BU40006 Week 10 Tutorial 2 2024-25

Week 10 Tutorial 1 – Tax Avoidance and the UK Tax Gap

In advance of this tutorial please read through the key papers identified throughout the Week 10
lecture 1 session:

Based on your reading make notes on the following questions and come to the tutorial session
prepared to discuss:

Required:

1. Discuss the difference between tax planning, tax avoidance and tax
evasion.

 Tax planning – Using tax reliefs for the purpose for which they were intended. So perfectly
legal and legitimate.
 Tax avoidance – tax that is lost when a person claims to arrange their affairs to minimise tax
within the law in the UK, or in other countries. In other words, exploiting tax rules to gain an
advantage the parliament never intended. Involving artificial, contrived transactions.
Operating within the letter of the law but not of the spirit.
 Tax evasion – tax lost when a person or company deliberately and unlawfully fails to declare
income that they know is taxable or claims expenses that are not allowed. Illegal activity
where businesses or individuals deliberately omit, conceal, or misrepresent information to
reduce their tax liabilities.

 NOTE: There is more than one type of tax evasion.

o Tax evasion in the shadow economy
o Tax lost as a result of other criminal or fraudulent activity
o Capital Gains Tax and Inheritance Tax and offshore tax evasion
o Tax evasion on investment and rental income

 NOTE: Tax avoidance is not the same as tax planning.

o Tax planning involves using the tax reliefs for the purpose for which they were
intended
o As you will be aware, the difference between tax avoidance and tax planning
is a very grey (subjective) area. It can be about perceptions, as one person’s tax planning
may be deemed by another as tax avoidance. What is acceptable to one person is not to
another.

NOTE: To tackle tax fraud HMRC:

 building checks and controls into systems

 changing legislation to make it more difficult or impossible to commit tax fraud
 working with businesses to help them spot when they are at risk of tax fraud
 HMRC have significant powers to conduct criminal investigation and specialist
investigations.
 Seek to collect what is owed, powers to collect through Proceeds of Crime Act, &
Accounting Freezing orders
BU40006 Week 10 Tutorial 2 2024-25

 HMRC work with partners such as professional bodies, financial institutions, government
departments, law enforcement, international tax and customs authorities.
 Encourage whistleblowing with Fraud Hotline
 Aim to prosecute, convict, director or financial disqualification, impose sanctions, publicly
publish details of tax evaders, freeze assets.
BU40006 Week 10 Tutorial 2 2024-25

2. Discuss the reasons for and benefits of taxation and explain what is
meant by the tax base.

Reasons for and benefits of taxation:

 Taxation is the mechanism that Governments use to generate money from society to pay for
public goods and services.
 The tax base is the total amount of income, property, assets, consumption, transactions, or
other economic activity subject to taxation by a tax authority

It can also be used as noted:

 Benefits society at large and tax is a redistribution of wealth
 Influencing consumer behaviour
 Providing merit goods
 Managing the economy
 Developing society
 Encouraging activity

3. Discuss the reasons why individuals or corporations evade tax.

 Intrinsic motivation is the willingness to comply beyond fear or punishment or being fined

 Right thing to do/scared of being caught

 Voluntary compliance in tax morale is important as it increases revenue with little

enforcement issues

 Low tax morale can result in tax avoidance/evasion which can move toward informal sector
and cause firms to revaluate investment decisions

In 2019 OECD conduct study:

 Individuals:

Age, religion, culture, gender, satisfaction with public services, trust in governments
can influence tax morale

 Organisations:

Varies across regions but challenges exist with transparency between firm and
revenue authority even if taxes paid on time

 Trust can be low in certain regions

 Risk of being caught and punished may be low (likelihood of prosecution/custodial sentence
only in extreme cases)
BU40006 Week 10 Tutorial 2 2024-25
BU40006 Week 10 Tutorial 2 2024-25

4. What does the literature say on regarding the motivations for low tax
morale and tax evasion

Kemme et al., (2020) study 21 OECD host countries between 2002-2013

 Low tax morale is associated with domestic tax evasion
 Individuals/organisation in countries with low tax morale engage in tax evasions through tax
havens.
 As with OECD influencing factors of age & religion, level of education and financial stress also
contributing factors

Raczkowski & Mroz (2018) examine the tax gap of 35 countries

 Conclude each countries tax gap differs and is dependent on the GDP, if GDP is high the tax
gap is lower

Murphy (2017) discusses consequences to society & economy from tax gap:
– Economic & societal instability, increased interest rates, austerity, breakdown of
trust in markets, increased failure in SME sector etc. (see P8)
– Murphy (2014) suggests tax avoidance largely undertaken by large business and high
net worth individuals who employ lawyers and accountants to find loopholes and
legally avoid paying tax
– Tax evasion mainly driven by shadow economy, criminal/fraudulent activity,
undeclared CGT & inheritance tax, offshore tax evasion
BU40006 Week 10 Tutorial 2 2024-25

