The weakness of the Inland Revenue

The Guardian, July 24 2002

November 1996. Budget day.   The chancellor of the exchequer, Kenneth Clarke, is in bullish mood. He is going to crack down on tax fraud and tax loopholes, he says. And, in particular, he is going to crack down on big businesses which cheat the Inland Revenue. “Tax experts will be redeployed to investigate even more rigorously how some big, sophisticated companies seem to pay so little tax,” he thunders. And he means it.

Two thousand new staff will be shared between the Inland Revenue’s Special Compliance Office, which takes on the most complex fraud inquiries, and its Large Business Office, which targets the biggest corporations in Britain: 1,000 staff will be redeployed from other work; the other 1,000 will be diverted from early retirement. And, over the next three years, the Inland Revenue will be given an extra £180 million to boost its compliance effort.

And if that sounds like an act of extravagance, Ken Clarke is not worried. The money will be recouped. And the Inland Revenue agrees. On that same day, it issues a press statement estimating that, as a result of this boost, it will collect an extra £2,000 million of tax in the three years of the project. Net projected gain: £1,820 million

It never happened.

Over those three years, the SCO actually brought in £334 million less than it would have done if it had simply carried on performing as it was when Mr Clarke made his announcement; the LBO lost ground for the first year and then improved, finally netting an extra £524 milllion. So, between them, over the three years when they were supposed to collect an extra £2,000 million, they actually collected only an extra £190 million. For which Ken Clarke had invested £180 million. Net real gain: just £10 million.

That startling failure is only part of a deeply worrying picture. We have found evidence that the entire compliance effort of the Inland Revenue is struggling under a history of poor investment and bad management which have left key divisions short of staff, demoralised and frequently outgunned by highly-resourced opponents who have poached many of their colleagues. According to one experienced source: “The Inland Revenue is in crisis. It is as bad as the state of the hospitals or the railways, maybe even worse: it just happens not to be visible. The whole system of revenue compliance is in a state of virtual collapse.”

In the case of Ken Clarke’s £180 million fiasco, it turns out that while he was ordering an extra 2,000 staff, the Revenue was already committed to cutting staff on a much bigger scale, so that the net effect of Clarke’s initiative was merely to slow down the rate at which the Inland Revenue was shrinking. But the problem goes deeper.

Insiders complain that the Revenue no longer even tries to put compliance at the centre of its work, that it has adopted ‘customer-friendly’ ideas from its American counterpart, even though the Americans have now found them to be a disaster. They point to the potent symbol that, under a PFI initiative, the Inland Revenue and Customs and Excise have sold their entire stock of 780 buildings to a property consortium, Mapeley, backed by the international financier George Soros and registered in the British Virgin Islands: the Inland Revenue, which is supposed to collect tax, has sold out to a landlord who is based in a tax haven.

Revenue investigators are still attempting to do their job but, like teachers or railworkers, they are trapped in an organisation that frequently obstructs them. And unlike any other part of the public sector, the hidden crisis in the Revenue threatens not only its own function but also the funding on which every government department depends.

On the best available estimate, the annual total of undeclared UK tax for companies and individuals is some £25 billion. Last year, inspectors in the Inland Revenue’s compliance units managed to uncover only £4.5 billion of it – and that was nearly £1 billion less than the previous year, when they found £5.4 billion. The success rate of the Revenue’s compliance effort is now back at the same level it reached nine years ago. But nine years ago, the national tax bill was only a third of its current size: either tax avoidance and evasion have gone out of style, or the Inland Revenue’s success rate has collapsed by a factor of two thirds in the last decade.

Last year, the Inland Revenue convicted only 56 people of tax-related offences – and 24 of them were their own staff and accomplices who had been caught fiddling the books. This compares with some 11,400 who were prosecuted last year for benefit fraud. According to the Revenue’s annual reports, in Nothern Ireland, in the last three years, there has been a grand total of only two tax prosecutions; in Scotland, in the last three years, there has been none at all.

What is most worrying is that the worst of the decline is at the core of the compliance effort, in the specialist central units which target the richest individuals and the biggest corporations. Look at the yield ratios – the amount which these sections gather for every £1 they spend on inquiries. In every single case, the yield has fallen since the point at which measurement began: the Special Compliance Office, which tackles the toughest cases, was collecting £20 for every £1 it spent, but now it collects only £15; the International section was collecting £188, now it collects only £96; the Oil Tax Office was collecting £176, now only £29; the Special Investigation Section, which targets tax avoidance schemes, was collecting £121, but now collects only £67; the Large Business Office was collecting £119, now only £75.

