PAC report: HMRC approach to compliance means public purse is missing out on billions in lost revenue

- ‘Tax gap’ running at 5.1% of annual liabilities; £42 billion total in unpaid tax   

- Unacceptable customer service levels unlikely to improve quickly 

- HMRC aims to recover only a quarter of fraud losses in Covid support like furlough 

HMRC collected £731.1 billion in taxes and duties in 2021-22, the highest on record, reflecting the end of the acute phase of the pandemic. But in a report today the Public Accounts Committee says HMRC is still not deploying the resources required to maximise the tax revenues it collects or provide an acceptable level of customer service. At a time of huge strain for the public finances £42 billion is owed in unpaid tax, and HMRC is failing to collect around 5% of the tax it is owed each year.  

In an historic cost of living crisis, HMRC must target scarce resources to ensure businesses and individuals who are able to pay, do. For every £1 HMRC spends on compliance activities, it recovers £18 in additional tax revenue. The failure to better resource compliance means Government is missing the opportunity to recover billions in lost revenue. 

The Committee is unconvinced plans to address HMRC’s ‘unacceptable’ customer service will sustainably reduce demand or deal with the poor level of service quickly enough.  

HMRC also lacks ambition to tackle fraud and error and recover losses. It only expects to recover around a quarter of the estimated £4.5 billion lost to fraud and error in its COVID-19 support schemes. Fraud and error are also high for research and development tax reliefs, which are ‘costly, prone to abuse and provide questionable benefit to the UK economy’. Problems with VAT’s susceptibility to fraud appear to be better managed in other European jurisdictions. 

Dame Meg Hillier MP, Chair of the Committee, said: “The eye-watering £42 billion now owed to HMRC in unpaid taxes would have filled a lot of this year’s infamous public spending black hole. But the public purse will continue missing out on billions of desperately needed revenues as HMRC will only employ more staff to tackle compliance over the next few years – not fast enough to dent the tax gap at a time of huge public sector spending pressures. Meanwhile taxpayers battle customer services that need improvement. 

“The PAC has reported on the many problems in the Covid support schemes that made an open goal for fraudsters, but HMRC is settling for trying to recover less than a quarter of estimated losses in schemes such as furlough. We recognise the problems HMRC faces - due to poor controls, the horse has bolted - but we believe there is a moral duty to pursue fraud. HMRC must ensure dishonesty is not seen to create advantage.” 

PAC report conclusions and recommendations 

1. HMRC has not yet returned to setting a formal compliance yield target, against which it can be meaningfully held accountable.HMRC has not set a formal target since 2020-21 because of the uncertainty caused by the pandemic, and instead has published expectations for its compliance yield that it uses to manage its performance rather than as an accountability mechanism. For 2022-23, HMRC is aiming to achieve a compliance yield of £36 billion. This yield may include compliance cases opened several years ago. High inflation provides a further challenge to HMRC being able to effectively measure and understand underlying changes in its performance. Increased revenues and yields due to inflation will make it easier for HMRC to achieve historic rates of compliance yield. HMRC will therefore need to establish what is a genuine change in performance from a change in underlying revenues. 

Recommendation: HMRC should return to a formal compliance yield target with HM Treasury from April 2023 and report the target publicly. In doing so, targets should take account of inflation and economic factors, for example by setting the target relative to tax revenue. 

2. Resourcing HMRC’s compliance work to maintain rather than reduce the tax gap means the government is missing out on billions in lost revenue. HMRC estimates that the tax gap - the difference between the amount of tax that should, in theory be paid to HMRC, and what was actually paid - was £32 billion in 2020-21, or 5.1% of all tax liabilities, the same proportion as in 2019-20. This masks changes in the tax gap for each category of tax, with the tax gap for VAT decreasing while the tax gap for Corporation Tax, excise duties and income tax Self-Assessment increasing in 2020-21. HMRC bases its compliance performance and resourcing on maintaining the tax gap and stopping it from growing. However, there remains scope for reducing it; for every £1 that HMRC spends on compliance activities, it recovers £18 in additional tax revenue. The pandemic has created more uncertainty in the data that HMRC uses to estimate the tax gap, but HMRC does not currently report the range of uncertainty in its headline estimate. HMRC told us that this would be difficult to do, but possible. 

Recommendations: 

1. HMRC should set out what level of investment in its compliance teams would be needed to reduce the size of the tax gap, and confirm what, if any, intention it has to pursue this.  
2. HMRC should also calculate and report an uncertainty range for its headline tax gap estimate to provide more transparency to users of the estimate.  

3. HMRC’s plan to only recover a quarter of losses due to fraud and error on its COVID-support schemes does not go far enough.HMRC estimates that total error and fraud across the lifetime of the COVID-support schemes is £4.5 billion, representing 4.6% of the £96.9 billion total support provided. This is lower than HMRC’s previous estimate, though the actual level of fraud and error remains very uncertain. HMRC has drawn together a wider set of data to improve its estimate, but this is limited by the shortage of data that HMRC collected on taxpayers’ working patterns at the time the schemes were running. HMRC has been given £100 million to fund a temporary taskforce to investigate fraud and error on the schemes and has opened about 40,000 investigations so far. However, of the £4.5 billion in fraud and error losses, HMRC forecasts by the time the taskforce closes it will have recovered only around £1.1 billion, with the rate of return for the funding expected to be less than if invested in tax compliance. HMRC is yet to demonstrate it has done all it reasonably can to recover the losses and avoid the dent to public finances. HMRC risks rewarding those taxpayers that were dishonest if it does not pursue more of the losses than currently planned.  