5. Explain what is meant by the tax gap and the reasons why it exists .
Tax gap

 The tax gap is the difference between the amount of tax that should be paid in the UK and
the amount of tax that is actually paid.
 Difference between the amount of tax that should be imposed and the amount that is
actually reported and paid on timely filed returns (Murphy, 2017)

Murphy (2017): The tax gap is perceived to be an important indicator of the overall health and
effectiveness of the tax system:

 the clarity and acceptance of tax policies

 the ease on interpretation of laws that enact those policies
 the effectiveness of the tax administration in making the laws easy to understand and
comply with, whilst also following up on non-compliance.

Data
 HM Revenue & Customs’ (HMRC’s) most recent estimate of the tax gap, the difference
between tax owed and tax that is actually paid, was £39.8 billion (4.8%) in 2022/23

 Limitation of HMRC is the time delay in producing information of tax gap

Who is responsible – DATA 22/23

Failure to take reasonable care – 30%
Error – 15%
Evasion – 14%
Legal interpretation - 10%
Criminal attacks – 9%
Non-payment – 13%
Hidden economy – 5%
Avoidance – 4%
BU40006 Week 10 Tutorial 2 2024-25

Source: 7. Tax gaps: Illustrative tax gap by behaviour - GOV.UK (www.gov.uk)

 However, we also know that international tax avoidance is not measured by the UK tax gap.

6. What implications does the tax gap and tax evasion have on the UK and
international economies?

 Political pressures & implications

 Murphy (2014) mentions the tax gap and the implications to society arising from it
 Managing the economy
 Implications & consequences on society at large, bigger the deficit due to tax gap, people
who depend on government for all/part of income or dependent on government services
 Therefore, tax gap can lead to social injustice an inequality (think about SDGs)
 Tackling that tax gap is vital if public services are to be preserved and if the UK is to get back
to work.
BU40006 Week 10 Tutorial 2 2024-25

There are a number of societal and economic implications of the tax gap:

Table from Murphy (2017) consequences and impact of the tax gap
BU40006 Week 10 Tutorial 2 2024-25

7. What is meant by BEPS and what is being done to address this and
other forms of international tax avoidance?

 BEPS are “Tax planning strategies that exploit gaps and mismatches in touch rules to
make profit disappear for tax purposes or to shift profits to locations where there is
little or no real activity, but the taxes are low resulting in little or no overall
corporate tax being paid” (OECD)

 The tax avoidance figures in the tax gap do not include BEPS (Base Erosion Profit
Shifting) arrangements that cannot be addressed under UK law and will be dealt
with through the OECD (Organisation for Economic Co-operation and Development.)

Transfer Pricing – these will improve tax base but not designed to address the gap more
for multinationals, this will not directly this increases tax base

Thin Capitalisation
As interest on debt is tax deductible, there is a tax incentive for companies to finance their
operations through debt. There are concerns from government that companies may use this
mechanism to artificially inflate the amount of debt, interest payable to get a tax advantage,
therefore, deeming this as tax avoidance.

Diverted profit tax

A tax currently set at a rate of 25% on profits that are diverted from the UK through either:
 a UK resident company and ANO engaging in transactions that lack “economic substance”, or
 a non-UK resident company supplying goods and services in the UK through a separate
person (avoiding a PE)

Information access and exchange

 HMRC has power to obtain information from taxpayers to determine the extent to which
they are being truthful about their taxable overseas activities

Digital Services Tax

 Applies to revenue earned from 1 April 2020
 These businesses will be liable to Digital Services Tax when the group’s worldwide revenues
from these digital activities are more than £500 million and more than £25 million of these
revenues are derived from UK users.
 Digital services tax is a 2% tax on the revenues of search engines, social media services and
online marketplaces which derive value from UK users.
 There is an allowance of £25 million - first £25 million of revenues derived from UK users will
not be subject to Digital Services Tax
BU40006 Week 10 Tutorial 2 2024-25

BEPS – 2.0
The first phase, BEPS 1.0, created 15 staged BEPS Actions to address cross-border taxation, with
(currently) 141 participating countries agreeing to minimum standards.

Now, BEPS 2.0 looks to go further, and deal with the challenges of taxing an increasingly digital
economy, split into two pillars.

The Background of BEPS 1.0

The BEPS 1.0 initiatives have created considerable change in international tax rules, focusing on
mitigating profit-shifting opportunities.

Led by the OECD and G20 countries, the action plans were published in 2015 following a series of
revelations around aggressive tax planning and tax evasion.

limitation of BEPS 1.0 is that it does not comprehensively address digital transactions, which are
increasingly prevalent in almost all industries, particularly in service delivery and online retail.

