The UK’s small businesses are to blame for the ‘vast majority’ of tax evasion, according to a new report by the National Audit Office (NAO). It calculates that a staggering 81% of the £5.5bn tax lost to evasion last year was caused by small firms.
Focusing on high street and online retail, the NAO report concludes that “tax evasion has been growing among small businesses” and calls for an effective strategic response from HMRC. These are the biggest scams identified:
Electronic sales suppression – artificially reducing transaction values using a variety of methods, including producing dummy accounts and keeping tills in ‘training’ mode. This is believed to have been worth £450m of the NAO’s total.
Phoenix companies – we write regularly about these, but some business operators can’t resist having a go; it’s when a company becomes insolvent to avoid paying its tax liabilities and debts, then effectively reforms as the same company with a new name. While the Insolvency Service requires a high burden of proof to show that directors have acted improperly, it is watching closely and will apply sanctions. Phoenixing is estimated to have cost the UK £500m last year.
VAT non-compliance by overseas retailers – VAT avoidance by selling goods and services online costs the Treasury around £300m.
The NAO says that online incorporation of new companies since 2011 has made the formation process from any location worldwide easier, leaving the UK more vulnerable to fraudulent activity.
Tax evasion is, unfortunately, a perennial feature of SME activity, regardless of the prevailing economic environment. Small enterprises escape the scrutiny of larger, audited companies. It is clear, however, that the fragile state of the UK’s public finances at present will sharpen the Government’s appetite for plugging these leaks and using the full force of the law.
Straightforward non-payment of corporation tax and VAT is a different matter, yet still carries hefty fines for businesses and sanctions for directors. Companies wound up by HMRC as the largest, if not sole, creditor risk action against directors and shareholders who have extracted (and not repaid) cash for themselves by establishing a loan account rather than pay company taxes. These might include disqualifications or even personal bankruptcy.
These situations often develop simply when a troubled small business becomes caught in a cycle of late settlement with suppliers and non-payment of tax. Before too long this has escalated into behaviour that will be penalised and finish the company.
Managers can’t afford to bury their heads in the sand: they must act sooner rather than later to keep their enterprises afloat and, in particular, stay on the right side of HMRC:
- Get on the front foot with tax. Engage and explore a ‘Time to Pay’ arrangement. Being unresponsive only aggravates HMRC and hastens a winding up petition.
- Look at extending credit terms. Revisit repayment profiles for loans and propose realistic, achievable amendments. A loan that remains serviced, albeit differently, is still profitable for a lender.
- Consider the moratorium framework to gain a short period of “breathing space” while pursuing a rescue or restructuring plan. During this legal moratorium no creditor action can be taken against a company without the Court’s permission.
SMEs unable to pay tax should seek professional advice on communicating with HMRC, the potential for debt restructuring, credit management, invoice discounting, overdraft planning, and contractual terms to explore a last-ditch attempt to stay afloat. Those tempted to pursue more aggressive strategies for tax evasion should desist immediately and review options for continuing in business.
Written by Runita Kholia, Senior Analyst at Buchler Phillips, a UK based independent boutique firm with an impeccable Mayfair heritage, specialising in corporate recovery, turnaround, restructuring and insolvency.