back on marketed tax avoidance schemes” said Jason Collins.