BEPS 2.0 is intended to consolidate those unilateral taxation regimes into an overall consensus
between BEPS participant countries to avoid double taxation or inconsistent tax treatments.

What Is BEPS 2.0 Reform Package?

The expanded BEPS framework attempts to modernise tax rules

There are two BEPS 2.0 pillars, which together comprise the global action plan:

 Pillar 1 focuses on rules for taxing profits and rights, with a formula to calculate the
proportion of earnings taxable within each relevant jurisdiction.
 Pillar 2 looks at global minimum tax levies of 15% to discourage companies from shifting
profits to lower-tax countries through international trading structures.

BEPS 2.0 Pillar One

Pillar One involves a new taxation methodology aimed at digitised companies and consumer-serving
organisations that trade or communicate with customers through a digital format.

Revenues generated from consumers in one country or from consumer data extracted from that
country will be subject to tax regardless of whether the organisation has a physical presence in the
jurisdiction.

In summary, Pillar One means that:

 Taxing rights will belong to the country where the company's customer is located.
 Organisations with revenues of €20 billion or more and a profit margin of 10% or greater will
be subject to the new rules.
 Over time, the threshold for inclusion will drop to €10 billion in annual revenue.
Profit allocations between countries will rely on a formulaic approach, a significant change from the
current transfer pricing regulations.
BU40006 Week 10 Tutorial 2 2024-25

BEPS 2.0 Pillar Two

Pillar Two is equally far-reaching and introduces global tax reforms that aim to end the competition
between countries to offer the lowest possible corporation tax rates to attract foreign investment.
The primary factor in Pillar Two is a set of rules called GloBE (Global anti-Base Erosion).

The largest multinationals, with a revenue of €750 million or more per annum, should pay a
minimum effective tax of 15% in every jurisdiction in which they trade.
Countries will be permitted to apply top-up tax rates where a multinational in their jurisdiction is
taxed below the minimum threshold.

Along with additional parent company tax charges for low-taxed foreign revenue, Pillar Two allows
for taxation at source for low-tax paying organisations.

Compliance will also likely command greater investment in resources, resulting in increased budgets
spent on updating tax functions, which will impact both organisations and governmental tax offices.
BU40006 Week 10 Tutorial 2 2024-25

8. What measures are taken to address the UK tax gap?

Although HMRC believes that reducing the tax gap is not a suitable annual performance
target and cannot be measured in a timely way, it does except that it should be assessed on
the movement of the tax gap overtime.

Academic research indicates that some of the factors affecting tax compliance are the
complexity of tax rules, customers’ knowledge of the tax system and individual perceptions
on the fairness of tax administration.

There are a number of key measures in place by HMRC to tackle different areas of the tax
gap:

Measures to tackle the Tax Gap

 Promote compliance
 Prevent non-compliance
 Respond to non-compliance
Strategies to achieve this:
 More initiatives to make it straight forward for taxpayers to comply – emphasise
interventions earlier in the tax cycle

 HMRC is focusing on factors that have helped reduce the tax gap in other countries:

 Focus on improving the taxpayers experience when dealing with HMRC

 HMRC is now developing organisation-wide customer strategies which focus on all

aspects of taxpayers’ contact with HMRC, not only compliance.

 One aim of HMRC’s strategy is to focus on helping small businesses to get their tax right
and make it harder for them to get it wrong

Ways in which HMRC are achieving this:

 Making Tax Digital:

 Incentives and simplification of corporation tax rules
 stamp duty land tax; land and buildings transaction tax
 basis period reforms:

Within all of these points we need to think about areas of the tax gap that will be improved by the
above approaches. This is where the critical engagement for this type of question would really
come into the answer.

Other areas of HMRC focus to reduce the tax gap

A major challenge for HMRC is to remain ahead of changes in non-compliant behaviour, for
example where taxpayers adopt new ways to avoid tax.
Over the past few years HMRC has introduced a variety of initiatives to tackle aggressive
tax planning
1. IR35 Rules
BU40006 Week 10 Tutorial 2 2024-25

2. Disclosure of Tax Avoidance Schemes (DOTAS)

3. General Anti-Abuse Rules (GAAR)

4. HMRC’s compliance approach for Large Business (HMRC’s compliance approach for
Large Business - GOV.UK (www.gov.uk))

Developed an efficient risk-based approach to manage the tax compliance of the UK's largest
businesses.

The compliance approach for large businesses includes two main areas:

(i) Tax Compliance Risk Management Framework

(ii) Business Risk Reviews

HMRC has developed a more strategic approach to tackling the tax gap

Other points that are not necessarily related to the UK Tax Gap but do potentially increase
the tax base:

o Digital Services Tax

o Diverted Profits Tax