The four fatal flaws in "Why HM Revenue & Customs have got the Tax Gap wrong"

Posted by Christie Malry on July 14, 2010 at 10:26 am



In June 2010, Richard Murphy released a Tax Briefing entitled Why HM Revenue & Customs have got the Tax Gap wrong (hereafter, "Tax Gap Briefing"). 

Some of the points made in Tax Gap Briefing were referred to in Parliament during the Finance Bill debate on 12 July.  David Gauke, perhaps drawing on material from this blog, pointed out some of the errors in Murphy's analysis.  However, Murphy still does not appear to accept the criticisms made:

But unfortunately all he picked up on were the minor points relating to double tax relief on corporation tax – affecting a tiny part (at most) of a £120 billion tax gap. Like many others on the right he seems more intent on analysing one sentence I wrote in The Missing Billions than actually addressing the issue.

Accordingly, this blog post aims to explain four fatal flaws in Richard Murphy's paper.  I will show that, as a result of these flaws, Richard Murphy's analysis cannot be relied upon in preparing an estimate of the tax gap.

Until Murphy corrects the errors in his analysis, HMRC's estimate of the tax gap, at £40bn, should be considered more reliable.

The four fatal flaws

The four flaws are:

  • Murphy fails to take account of double tax relief in his estimates. As a result, he incorrectly treats amounts which have been relieved as a deliberate part of government tax policy as if it were part of the tax gap.
  • Murphy uses an invalid methodology to analyse companies into 'small' and 'large'.  As a result, he draws erroneous conclusions as to the tax avoidance behaviour of small and large companies.
  • Murphy incorrectly considers all late payments to be part of the tax gap.  In doing so, he ignores the offsetting impact of taxes paid in one year that related to previous years, thereby overstating the tax gap.
  • Murphy's flawed logic treats all differences that are in his favour as validating his arguments and all differences that contradict his arguments as evidence of government error.  In addition, he concludes, inappropriately, in cases where official figures contradict each other that this somehow validates his estimates.  It does not.

There are many other minor errors in the paper.  There are also countless spelling and typographical errors which suggest that the document was not reviewed properly (if at all) prior to its publication.

Flaw 1 - Double tax relief

This section includes material from this blog post.

Double tax relief is a specific exemption from UK corporation (and, for individuals, income) tax for companies to ensure that companies which are resident in one jurisdiction but trade in another do not get taxed twice on those profits.  This is a result of the way that most countries tax companies and citizens: they tax their own residents on their worldwide income and they tax all others on income that arises in their jurisdiction.

Double tax relief is entirely deliberate.  As the HMRC International Manual explains:

Clearly, if businesses end up paying tax on the same income in more than one country, they will not want to do business overseas. Relieving double taxation is a means of removing barriers to international trade, to the operation of free and open markets and to the free movement of persons and of capital.

The way double tax relief works in the UK is by charging UK companies the excess (if any) of UK corporation tax over any foreign tax charged on profits earned overseas.  So, if a company trades abroad and earns profit of £100, on which foreign tax of £20 is charged and the UK tax would be £30, the company is liable for £10 (£30 - £20) in the UK.

In calculating the tax gap, HMRC has treated double tax relief as the acceptable use of a legitimate relief.  We know this, because Schedule T11.3, which Murphy uses as a source, specifically deducts double tax relief of £16,764 million 1 from total tax chargeable of £65,461 million 2 to arrive at a corporation tax payable figure of £47,731 million 3

Murphy's analysis of the tax gap refers to corporation tax payable (£47,731 million) rather than total tax chargeable (£65,461 million) 4.  Because this equates to an effective tax rate of 21.1% 5, Murphy concludes that there is widespread tax avoidance 6:

There is, based on this evidence, a tax gap in the corporate sector.

However, once you account for double tax relief, the apparent avoidance goes away.  Dividing total tax chargeable of £65,461 million by the total chargeable profits of £225,905 million 7 gives an effective tax rate of 29.0%, which is very similar to the UK large company corporation tax rate of 30.0% 8.

Murphy has briefly attempted to explain how he believes that his calculations are still valid.  His explanation, and my response to it, are included in this blog post.  I do not believe that his explanation in any way addresses the points raised here.

Flaw 2 - Analysis of small and large companies

This section includes material from this blog post.

Murphy has undertaken his own analysis of HMRC's Sch T11.5 in order to draw inferences about the avoidance behaviour of large and small companies 9.

Sch T11.5 provides information about gross and net trading profits by selected industries, together with their deductions and corporation tax payable.

