SMEs understate turnover and hike costs to evade tax

Overstating costs and understating turnover, as well as paying cash in hand, are the most prevalent forms of tax evasion used by small to medium sized companies, according to research into tax evasion commissioned by HMRC

Tax advisers and agents were also cited as sometimes helping with low level avoidance, with SMEs saying they looked to them to either influence or moderate tax evasion behaviours.

This usually depended on the main reason for the business using a tax agent, whether that was to offer peace of mind by ensuring the business’ financial affairs appear to be in order (ie, keeping the business ‘safe’ from prosecution) and ensuring that the business does not pay any more tax than it needs to, the HMRC commissioned report states.

A minority appeared to engage in evasion on the advice of an agent (who might for example point out personal expenses that could be put against the business), but for the most part agent involvement served to moderate evasion behaviours (ie, by preventing personal expenses from being put through the business).

Businesses typically chose not to inform agents of any activities which were known to be high-risk evasion, ‘since it is understood that agents would not be comfortable with the level of risk involved’, the report stated.

Ultimately, how the agent was used (and the extent to which their advice was followed) was determined by the business’ attitudes and perceptions in relation to tax.

Understating turnover

A popular evasion tactic is to understate turnover, often associated with work that is paid cash in hand. Money is either ‘pocketed’ for personal spend (low value amounts), or put back into the business.

This may take place at the request of the customer (to reduce their bill by removing VAT), or be driven by the business (specifically to reduce the business’ tax liabilities).

Questioned about understating turnover, one interviewee said that use of this ruse was down on previous years, stating: ‘I would say half of it [is work done off the books and income not declared]. It is 50%.

‘It used to be a lot more. It has changed because, obviously, well, it was, I would say 80% of it, used to be cash-in-hand and that, but because of the way clients have got building companies, they need proper invoices now.’

Overstating costs

Costs are typically overstated by claiming for a range of personal expenses through the business (including vehicles, fuel/mileage, restaurant bills, hotels, flights, electrical goods, or even domestic cleaning/ gardening) so as to reduce tax liabilities. Costs may also be overstated by taking business stock for personal use (for example, household goods or building supplies to be used for home projects).

One survey respondent said: ‘I might put through a car bill that might belong to my wife, for example, I’ll put that through. I might put through a mobile phone bill that belongs to my daughter, I might do that. Yes, it’s all minor stuff, nothing major, but it’s stuff that will make a difference personally.’

Understating employee earnings

This may include not putting certain members of staff through PAYE at all, ie, family members, casual workers, or part-time employees.

It could also involve under-reporting hours worked (paying some shifts in cash ‘off the books’), to reduce total tax paid to the benefit of both the business and the employee.

There were also examples of more complex evasion strategies among a minority of businesses interviewed (for example, purposely not reporting improvements to business premises to avoid increases in business rates or illegitimate use of off-shore accounts).

Almost all businesses were aware that prosecution is a possible consequence of tax evasion for some, but believed that this outcome was only applicable in extreme cases.

The 41-page Understanding evasion by Small and Mid-Sized Businesses HM Revenue and Customs Research Report 433

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