Some of these figures have fluctuated. The international department, in particular, can surge and fall according to a handful of huge settlements. But the trend is clear. The malaise runs deep. According to one specialist: “They don’t have enough staff, and most of them don’t have enough skills to do the job. They are absolutely swamped. If they have a hundred potential cases, they have to select the best five or ten. They have inexperienced people looking through hundreds of pages of accounts and masses of third-party information, and they can’t spot the scams. It’s like asking asking a naval cadet to captain a battleship. It’s pathetic.”

All the specialist offices are struggling with too few experienced staff. The LBO is losing 25% of its inspectors each year, and companies complain of long delays in processing their returns. The Special Investigation Section is described by some corporates as ‘a black hole’ into which cases disappear for years at a time. The solicitors’ office is said to be under considerable pressure and acting as a bottleneck creating delays in handling queries from all over the Revenue. The Share Valuation Office is said to be suffering from overwork, with 30% of their cases taking more than a year to process.

And then there is the vexed question of policing the employers who cheat on their national insurance payments. In the Inland Revenue’s last annual report, there is a small but revealing hole. For the previous year, ending March 2000, the annual report recorded that Revenue staff succeeded in tracking down £259 million in national insurance contributions which employers had failed to hand over. But for the year, ending March 2001, under the same heading, it records…. nothing at all.

This little hole is clearly important, because Gordon Brown is relying on extra national insurance contributions to pay for his expanded health service: there is no room in his plans for cheating. And it is surprising since the authorities have a colourful history of catching employers who have tried to dodge their contributions by smuggling salaries to their staff in the form of fine wines, diamonds, gold, trading vouchers, insurance premiums, platinum sponge – anything other than cash. So what happened to last year’s efforts to catch them out? Where is the missing £259 million – or whatever they may have collected?

The answer appears to be, first, that the Inland Revenue has buried the truth and, second, that, even though the Revenue claims that this burial was nothing more than an administrative convenience, the truth is that in the financial year ending March 2001, the government’s efforts to catch employers who cheated on their national insurance, collapsed in a heap of mismanagement and staff cuts.

The Inland Revenue took over the policing of national insurance from the contributions agency in 1999, adopted its specialist staff and, for one year, left them to do their work. So they collected £259 million. But in April 2000, the Revenue’s management chose to merge the specialists with its own employer compliance teams who were already policing PAYE, tax credits, repayment of student loans and various statutory payments. It then cut the staffing in these teams so that they ended up even smaller than they had been before it added national insurance to their workload. The result, according to insiders, is that the collection of unpaid national insurance fell through the floor.

The Inland Revenue claims that it failed to publish any figure for this first year of work by the newly merged teams, simply because it does not know how much national insurance they collected in amongst the other taxes which they police. However, what the Revenue does admit is that, at the end of a year which could have seen their results rise by some £259 million, the understaffed units, in truth, proceeded to collect a total of £3.6 million less than they had done the year before.

Not enough staff with not enough training. These problems have a long history: slashing cuts which saw the loss of 12,500 Revenue jobs between 1992 and 1996 alone; a purge on graduate recruitment in the early 1990s; cuts in in-house training; the replacement of inspectors by unqualified clerical staff whose old jobs have been computerised; bad pay; repeated complaints that front-line staff were devalued and taken for granted; a ‘delayering’ of management which reduced the prospects of promotion; all leading to a torrential brain drain out of the Revenue’s compliance departments and into the far more highly-paid world of private-sector tax advice.

Some of the results are merely silly, albeit symbolic of the decline. London Revenue offices, for example, have been so overloaded that they have had to send some of their corporate tax work to colleagues in the north east of England – and some of the files have been going missing en route.

But at its core, the shortage of staff means a shortage of experience and skill. Complex frontline work, which requires the hand of a trained inspector, is being taken on by staff who have been redeployed from clerical work: this includes the crucial phase of risk assessment, when the Revenue attempts to spot accounts and tax returns which need further investigation. With an edge of cruelty, leading tax lawyer Robert Venables QC told a conference on tax avoidance four years ago: “The technical quality of Revenue officials has dropped steadily, except in the capital taxes office where it has dropped precipitously.”

There is alarming evidence that one result of this weakening is that the Revenue are shying away from difficult inquiries. When Deloitte and Touche privately surveyed multinational companies two years ago, they found that their biggest worries were that the Inland Revenue would investigate their tailor-made tax-avoidance schemes and their transfer pricing arrangements (which allow them to avoid tax by fixing the price of goods which are transferred from one subsidiary to another via tax-free havens). Both these areas are notoriously difficult.

