Labour's Plan to Close the Tax Gap

The March 2024 Budget adopted one of the mainstays of the Labour Party’s tax proposals by announcing that the government will remove the current advantageous tax treatment of non-domiciled individuals. However, politically, it remains important for the Labour Party to differentiate itself on tax policy and provide fiscal legitimacy for its spending plans. As a result, in addition to pledging to tighten the existing plans to remove the favourable tax treatment of non-doms, Labour is now focussing on its pledge that it will target raising an extra £5bn a year by tackling tax avoidance. Key to this target is its plan to close the tax gap which is set out in its recent publication of the same name.

Labour say that their Plan to Close the Tax Gap “will relentlessly pursue the money that is owed, with a plan to make sure people pay the right tax in the first place, and that directly tackles tax avoidance and evasion”. Labour claims that this plan will raise a net £700m in 2025/26, rising to £5.1bn a year by the end of the parliament. So what is in this plan?

The plan essentially involves four elements:

• Boosting compliance activities in HMRC, recovering more tax revenues

• Investing in technology in the tax system to improve taxpayer experience

• Make legal changes to ensure there is a genuine deterrent to tax evasion

• Further detailed work to modernise HMRC.

What is the tax gap?

The ‘tax gap’ is a measure of the difference between the amount of tax that is owed and the amount that is collected. HMRC most recently published its annual estimate of the tax gap in June 2023, which indicated that the tax gap “remained at an all-time low of 4.8%”.

According to HMRC, the report, published annually, shows a long-term reduction in the tax gap. Errors, a lack of sufficient care, evasion and criminal attacks all contribute to the tax gap, which has fallen from 7.5% in 2005/2006 to 4.8% in 2021/2022.

Labour’s publication argues that a number of factors have led to what it sees as stalled progress (or worse) on the tax gap. Partly this is seen as due to HMRC resourcing. Whilst acknowledging that spending in some areas has increased, Labour argue that was in large part due to Covid and in other areas spending has fallen. This has led to poor service levels for taxpayers. In addition, the publication argues that HMRC’s compliance work has been scaled back, especially in the most serious cases of tax fraud with the number of prosecutions falling. As such, the deterrent effect of legislation is undermined. There is also recognition that there are “issues with HMRC’s legal framework that makes investigations harder, longer and more expensive, and means it is more difficult to prosecute people who are avoiding tax”. Labour also points to problems and slowdown with HMRC’s digitalisation programmes, including Making Tax Digital (MTD). Finally, the publication notes that the tax gap figure only covers the UK and does not include amounts lost on assets held offshore by UK taxpayers and, although in 2022 the government committed to publishing an estimate on this, this appears to have been delayed.

Labour’s plan

Labour points to two important estimates for its plan to boost spending on HMRC:

• The Chief Executive of HMRC has said that for every marginal £1 that HMRC spends on compliance activity, there is a return of £9 in additional tax revenue

• the National Audit Office have estimated that investments in technology can achieve a return of £2 for every £1 of investment within a parliament.

Accordingly, Labour plans to invest £555m per year in additional HMRC resources (a 12% increase) and an extra £300m for HMRC’s capital budget. The document includes a long shopping list of areas where this extra resource would be spent, following consultation with HM Treasury and HMRC. These include:

• increasing staffing on compliance (an estimated 5000 new staff), with a focus on offshore compliance and segments with the greatest complexity and return

• creation of a ring-fenced pot of "blockbuster" funding to be used on strategically important criminal cases for deterrent effect

• improving HMRC’s core taxpayer service

• investing in digitalisation to improve both compliance and taxpayer service. Labour plans to work with HMRC and business to bring a new focus to digitalisation, including greater use of AI.

Alongside resourcing, there is a list of legislative and regulatory changes to be considered, including:

• taking forward the outcome of the review on regulating the tax advice market

• requiring a wider range of tax schemes to be reported to HMRC under the DOTAS rules

• exploring the use of deferred prosecution agreements to individuals for tax evasion.

Deferred prosecution agreements (DPAs) are currently only used for corporate bodies to avoid a lengthy trial as the corporate can make full reparation without a conviction, under the supervision of a judge, with full transparency. The proposal is to extend their use to individuals.

At the moment, HMRC’s approach to possible cases of tax fraud involves the use of Code of Practice 9 (COP9). Under COP9, the individual under investigation and HMRC will enter a contract whereby the individual commits to make a complete, accurate, open and honest disclosure of all deliberate behaviour and all other irregularities in their tax affairs. In return HMRC commits not to open a criminal investigation. However, there has been criticism, particular by the Public Accounts Committee, of the small number of actual prosecutions and the corresponding lack of deterrent effect.

Similarly, companies can be subject to criminal offences for failure to prevent the facilitation of tax evasion or for the failure to prevent fraud more generally (including cheating the public revenue). As the publication points out, although the facilitation of tax evasion provisions were introduced seven years ago, there have been no prosecutions to date. Again, there is debate concerning the deterrent effect of the rules in absence of actual prosecutions, though HMRC would argue their mere existence has led to behavioural changes by companies that will have reduced tax evasion.

Comment

There is general agreement that properly resourcing HMRC can lead to significant increases in the tax take, more than enough to offset the additional cost. As such, there is no real surprise that both Labour and Conservatives appear committed to increasing HMRC funding. For example, the Chancellor Jeremy Hunt announced additional funding for HMRC at both the 2023 Autumn Statement and the March 2024 Budget.

It seems clear that with this renewed focus on HMRC funding and compliance resourcing, there is likely to higher numbers of tax investigations and an (even) greater focus on tax avoidance. Labour’s plan, however, appears to involve an increasing shift from civil to criminal investigations. HMRC’s current strategy is to focus on cases that are sufficiently high value and high profile, given the increased complexity and cost of criminal prosecutions. Whilst that focus will most likely remain, there is clearly an incentive for all business to ensure that they continue to monitor the management and administration features of their tax compliance activities to ensure that they do not fall foul of any future change of policy.

For our earlier article on Labour’s tax plans, see our Insights article.