A term bandied about in tax policy over recent years is the "tax gap" – questioning what measures can be taken to reduce it.

It is unclear how much more a UK government can do to close a “gap” between how much tax it is owed and what is being paid, a tax expert says. 

The Chancellor of the Exchequer, Rachel Reeves, recently said that she has to fill a £22 billion ($28.6 billion) “black hole,” creating concerns that she will curb tax-free pension savings levels and raise capital gains taxes. Labour says it will not change VAT rates or income tax rates. 

“The tax gap is the difference between the (theoretical) amount of tax that should have been paid in a particular year, and what has been declared,” Barbara Bento, head of Buzzacott’s tax investigations and dispute resolution team, said in a note. 

“Closing this gap has been the goal of previous governments, with the introduction of disclosure facilities targeting offshore income and gains, and the push to eliminate marketed tax avoidance schemes. The gap has already narrowed considerably over the last decade (in percentage terms) so it is uncertain how much more funding can be raised in this way,” Bento said. 

The new government has pledged to raise an additional £5 billion a year to help meet its manifesto commitments. To do this, it will be increasing investments in technology and HMRC’s workforce, and making legislative changes such as strengthening HMRC’s powers to enforce payment of tax once an investigation has concluded. 

The tax gap is estimated to be £39.8 billion (in the 2022/23 tax year) with 60 per cent of that apparently coming from small businesses, which would incorporate elements of corporation tax, income tax, National Insurance contributions, and VAT.  

“With more funding and resources at its disposal, we would expect to see HMRC increasing and improving its current processes to tackle errors in these areas. But with more to pay for and increasing pressure from the government to increase tax yield, we would also expect an increasingly aggressive approach from HMRC,” Bento said. 

Another front in the “tax gap” debate is foreign income and gains. The government has already signalled that the resident non-domicile regime is on the way out, to be replaced with a temporary residence system. A key concern is what happens to the inheritance tax obligations of those non-doms who remain in the UK. (Some lawyers argue that without assurances, thousands of non-doms will leave the UK.)

“Given the public’s perception of people engaging in offshore planning, and Labour’s desire not to upset small business owners, this may be HMRC’s greatest focus, at least publicly,” Bento said. 

“There is also the benefit of higher penalties in cases involving offshore irregularities (sometimes as high as 200 per cent) which further increases any yield in this area (and the attractiveness to HMRC),” she said. 

“Even if cases are not prosecuted, an increase in allegations of deliberate behaviour, if accepted or upheld, will increase yield by increasing the number of historical periods which can be corrected (from four, six or 12 years to 20), increasing the penalties that can be charged and also in some instances allowing a company’s liabilities to be transferred to a director, so that insolvency will not prevent HMRC from collecting what is owed,” Bento said. 

These notices require a financial institution to provide information and documents in relation to a named taxpayer, Bento said, arguing that this is likely to result in further compliance checks and nudge letters, as HMRC chases seemingly undeclared income, or taxpayers whose outgoings do not match their declared “means” (the income they have declared).