But when the survey asked what the Inland Revenue actually chose to investigate, the multinationals reported that inspectors were picking most frequently on their PAYE returns and their entertainment spending – both easy targets and both ranked way down their league table of tax worries. More than 70% of those who said transfer pricing was their highest risk had not been investigated at all in the previous three years. In the specialist financial sector, those corporates who reported that tax-avoidance schemes were their highest risk reported that in the previous three years, not even one of their avoidance schemes had been investigated by the Inland Revenue.

Critics insist that this is not simply a case of poor funding. They complain that the Inland Revenue is now managed by people who do not value compliance; that whereas once the compliance departments were the most prestigious places to work, they are now marginalised; that any ambitious new recruit will head for the management departments, where the promotion prospects are better; that the Revenue board is dominated by people who do not understand the value of tax investigations.

Senior members of the current board have an unfortunate background in notoriously mismanaged projects: the chairman, Nick Montagu, is a career civil servant who oversaw the privatisation of British Rail and the selection of the consortium which overspent so hugely on the Channel Tunnel; one of his deputies, Tim Flesher, comes from the chaos and queues of the Home Office immigration department; the other, Ann Chant, comes from the backlogs and bitterness of the Child Support Agency. None of these three has ever run a tax inquiry. The other two members of the board have been promoted from within the Revenue but only one of them, Dave Hartnett, has a background in investigation and is highly regarded by compliance officers.

Arguing that it wants the Inland Revenue to be ‘an enabler as well as a regulator’, the board has passed down a host of performance targets which are pre-occupied by ideas of customer-service rather than compliance: 80% of post is to be dealt with within 14 days; 90% of phone calls are to be answered within 30 seconds; 95% of visitors are to be dealt with within 15 minutes. There is little or no mention of catching tax cheats.

Last year, the Large Employers Compliance Officer was able to start checking the PAYE returns of only 282 of the 3,000 companies for which it is responsible; in more than a third of its cases, it took three years to come to a conclusion. Ten years ago, it was collecting £10 for every £1 it spent; last year it collected only £7. But last year, this same department won the Inland Revenue’s in-house competition for the best customer service, because they devised a new departmental structure which introduced the new role of Customer Account Manager.

The Revenue’s chairman, Nick Montagu, last year pointed to the United States as a model for his belief that the Inland Revenue should invest in ‘voluntary compliance’, serving its customers rather than investigating them. Last month, however, the US General Accounting Office reported the collapse of the American model. There were ‘large and pervasive declines’ in just about every compliance department of the Internal Revenue Service, the GAO reported, noting that this was ‘a strategic problem’ which had been created by cuts in staff, increased workload and the shift of workers from compliance to customer service; and warning that, in the absence of effective compliance, there were worrying signs that more US tax payers were starting to cheat on their returns.

Life for Inland Revenue inspectors has been made even more difficult over the last few years by the introduction of faulty computer software and by a major reorganisation, with the network of district offices being reshaped into seven new regions and 65 new areas as well as the Inland Revenue taking over the work of the old contributions agency. The union officer who is responsible for tax inspectors, Graham Steel, said: “The change is being managed by people who don’t understand the Inland Revenue very well. Morale has dropped.”

There are still many dedicated tax inspectors working against the odds to enforce tax law against the rich and powerful. They do expose some cheats and they also win some internal political battles: the Revenue board, for example, has now agreed to scrap a bonus system which encouraged special compliance officers to process smaller, simpler cases in favour of choosing ‘quality’ targets. They also lose internal battles. The controversial reform of the Revenue’s policing of multinationals, disclosed in yesterday’s Guardian, has been brought in despite the opposition of experienced inspectors who protest that, apart from the fact that it is too soft on multinationals, a programme of change which requires them to run 17 pilot studies in addition to their normal workload, is being introduced without any extra resources.

For a chancellor with ambitious spending plans, this is a frustrating picture. The best accountants in Britain are warning that he is opening up a gap of some £12,000 million between what he wants to spend each year and what the Revenue is collecting. If the Revenue were doing its job properly, that gap would disappear. As it is, the Treasury appears to be tempted to move in two quite different directions. On the one hand, the tax world is alive with rumours that they are contemplating a tax amnesty, a move which is seen by experienced investigators as defeatist and an encouragement to swindlers. On the other hand, the National Audit Office last month launched an inquiry into the effectiveness of the Revenue and the Customs and Excise. For those who believe that public services have a right to their revenue, much depends on what the NAO are prepared to unearth.