The report on tax compliance, published on 16 December, makes a distinction between upstream and downstream compliance work carried out by HMRC.
Upstream compliance work is designed to encourage voluntary compliance. It includes legislative changes to close tax loopholes; changes to HMRC processes to reduce opportunities to avoid or evade tax; and operational activities to prevent non-compliance before it occurs. It increasingly involves using education, nudges and prompts to reduce errors and support taxpayers to get their tax affairs right first time.
Downstream compliance work is designed to identify and tackle non-compliance after it has happened. It involves monitoring risks of non-compliance, investigation and follow-up action. These actions include educating the taxpayer to put their tax affairs right, collecting any taxes owed, issuing penalties and, where necessary, pursuing matters through tribunals or through civil or criminal courts.
Lasting impact of the pandemic
The report notes that even prior to the pandemic, HMRC had started moving its focus towards upstream work and away from downstream work. Lockdown restrictions affected its ability to carry out investigations and the need to redeploy HMRC compliance staff to administer COVID-19 support schemes accelerated that trend further.
Throughout 2020/21, HMRC had redeployed 1,356 full time equivalent staff from its Customer Compliance Group (CCG) to work on these schemes, with a peak of 4,396 working on them during May 2021. Staff available for remaining compliance work reduced by 12% in 2020/21 which had a direct impact. HMRC closed 103,000 (29%) fewer compliance cases compared with the previous year and opened 114,000 (32%) fewer.
The report also highlights that upstream yield represented 22% of the yield in 2019/20 and 30% in 2021/22. But compared with historic levels, HMRC’s compliance work has raised around £9bn less revenue since the pandemic began. Compliance yield as a proportion of total revenues decreased from the previous average of 5.2% to 5.0% in 2020/21, equating to a £1.5bn reduction. It then fell to 4.2% in 2021/22 (the lowest level since 2011/12), equating to a £7.5bn reduction.
The tax system became an increasing target for fraud and criminal attacks during the pandemic. The total value of tax repayment claims rose by around £1.5bn (19%) in 2020/21 compared with 2019/20. HMRC stopped around £1.1bn of these payments before they were made but estimates that between £52m and £219m was extracted by fraudsters.
The NAO says that criminal prosecutions also decreased significantly in the pandemic when many courts were unable to operate. Before the pandemic, the number of prosecutions had reduced from around 900 in 2017/18 to around 700 in 2019/20 as HMRC focused more on serious and complex cases. In 2020/21, there were just 163 prosecutions, rising to 236 in 2021/22.
The future of tax compliance
HMRC’s internal planning indicates that it will be challenging to keep the tax gap from growing over the next three years. CCG will need to achieve its upper planning estimate for the yield from its core compliance work to meet the level it thinks will be needed to maintain the tax gap. In practice, it expects to achieve yield somewhere between its upper and mid-point estimates.
The NAO suggests that there needs to be a greater emphasis on cost-effectiveness of compliance work. During the pandemic compliance yield per staff member fell, which HMRC expects to recover this over the next five years. Compliance staff generated around £1.1m a year per staff member across 2020/21 and 2021/22 compared with £1.3m per staff member on average in the five years before the pandemic. While the NAO says HMRC’s compliance work still offers good value for money, its compliance yield measure needs to be sufficiently robust and transparent to instil confidence in the absolute level of returns it can generate.
HMRC expects the number of compliance staff to increase by around 2,500 (10%) between 2021/22 and 2022/23. However, new staff typically need up to four years to become fully effective which will impact how quickly it sees results.
The report concludes that HMRC faces a challenge to restore compliance performance and suggests that it can do more to demonstrate that its compliance yield measure has sufficient quality assurance and transparency.
Process improvements for estimating compliance yield include:
- applying improvements made to quality assurance processes for downstream compliance yield to upstream yield, including assurance work to test underlying evidence. This is something that ICAEW has also called for when being consulted on upstream activities by HMRC;
- reviewing its assumptions considering the current economic climate, including non-payment rates; and
- updating how it selects and targets the sample of cases to test, so that a robust extrapolation of errors can be used to calculate to what extent they affect the overall estimate of compliance yield each year.
The report also recommends that HMRC takes the following measures.
- Supplement published compliance yield figures with more detailed commentary and analysis of trends between the different components of yield, and what these say about performance. This should indicate levels of uncertainty and could include sensitivity analysis of core assumptions used in the compliance yield estimate.
- Assess the potential impacts on taxpayer behaviour and levels of non-compliance following changes to compliance processes during the pandemic that have been made permanent, such as fewer face-to-face visits and digital filing of returns.
- Analyse the relative rates of return from different types of compliance intervention to help inform how it prioritises and allocates resources on areas that will be most impactful. This should build on its existing analysis of rates of return.
- Ensure that there is more consistent evaluation of the effectiveness of all types of its compliance interventions. The findings should be used to assess value for money.
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