Tackling the hidden economy

• Report: HMRC: Tackling the hidden economy
• Public Accounts Committee

Edward Leigh MP, Chairman of the Committee of Public Accounts, today said:

“HM Revenue and Customs is apparently making little ground in its efforts to diminish the cash-in-hand culture operating in the UK.

“HMRC has no solid estimate of the level of losses but it might be over £2 billion a year. With a detection rate of only 1.5 per cent, the chances of being caught are very slight. For those who are caught, the penalties imposed are usually relatively trifling: on average only 3 per cent of the tax detected. And in very few cases, just two out of a thousand, is a prosecution launched.

“The Department has had some success at motivating people with offshore accounts to come clean and voluntarily to pay the tax they owe. It should devise similar schemes to persuade those in other risk areas - such as self-employed builders and buy-to-let landlords – to put their tax affairs in order.

“HMRC must also do much more to publicise both the benefits of joining the formal economy and the potentially serious consequences of not doing so. And if such publicity is to have any effect, then it must be backed up by resolute action by the Department to complete more investigations, apply the full range of new penalties available and ramp up the number of prosecutions.”

Mr Leigh was speaking as the Committee published its 55th Report of this Session which, on the basis of evidence from HM Revenue & Customs, examined the scale and nature of the hidden economy, encouraging people into the formal economy, detecting people in the hidden economy, and the Department’s use of penalties and criminal investigations.

There are no reliable estimates of the tax lost through the hidden economy but it could be over £2 billion a year and involve around 2 million people. HM Revenue & Customs (the Department) spent £41 million in 2006–07 on encouraging people and businesses into the formal economy, and detecting and imposing sanctions on those operating in the hidden economy. The Department achieved a return/cost ratio of 4.5:1 which should increase as recent initiatives achieve their full effect. Areas of risk include

• self-employed people, such as builders and decorators, who often receive cash payments;
• individuals who trade on the internet, and
• buy-to-let landlords.

Since 2003–04 the Department has detected some 30,000 hidden economy cases a year, a detection rate of only around 1.5 per cent. The amount of tax from cases detected in the hidden economy has, however, increased by 13 per cent in real terms since 2003–04. The return on the Department’s investigations in 2006–07 was 5:1.

To increase detections, the Department has been making more use of data matching techniques. It also set up the Tax Evasion hotline in 2005 for members of the public to report suspicions of tax evasion. The hotline received over 120,000 calls in 2006–07 but progress in investigating cases has been slower than the Department expected. The Department completed 2,000 investigations compared with 5,500 planned, yielding additional tax assessments of £2.6 million compared with £32.5 million planned. Investigations of small businesses, businesses which should be registered for VAT but are not, and employers’ compliance yield higher returns.

When the Department detects people in the hidden economy, it can impose a penalty of up to 100 per cent of the tax owed. In most cases it either imposes a much lower penalty or waives the penalty. In 2006–07 the Department imposed penalties of £5 million, amounting to around 3 per cent of the tax identified. Prosecutions rose to 69 cases in 2006–07. The Department did not receive much publicity on these cases, limiting their wider deterrent effect.

To encourage people to declare tax owed, the Department has run advertising campaigns, which have led to a further 8,300 registrations and should result in additional tax of £38 million over three years. In 2007, the Department introduced the Offshore Disclosure arrangements to encourage people holding overseas bank accounts to voluntarily disclose and pay any tax owed. This followed landmark rulings against several major financial institutions which required them to disclose to the Department details of around 400,000 bank accounts. Some 45,000 people came forward bringing in around £400 million at a cost of £6 million, a return of £67 for every £1 spent.