What is the tax gap?

The “tax gap” has become an important issue in the public debate on avoidance. HMRC provide an estimate of the tax gap, which they define as “the difference between tax collected and the tax that should be collected”. This research analyses a limited part of the tax gap as measured by HMRC, namely that for corporation tax.

The paper identifies a number of problems with the behaviour being measured by HMRC in its tax gap estimates. In particular, HMRC’s measure of the tax gap includes transactions which courts find to be compliant with the law. Whilst they comply with the courts’ interpretation of the intention of Parliament, these transactions do not comply with HMRC’s interpretation of the intention of Parliament, and are thus included in the tax gap. This exercise might be useful for HMRC’s internal purposes; however, it is deeply misleading to suggest that this behaviour represents non-compliance or a failure to pay tax which is due.

The paper also identifies a number of technical issues about the methods employed in the estimation exercise undertaken by HMRC.

The paper also considers a completely different approach to measuring the tax gap of corporations. This approach compares the difference between accounting profit declared in financial statements with taxable profit [the “book-tax gap”]. However, there is a major and fundamental problem with this approach, that the tax base for corporation tax differs from measures of profit in financial accounts. Even setting aside the general conceptual issues with the book-tax gap method highlighted in the paper, this particular estimate is extremely problematic as the methodology used makes unreasonable assumptions.

Michael Devereux, Judith Freedman and John Vella, The Tax Gap for Corporation Tax, CBT Report