Tax avoidance vs tax evasion – what do small businesses need to know?

Small businesses and the self-employed usually have to file a tax return each year, which can be complex and time-consuming.

As a result, there are a range of schemes that claim to simplify and lower companies’ tax bills either through tax avoidance or tax evasion.

By signing up to one of these schemes, you could risk breaking the law or ending up paying less tax than you owe.

Read on to find out the difference between tax avoidance and tax evasion, the type of schemes you need to look out for, and what to do if you work through an umbrella company.

• How to do a Self Assessment tax return
• Self-employed tax changes
• Self Assessment and tax resource
• How much does business insurance cost?

Tax avoidance vs tax evasion – what’s the difference?

Tax evasion and avoidance schemes are designed to reduce people’s tax bills and are both viewed negatively by HMRC.

The difference between tax avoidance and tax evasion is that tax avoidance schemes operate within the law, but are described by HMRC as not being ‘in the spirit of the law’.

Genuine mistakes on a tax return such as misculautions and missed deadlines can also be considered tax avoidance.

On the other hand, tax evasion involves deliberately withholding or providing inaccurate information to pay less tax.

Examples of this include:

• providing false documents – creating fake invoices or contracts to reduce payments
• making false expense claims – claiming tax relief for costs you haven’t incurred
• failing to declare goods – or underestimating their value to pay less tax

Is tax evasion illegal?

Yes, tax evasion is treated as tax fraud. If you’re found guilty of tax evasion after an HMRC investigation, you could receive a big fine or a prison sentence.

Read our guide on HMRC tax investigations to find out more about what happens during an investigation, what HMRC checks for, and the benefits of business legal protection insurance.

What are the penalties for tax evasion in the UK?

Anyone found guilty of income tax or VAT evasion could receive an unlimited fine or a maximum of seven years in prison.

If you’re convicted of providing false documentation to HMRC, you could receive a six-month prison sentence or a maximum fine of £20,000.

For the most serious cases of tax evasion, known as “cheating the public revenue”, offenders could be sentenced to life in prison and/or an unlimited fine.

Tax evasion and avoidance schemes – what are the key signs?

Businesses should think very carefully and speak to a professional accountant or tax expert before joining any kind of tax scheme as there’s a chance it could be illegal.

Tax avoidance schemes will often claim to be tax efficient, legitimate, or even endorsed by HMRC.

Here’s what you need to watch out for:

• extra payments – if you’re paid money outside of your salary through loans or grants, this could mean that income isn’t being taxed
• unnecessary transactions – if payments are being made that don’t seem to have any purpose and the money appears to be going round in circles
• bold claims and benefits – if you’re being told that your take home pay will increase significantly

If you think you might be part of a tax avoidance scheme, you should contact HMRC immediately. You’ll have to settle what you owe so the sooner you report it, the less interest you’ll pay.

Tax avoidance schemes and umbrella companies

The number of contractors working through umbrella companies has increased significantly since April 2021 when IR35 rules were introduced.

Joining an umbrella company means contractors don’t have to set up their own limited company and don’t have to manage things like payroll.

However, because of the way they’re set up, umbrella companies can be used for tax avoidance.

HMRC advises all contractors, freelancers, and agency staff who work through umbrella companies to check their payslips to make sure they’re not part of a tax avoidance scheme.

One of the main things to look out for is if your payslip shows a wage lower than the amount of money that gets paid into your bank account. For example your payslip says your net pay is £1,800, but you actually receive £2,200 from the umbrella company.

Putting a lower wage on your payslip allows the umbrella company to pay less tax. If you’re receiving extra income from an umbrella company that isn’t shown on your payslip, you could be part of a tax avoidance scheme.

Extra payments are often described as:

• bonuses
• profit shares
• loans
• credit facilities
• capital payments

You can use HMRC’s tax calculator and National Insurance calculator to work out how much tax you should be paying and whether it matches up to your payslips and bank account.

HMRC, tax evasion, and tax avoidance – what do you need to know?

HMRC takes tax avoidance and evasion very seriously and is always looking out for new schemes. Below is an overview of its tax avoidance campaign and the reporting process.

HMRC campaign names tax avoidance schemes

In April 2022, HMRC named tax avoidance scheme promoters for the first time as part of its Tax Avoidance – Don’t Get Caught Out campaign.

The named schemes encourage people to agree to an employment contract and work as a contractor. They pay contractors the national minimum wage, with the rest of their monthly salary paid through a loan to try to avoid paying National Insurance and income tax.

HMRC says it will be updating the list regularly, but that it doesn’t cover all tax avoidance schemes so self-employed people should remain vigilant.

The Don’t Get Caught Out campaign has a range of case studies, as well as an interactive risk checker and payslip guidance to help small businesses and the self-employed identify tax avoidance schemes.

How to report tax evasion schemes

There are various ways to report tax evasion and avoidance issues to HMRC.

If you suspect a business is committing tax fraud, such as not paying enough tax or registering a business without telling HMRC, you can file a report through the government website.

For suspicious emails that claim to be from HMRC, you can complete an online form or forward them to [email protected].

If you think you’ve identified a tax evasion or avoidance scheme, you can report it to HMRC through the government website.

Do you get a reward for reporting tax evasion in the UK?

There are financial rewards available for reporting tax evasion, although HMRC says most people provide information without expecting payment.

You’ll only receive a reward if the information is “exceptionally helpful” to an investigation, with most payments less than £5,000.

Do you have any tips for identifying tax evasion schemes? Let us know in the comments below.