Murphy has split these industries into "large companies" and "small companies" by calculating an average income chargeable to corporation tax (by dividing the total sector income chargeable to corporation tax by the number of companies in the sector).  He has then deemed "small companies" to be those sectors with an average income chargeable to corporation tax of less than £150,000.

Company sectors will include both large and small companies.  It's mathematically and logically invalid to attempt to split them in this way.  It cannot be done.  Murphy's methodology produces only "profitable industry sectors" and "unprofitable industry sectors".  More information would be needed from HMRC to prepare a split between large and small companies.

Because his method fails to produce "large companies" and "small companies", the deductions he draws about the tax avoidance behaviours of large and small companies 10 are invalid.

As pointed out here, he has even failed to follow his own methodology correctly.

Flaw 3 - Treatment of late payments

Murphy states that the tax gap in relation to late payments is £28 billion, not the £3 billion estimated by HMRC 11.  This is on the grounds that there are £28 billion of tax debtors as at March 2009, and HMRC's methodology is to recognise "late payment" in the tax gap.

However, this misinterprets HMRC's methodology.  The methodology clearly states that voluntary payment of taxes due in earlier payments is to be deducted from the gross tax gap in arriving at the net tax gap 12.

It is therefore a fallacy to include the entire £28 billion within the tax gap, as amounts received in respect of prior year taxes need to be knocked off it. An alternative approach is to recognise only that portion of tax debtors that are never expected to be received.  This is what HMRC have done.

The HMRC estimate is therefore significantly superior to Murphy's estimate.

Flaw 4 - Flawed logic

Murphy frequently makes use of flawed reasoning to justify his wild claims.  For example,he suggests that the HMRC figure for tax paid late is "just  £1.8 billion" 13 while "the Ministerial claim is ... £3 billion" 14.  Hence he concludes that the correct figure must be £28 billion 15.

With respect to personal avoidance, he notes that the HMRC figure is £1.1 billion 16 and that George Osborne has appeared to say that the avoidance figure for capital gains tax alone 17 exceeds £1 billion 18.  He therefore concludes that the Tax Research UK figure (of £13 billion) is "confirmed" 19.

Yet, when data appear to disprove his estimates,he merely says that "more work is needed to support the Tax Research UK figure" 20. In fact, the honest response would be to admit that the Tax Research UK estimates are wrong.

Despite apparently having little faith in government figures, Murphy is quick to pounce on figures that seem to accord with his estimates.  Hence,he claims that Osborne's statement "exactly confirm" his estimates 21.

Other comments

The briefing uses a great deal of emotive language, such as describing the minister's "errors", HMRC estimates being "outside the plausible expected range" 22,or being "highly unlikely to be a correct figure" 23.  Given the four fatal flaws in Murphy's analysis, these are litle more than value judgements. They are not supported by factual observations.

Credit is due to David Gauke for his rebuttal of Murphy's paper in the debate.  The tax gap is a vital issue to the UK economy and it is critical that policy decisions are based upon accurate, considered facts. Until these four fatal flaws are corrected,Murphy's paper is simply too unreliable to contribute to that debate.

Collaborative reviewing

Please help identify and fix further errors in Tax Gap Briefing by contributing to the collaborative version here.  You will need to sign up for a free a.nnotate account to add permanent comments.


  1. Sch T11.3, Double tax relief, 2007-08, "Amount" column
  2. Sch T11.3, Total tax charge, 2007-08, "Amount" column
  3. Sch T11.3, Corporation tax payable, 2007-08, "Amount" column
  4. Tax Gap Briefing, table on p.11, "All industries" row / "Tax payable" column
  5. Ibid, "All industries" row / "Tax rate" column
  6. Ibid, p.12
  7. Sch T11.3, Total chargeable profits, 2007-08, "Amount" column
  8. The difference is explained by HMRC as being due to the marginal small company rate and the small companies' rate
  9. Tax Gap Briefing, p.11
  10. Tax Gap Briefing, pp. 11-12
  11. Tax Gap Briefing, p. 7
  12. Tax Gap Briefing, p.4
  13. Tax Gap Briefing,p.1
  14. Tax Gap Briefing,p.1
  15. Tax Gap Briefing,p.5
  16. Tax Gap Briefing,p.1
  17. It's not clear that this is in fact what Osborne means.  I have requested clarification from HM Treasury and await their reply.
  18. Tax Gap Briefing,p.2
  19. Tax Gap Briefing,p.8
  20. Tax Gap Briefing, p.2
  21. Tax Gap Briefing,p.2
  22. Tax Gap Briefing,p.15
  23. Tax Gap Briefing,p.15

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