Recommendation: In determining what further recovery action to take on fraud and error on the COVID-19 support schemes, HMRC should: 

1. keep under review the return on investment of spending more resources on recovery; and 
2. set out how it will ensure it maintains a level playing field for individuals and businesses that did not abuse the schemes, rather than being seen to reward those that were dishonest. 

4. We are concerned that HMRC may be lagging behind other established tax authorities in preventing fraudulent VAT registrations. HMRC is constantly changing its processes to prevent criminals from exploiting the tax system. VAT is particularly susceptible to fraud and criminality as it can involve HMRC repaying large amounts to taxpayers. We raised concerns about a case where a criminal used a legitimate company’s details to apply for a VAT registration number and make fraudulent VAT repayment claims. We understand that the criminal was successful in the UK, but that safeguards adopted by the German tax authorities appeared more effective at identifying similar fraudulent activities at an earlier stage.  

Recommendation: HMRC should engage with its international counterparts to understand what lessons it can learn in preventing fraudulent VAT registrations and minimising the impact on honest taxpayers. 

5. Taxpayers and their agents are still not receiving an acceptable level of customer service. In the last five years, HMRC has reduced its customer service staff numbers from 25,500 to 19,500. During the pandemic, HMRC’s performance in replying to post or handling calls fell significantly, partly because it did not have sufficient customer service staff to manage the pressures that the pandemic brought. We were surprised to learn that at times in the past, HMRC has simply closed its telephone line when it could not cope with demand. It is not acceptable not to answer calls from people who are trying to pay the government money. HMRC’s plan for improving customer service is to continue digitalising the tax system, moving people away from phone and post onto online systems. Taxpayers report being more satisfied with HMRC’s digital services than its phone and post services. However, we are not convinced that its plans will sustainably reduce demand for traditional channels or deal with the unacceptable level of service that taxpayers and agents are currently suffering. The move to online services will not happen quickly and will not be appropriate for all circumstances or customers. 

Recommendation: HMRC should write to the Committee setting out its plan to improve customer service to adequate levels as quickly as possible, and within three months, including: 

1. a) the metrics HMRC will use to monitor its customer service performance, including metrics it needs to demonstrate it can answer calls and deal with post in a timely manner; 
2. b) the level of customer service taxpayers and their agents can expect to receive over the next three years against each of these performance metrics;  
3. c) how it will support customers who are unable to engage digitally or have a preference for post or telephone contact; and 
4. d) its contingency arrangements if its plans to reduce demand for traditional channels are unsuccessful or take longer to implement. 

6. HMRC has further to go until it can differentiate between taxpayers who are genuinely struggling, and those who can afford to meet their liabilities but are choosing not to. Total tax debt in August 2022 was £46 billion, less than at the height of the pandemic in March 2021, but significantly higher than before the pandemic. HMRC’s data suggest that the tax debt has started to increase again as the economy slows down and taxpayers feel the effects of the cost-of-living crisis. HMRC has previously taken a standardised approach to debtors, but is now trying to vary its approach depending on whether a debtor is in genuine financial distress. This segmentation requires good data on the behaviour of its debtors, as well as sufficient capacity to take a tailored approach. HMRC has increased its debt management service by 700 people and is experimenting with data from credit reference agencies to gain insights into its debtors. However, HMRC’s ability to understand debtors’ circumstances will be limited until it has completed its single customer account project, which will join up taxpayers’ records that are currently held in its different digital systems. 

Recommendation: HMRC should set out how it will strike the right balance between providing support to taxpayers who need it, whilst ensuring that those able to meet their liabilities are doing so. HMRC should also set out when its single customer account will be ready and consider how it can bring the implementation of it forward. 

7. Research and development tax reliefs are costly, prone to abuse and provide questionable benefit to the UK economy. The government has a target of 2.4% of GDP to be invested in research and development. In 2021-22, HMRC spent £9.5 billion on research and development reliefs, with expenditure having continued to grow year-on-year. HMRC told us that analysis it has undertaken demonstrates that these reliefs increase research and development investment, albeit marginally for small and medium-sized enterprises, but the benefit to the UK economy of that investment is not clear. Based on HMRC’s latest estimates, abuse of the reliefs cost the taxpayer £469 million in 2021-22, though work to establish the true scale of the problem remains ongoing. Abuse of the small and medium-sized scheme is particularly worrying, with 7.3% of claims for relief estimated to be fraudulent or erroneous. HMRC has undertaken work to reconcile the £21.6 billion gap between HM Treasury and Office for National Statistics estimates of research and development expenditure, but discrepancies remain. HMRC is introducing new measures from April 2023 to strengthen its compliance approach and bear down on abuse of the schemes. 

Recommendation: HMRC should develop its analysis of the additional research and development expenditure its relief schemes result in, to consider what impact that expenditure has on the UK economy. HMRC should report to the Committee on its findings within 12 months.