Minding the Tax Gap: VAT - the tax that nobody really loves

Value Added Tax has never been terribly popular, or indeed, terribly well understood. According to HMRC, something like 14% of the gross VAT Theoretical Tax Liability (VTTL) goes uncollected, significantly in excess of the proportion of the tax gap overall. If that figure were reduced to the 8% seen across the piece, that would imply extra government income of  £4.8 billion, not an amount to be sneezed at.

There are some unique features. Missing Trader Intra-Community (MTIC) fraud, where fraudulent traders acquire goods VAT free from EU Member States; charge VAT on their onward sale and then 'disappear' to avoid handing it to the authorities, became extremely prevalent towards the end of the previous decade, as well as its more serious variant, 'carousel fraud' where a series of contrived transactions within and beyond the EU created large unpaid VAT liabilities and, in some cases, fraudulent VAT repayment claims. In 2005/06, it is estimated that such frauds cost the public purse between £2.5 and £3.5 billion, although better compliance work and risk analysis is thought to have been reduced to between £0.5 and £1.5 billion four years later.

However, VAT is a tax that few like, and its evasion is more likely to be seen as fair game. Paying tradesmen in cash is far from unheard of and, whilst it has a beneficial impact on household expenditure, the impact it has on the small business sector in terms of an uneven playing field for honest traders, and on public revenues in terms of loss of income and potentially greater borrowing is certainly a negative one.

Interestingly, the rate of VAT loss has, over the past eight years, stayed reasonably constant overall, although there have been variations. The average tax gap over that period has been 13.8%, ranging from 11.7% in 2004/05 to 15.6% in 2002/03.

Meanwhile, HMRC is cracking down on certain sectors where the perceived risk of tax loss is greatest. For example, public campaigns have been launched in different parts of the country targeting restaurants, especially fast food ones - restaurants and hotels represent 18% of VAT liabilities arising from the household sector, plumbers and electricians. Risk analysis is the name of the game, plus a degree of 'Big Brother' tactics - "we're watching you, do you fancy your chances of getting away with it?".

In short, if it's cash in hand, perhaps the question being asked is, "do you think that the person you're doing business with is inherently honest?". That isn't necessarily a comfortable one, especially if you're relying on them to do their job professionally and safely. But, if they're evading their taxes, what other corners are they cutting?