The annual HMRC summaries of the tax gap – the difference between that tax that should be paid and what is actually paid – make thought-provoking reading. In future, these summaries of the tax gap seem likely to be subject to a higher level of parliamentary and media scrutiny.

However, the government has the opportunity to reverse a policy proposal that could worsen the tax gap. That proposal could make it more difficult for the UK economy to grow.

There are many factors contributing to the tax gap, including criminal behaviour. All of these factors are hard to tackle, given the staffing and resource issues affecting HMRC, the costs involved in developing better systems and the impact of remote working. 

The latest HMRC annual summary estimates the total tax gap in 2022/23 as £39.8bn, with the corporation tax gap widening significantly since 2005/06. The tax gap attributed to small businesses has risen in recent years and now accounts for 60% of the total tax gap, while the gap attributed to large businesses has fallen.

These figures call into question the previous government’s announcement in March 2024 that the monetary thresholds for statutory audit for smaller companies would be raised by 50% for periods beginning on or after 1 October 2024. 

The previous government suggested that this may take 132,000 companies out of statutory audit. The intention of reducing business costs may initially seem laudable from a deregulatory perspective. However, it ignores the longer term benefits of statutory audits for business, the UK economy, providers of finance and the overall reputation of the UK as a good place for businesses to start up, grow and invest. 

The audit requirement is, in some sense, an ‘annual financial MOT’ that should help reduce the risk of errors (whether deliberate or unintentional) in company accounts and other corporate filings, without the need for extra government spend. It benefits from the physical inspection of stock and other assets, and it involves work by auditors on accounting records, systems of control, plans and financial forecasts, and sources of finance. All of these are essential building blocks for sustainable business growth. 

Annual audits also generate the audited financial track record that a stock exchange listing needs, and confidence in businesses wanting to grow among providers of finance and other stakeholders. They help reduce the risk of unexpected small company collapses and increase the chance of survival for startups – and the jobs on which the future success of the UK economy depends.

If the government abolished vehicle MOTs, the condition of vehicles would deteriorate and accidents caused by mechanical failure would increase. Similarly, as more and more companies are taken out of statutory audit, there is a risk that the quality of their reported financial results, systems, plans and financial forecasts progressively worsen to the detriment of shareholders, tax receipts and the aspirations of economic policymakers.

The planned 50% increase in monetary thresholds for exemption from statutory audits is short-sighted. There may even be an argument for reducing these thresholds. Too many companies have already been taken out of the need for an annual financial MOT.

Economic growth and investment depend on trust, good systems, properly costed plans and reliable financial information as a basis for sound decision-making. Excessive deregulation can lead to an increased likelihood of startup failure and poor decision-making, based on inadequate systems that produce numbers that don’t stack up, thanks to the absence of financial challenge.

Part of the justification for raising audit exemption levels is that audits of smaller companies are about box-ticking and bureaucracy. This is because UK auditing standards are designed for large, listed companies and other public interest entities. They are massively disproportionate for smaller entities. 

Surely the time has now come for the UK’s auditing standard-setter, the Financial Reporting Council (FRC), to adopt the International Standard on Auditing for Less Complex Entities (ISA for LCE). This standard runs to 158 pages, compared with the 1000+ pages of the full suite of standards, which are becoming ever more complex. These standards are similarly burdensome to many less complex charities and various public bodies.

The ISA for LCE has been approved by the International Auditing and Assurance Standards Board (IAASB), supported by the International Federation of Accountants and certified by the highly respected Public Interest Oversight Board as being responsive to the public interest. The FRC adopts IAASB standards and adds material specifically for UK auditors, but the UK is now a laggard rather than a trailblazer in the setting and adoption of auditing standards. 

The situation needs to be resolved promptly to reduce unnecessary burdens on smaller businesses. The FRC has the power to address any shortcomings in this new standard and should have the courage to do so, in the interests of better quality audits for smaller UK entities. This could have a massive impact in reducing the tax gap and encouraging economic growth.

The views expressed in this article are the author’s own and do not necessarily reflect those of ICAEW.