Public Service Agreement 2005-06 to 2007-08: Technical Notes Objective 1

Objective 1

Improve the extent to which individuals and businesses pay the amount of tax due and receive the credits and payments to which they are entitled.

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PSA Target 1: By 2007-08, reduce the scale of VAT losses to no more than 11 per cent of the theoretical VAT liability

Technical Note

The theoretical VAT liability (VTTL) is an estimate of the tax that should be collected in the absence of any losses. It is constructed largely from the Office for National Statistics (ONS) national accounts sources, which are independent of the VAT administrative systems. The difference between the VTTL and net VAT receipts is an estimate of VAT losses known as the VAT gap.

VAT losses are attributable to a number of causes, from error, ignorance and financial difficulty through to abusive avoidance and deliberate fraud such as Missing Trader Intra Community Fraud (MTIC) VAT fraud.

The VAT strategy designed to deliver the VAT gap target was outlined in the Pre Budget Report 2002

The technical approach for measurement of VAT losses is set out in Measuring Indirect Tax Losses published in November 2002.

The latest estimate outlined in Measuring Indirect Tax Losses (PDF 1.7MB) published in October 2007 shows a VAT gap of 14.2 per cent for 2006-07 amounting to a reduction of nearly 2 percentage points against the baseline in 2002-03 of 16.1 per cent.

An assessment of progress and the overall effectiveness of the strategy will be reported annually.

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PSA Target 2(i): By 2007-08, reduce the illicit market share for cigarettes to no more than 13 per cent

Technical Note

The size of the illicit cigarette market is the difference between the estimate of total consumption and legitimate consumption. The illicit market share is expressed as a percentage of total consumption and represents the level of illicit activity.

The estimate for total consumption is based on cigarette smoking prevalence rates and consumption per person estimates measured by the General Household Survey. Legitimate consumption is measured from cigarette clearances from tobacco warehouses, duty paid imports and legitimate cross border shopping.

The current methodology used in Measuring Indirect Tax Losses - 2007 was published in October 2007 with estimates of the illicit market share presented as lying within a range defined by the upper and lower estimates. (The original methodologies for estimating losses due to illicit activity in excise goods were first set out in Measuring Indirect Tax Fraud: HM Customs and Excise, November 2001.) While this does not mean that the true value necessarily lies towards the centre of the range, movement in the mid-point estimate does give an indication of the long term trend and is used by the Department for evaluating performance against the PSA target. This shows a decline in the level of the illicit market between 2001-02 and 2005-06 from 20 per cent to 13 per cent.

Although the PSA target relates to the whole of the Spring Report (SR) period, an assessment of progress on the overall effectiveness of the strategy is reported annually. The estimate for the illicit market share in 2006-07 will be published at Pre-Budget Report 2008 (PBR2008), with final outturn data for 2007-08 published at PBR 2009.

PSA Target 2 (ii): By 2007-08, reduce the illicit market share for spirits by at least a half

Technical Note

The size of the illicit cigarette market is the difference between the estimate of total consumption and legitimate consumption. The illicit market share is expressed as a percentage of total consumption and represents the level of illicit activity.

The total consumption relies on data from the Expenditure and Food Survey (EFS), which only becomes available around 18 months after the survey period. Legitimate consumption includes spirits clearances from warehouse, duty paid imports and legitimate cross border shopping.

The current methodology used in Measuring Indirect Tax Losses - 2007 was published in October 2007 with estimates of the illicit market share presented as lying within a range defined by the upper and lower estimates. While this does not mean that the true value necessarily lies towards the centre of the range, movement in the mid-point estimate does give an indication of the long term trend and is used by the Department for evaluating performance against the PSA target. The PSA target will use as its baseline the final estimate for 2002-03.

The latest published estimate for 2005-06 shows the illicit market lying within the range of 0 per cent to 10 per cent, with the mid-point showing a decline in the level of the illicit market between 2001-02 and 2005-06 from 8 per cent to 5 per cent.

