In recent months, mounting evidence has painted a damning picture of the UK’s tax system – one that is increasingly failing both small businesses and vulnerable individuals. At the heart of the issue lie two interlinked issues: a punitive penalty regime that disproportionately targets those on low incomes, and a widening tax gap among small businesses (now responsible for a growing element of unpaid corporation tax).

Together, these trends reveal systemic issues within HMRC, ranging from outdated IT infrastructure to inadequate customer service and ineffective compliance strategies. While these systemic issues may not come as a surprise to many in business, the consequences might shock others – billions lost in tax revenue, eroded public confidence, and life-altering financial burdens on those least able to bear them.

When bureaucracy harms the vulnerable

HMRC’s current penalty framework has become a source of mounting concern. Designed to incentivise timely tax filing, the system has instead evolved into a bureaucratic trap. Individuals with no tax liability, often low earners with intermittent income, find themselves issued automatic late-filing penalties, even when there is no underlying tax to be paid.

This rigid system disproportionately affects those who are least able to navigate HMRC’s administrative processes. Many individuals may not even realise they are required to file, or may be unable to do so due to personal circumstances such as illness or mental health challenges. The penalty notices, often confusing and poorly explained, escalate rapidly over time, creating a cycle of debt and stress.

While future reforms under Making Tax Digital promise to cap penalties, the phased roll-out means that the most vulnerable – those earning below £20,000 – will be the last to benefit. This approach runs counter to the principles of equality and proportionality in tax administration.

The growing small business tax gap

Parallel to the penalty issue is the alarming growth in the small business tax gap (projected tax income against actual tax income). HMRC data indicates that 40% of corporation tax due from small businesses goes uncollected, a figure that has doubled over the past five years. This widening gap is particularly troubling given HMRC’s past success in reducing non-compliance among large and mid-sized enterprises.

The reasons for this trend are complex but interrelated. Budget cuts and resource reallocation have weakened HMRC’s front-line services. Key personnel were diverted to Brexit and pandemic-related tasks, leading to the erosion of specialised small business support and compliance functions.

Inadequate training, high staff turnover, and the closure of local HMRC offices have further contributed to the breakdown in service. As HMRC’s digital systems struggle to bridge the gap, small businesses often find themselves adrift, lacking the guidance needed to meet their obligations.

At the same time, the emergence of aggressive avoidance schemes masquerading as legitimate small businesses has skewed compliance metrics. These schemes frequently escape detection or are misclassified, distorting the data and inflating the apparent rate of non-compliance.

Systemic failures and public consequences

The cumulative effect of these problems is stark. On one end, individuals on modest incomes are penalised with precision. On the other hand, the tax liabilities of small businesses are increasingly slipping through HMRC’s fingers. Neither outcome serves the public good.

The irony is painful: those least able to pay are pursued with vigour, while billions of pounds in corporate tax liabilities go uncollected. This misalignment reflects deeper systemic issues: a focus on process over outcome, and on easily enforceable rules over fair and effective governance.

This is not to undermine the efforts of HMRC staff, many of whom work under significant pressure. The problem lies in the system: a penalty regime that fails the vulnerable, and compliance tools that are not keeping pace with modern tax behaviour.

Reforming for fairness and function

Addressing these challenges requires more than just additional funding – it demands targeted, structural reform. First, there is an argument to suggest the penalty regime should be recalibrated. In a fairer world, penalties should surely reflect the taxpayer’s ability to pay, while also taking into account the actual harm to the public purse. For non-liable taxpayers, is it time to review whether the automatic issuance of penalties should be suspended, and a discretionary approach applied based on context?

Second, HMRC’s compliance strategy needs rebalancing. Should there now be a greater focus on supporting compliance, particularly for smaller enterprises? Research indicates that outreach, education, and proactive engagement can significantly reduce the tax gap more effectively than punitive investigations alone.

Third, digital transformation must be meaningful. It is not enough to digitise paper processes; systems must be designed to be intuitive and accessible, especially for those with limited digital literacy or financial resources.

Finally, has the time come for HMRC to start investing, rather than disinvesting, in its people? Training, retention, and regional presence are critical. A well-trained workforce, supported by robust systems, is essential for equitable and effective tax administration.

A legacy of short-termism

HMRC’s operational direction in recent years has often prioritised short-term firefighting over strategic investment. While emergency responses to Brexit, COVID-19, and other immediate challenges were unavoidable, they came at the expense of long-term planning.

Key strategies, involving the consolidation of offices, reducing the number of experienced staff and underinvesting in system resilience, are now returning to haunt the department. The chickens have come home to roost, with systemic cracks widening just as the demands on HMRC grow more complex. Without a strategic reorientation, the cycle of reactive fixes and mounting problems will continue.

Conclusion: What about the ROI?

The UK’s tax system is at a crossroads, with a failure to act risking the entrenchment of injustice and undermining trust. But with the right reforms, anchored in fairness, proportionality, and administrative competence, there is an opportunity to restore credibility and ensure that tax policy serves both the economy and the people.

Setting aside emotion, let’s examine the figures in isolation. Ironically, in a world dominated by numbers, if we compare the amount of tax outstanding to the investment required to improve collection, there must surely be a significant potential return on (any) investment?

At Wilkins Southworth, we advocate for practical, balanced solutions that reflect the realities faced by both individuals and businesses. We work to resolve disputes, ensure compliance, and promote fair outcomes in a system that often feels anything but.

If you’re facing challenges with HMRC or need clarity on your tax position, call us today for expert, confidential advice tailored to your situation.