• HMRC estimated £5.5 billion lost due to tax evasion in 2022-23 – 81% from small businesses (up from 66% in 2019-20).
  • HMRC does not know how successful it is in tackling tax evasion.
  • Significant weaknesses in government systems have left the UK too open to tax evasion.

The UK is losing billions of pounds a year in revenue due to tax evasion among small businesses, which can easily exploit weaknesses in government systems, according to a new National Audit Office (NAO) report on tax evasion in retail.1,2

As well as raising public funds, reducing tax evasion encourages a level playing field between businesses by denying evaders an unfair competitive advantage.

According to HM Revenue and Customs (HMRC), while the overall level of tax evasion has stabilised in recent years, it has increased among small businesses. The tax authority has not estimated the scale of evasion by sector, but it has targeted campaigns at some high-risk retailers including takeaways and sweet shops.3

HMRC also does not have a specific strategy to clamp down on tax evasion, which means it lacks a focus on, or explicit objective for, its performance in this area. Instead, its aim is to stop overall levels of non-compliance increasing.4

This means there has been too little emphasis on some widespread forms of tax evasion in the retail sector like electronic sales suppression (ESS) and abuse of the insolvency process to avoid paying tax debts (known as phoenixism).5,6

Although HMRC estimated that phoenixism accounted for 15% of its tax debt losses in 2022-23 (equivalent to more than £500 million), the Insolvency Service disqualified only seven directors specifically for phoenixism between 2018-19 and 2023-24, out of a total of 6,274 disqualified directors.7

HMRC has had success in raising more tax from online retail by making online marketplaces liable for Value Added Tax (VAT) on sales by overseas retailers,8 a move followed by other countries. It now estimates that it collects at least £1.5 billion more in VAT a year – five times what it initially predicted.

However, significant gaps remain in checks around online retailers, and overseas companies can falsely present themselves as UK-based to evade VAT.9

Weaknesses in company registration criteria present another significant risk. Since 2011, when online incorporations were introduced, it has been quick and easy to set up UK companies online from anywhere in the world, leaving the UK vulnerable to tax evasion from fraudulent businesses.

Government introduced tighter requirements at Companies House from March 2024.10 But some new measures will not be in force until Companies House develops the necessary systems and capability, or until further secondary legislation is in place (e.g. verifying directors’ identities).

In 2022-23, there was a surge in company registrations ahead of these stricter rules being implemented.11 Of the registered companies declaring themselves as retailers, 42% were incorporated since January 2023 compared with 23% of companies in all sectors. This may indicate a potentially higher risk of fraud in the retail sector.

HMRC has also not yet used all the powers it has secured to tackle evasion in retail.12 It should evaluate the extent to which it is using these powers, establish what barriers it faces, and identify any gaps that limit the actions it can take.

“Although tax evasion has been growing among small businesses, HMRC has so far lacked an effective strategic response.

“Its assessment of risks has given too little emphasis to widely used methods of evasion such as sales suppression and phoenixism. It has also failed to use new powers to tackle tax evasion.

“Tackling tax evasion is not a straightforward task. But real opportunities exist for HMRC to work more systematically across government to reduce it. Tighter controls and more compliance work could raise significant sums and improve value for money.”

Gareth Davies, head of the NAO

Read the full report

Tackling tax evasion in high street and online retail

Notes for editors

  1. The report examines whether HMRC, with other relevant parts of government, is well-placed to tackle tax evasion in high street and online retail.
  2. Tax evasion occurs where taxpayers deliberately omit or falsify information in tax returns to reduce their tax liability. It does not include error or failure to take reasonable care, and is different to the hidden economy and organised crime.
  3. Tax evasion estimates are indicative. HMRC does not put a range on its estimates, and levels of evasion could be much higher or lower.
  4. HMRC has an overall compliance strategy that focuses on tackling all forms of non-compliance, which include careless mistakes and tax avoidance as well as evasion. The strategy is primarily tailored around types of taxpayers, such as small or medium-sized business. HMRC has chosen not to develop a specific strategy for tackling tax evasion in case this undermines its ability to deploy resources flexibly to changing risks. This means HMRC does not have a specific focus on, or explicit objective for, its performance in tackling tax evasion.
  5. ESS has increasingly involved using and supplying sophisticated software to remove or reduce the recorded value of transactions to under-declare income and reduce taxes. Other types of sales suppression include running ‘dummy’ sets of accounts, or running tills on training mode.
  6. Phoenixism involves a business artificially declaring itself insolvent to avoid paying debts including tax, before reforming as essentially the same company.
  7. The Insolvency Service is responsible for enforcement relating to director disqualifications and corporate abuse. HMRC supports the Insolvency Service’s efforts in investigating directors for potential wrongdoing. According to the Insolvency Service, phoenixism is defined very precisely and requires a high burden of proof, and in many cases may be less serious than other forms of misconduct identified. The Insolvency Service therefore may have disqualified some company directors involved in phoenixism using a different reason. The Insolvency Service is reviewing how it measures its performance in tackling phoenixism.
  8. Introduced in January 2021.
  9. Online marketplaces are liable for VAT from overseas retailers, increasing incentivises for sellers to falsely represent themselves as UK-established. Marketplaces need to determine the correct liability or demonstrate they have taken reasonable steps to do so, including whether sellers are UK-established. HMRC’s latest indicative estimate (from 2021-22) of annual VAT evasion by overseas retailers selling goods or services online is £300 million.
  10. The Economic Crime and Corporate Transparency Act 2023 significantly changes the role of Companies House to improve the reliability of information on the company register. The first changes came into force in March 2024 – they include increased sharing of data, and new powers to check information for company registrations, request evidence and remove inaccurate information.
  11. There were 801,000 company registrations in 2022-23. This was 136,000 (20%) more than in 2019-20.
  12. HMRC was given powers to require overseas businesses with no UK establishment to appoint a UK VAT representative, but to date it has not used these powers. Meanwhile, in 2022 government introduced new civil enforcement and data collection powers for HMRC to tackle ESS. It has not yet issued any penalties using these powers.