Although the PSA target relates to the whole of the SR period, an assessment of progress on the overall effectiveness of the strategy is reported annually. The estimate for the illicit market share in 2006-07 will be published at PBR2008, with final outturn data for 2007-08 published at PBR 2009.

PSA Target 2 (iii): To hold the illicit market share for oils in GB at no more than 2 per cent

Technical Note

The market share of illicit diesel fuel represents the difference between estimates of theoretical consumption on the mainland market, less UK duty paid consumption and legitimate cross-border shopping.

The theoretical consumption is calculated using data from Department for Transport (DfT) and Driver and Vehicle Licencing Agency (DVLA) on the total number of kilometres travelled by diesel vehicles and average vehicle consumption rates, including the National Travel Survey (NTS) and Continuing Survey on Road Goods Transport (CSRGT). The latter is also derived from the Vehicle Certification Agency. Customs clearances data is used for UK duty paid consumption.

Details of the methodology used, margins for error and the estimates of cross border shopping are set out in Measuring Indirect Tax Losses - 2007, published in October 2007.

The latest assessment available is a central estimate that the illicit market share for diesel in Great Britain (defined as England, Scotland and Wales) is 2 per cent for 2005-06, down from 4 per cent in 2004-05.

Although the PSA target relates to the whole of the SR period, an assessment of progress on the overall effectiveness of the strategy is reported annually. The estimate for the illicit market share in 2006-07will be published at PBR 2008, with final outturn data for 2007-08 published at PBR 2009.

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PSA Target 3: By 2007-08, reduce underpayment of direct tax and National Insurance contributions due by at least £3.5 billion a year

Technical Note

The target covers all direct taxes and National Insurance contributions (NICs).

Reducing the tax gap (ie extent of underpayment of tax due).

For direct taxes and national insurance contributions we will reduce the tax gap by at least £3½ billion per annum by 2007-08. And, we will reduce the gap by at least £1½ billion in 2005-06 and at least £2¼ billion in 2006-07. We will count towards achievement of this target the yield from:

  • overall improvement in compliance yield above a 2003-04 baseline
  • additional revenue raised by operationally driven legislation

Summary

This note provides an overview of the measurement approach for PSA.3 which looks at the overall improvement in compliance yield seen over the SR2004 period.

The key measure used to track achievement is compliance yield (to the extent that the additional liability is collected). Implicit in scoring compliance yield is the assumption that underlying levels of non-compliance would otherwise have remained the same over the PSA period, (which is consistent with the Budget Assumptions for forecasting Direct Tax receipts). Therefore, any increase in collected yield (above inflationary levels) will contribute to a lower tax gap.

Overall business improvements

This covers changes in compliance yield resulting from:

  • productivity gains for all staff
  • the continuing impact of spend to raise resources now within baselines
  • includes yield from new initiatives (ie Offshore Disclosure Facility)

The baselines are based on the achievement of operational compliance yields as recorded each year in the Inland Revenue (and now HMRC) Annual Reports. These provide a clear and auditable trail stretching back a number of years.

Key assumptions

The baseline year has been agreed with HM Treasury (HMT) to be 2003-04. We agreed that an adjustment for growth was required and that this adjustment should track theoretical liability and that nominal GDP growth is a suitable proxy. We also agreed that 4 per cent growth a year would be a reasonable assumption.

The method for measuring yield has two benefits:

  • The methods are understood within operational compliance and there is line of sight to operational performance.
  • There will be a clear trend by reference to the baselines. HMRC will not have to re-work the 2003-04 numbers to accord to the new method.

This means that the method is very transparent and can easily be used to set and measure directorate level achievement. But the method also means that the broader indirect effects of compliance activity are not covered unless they were (like some future effects) included in the historical method for scoring yield. This method includes the following:

  • direct yield - liabilities for the current and previous years with adjustments for consequential effects for the following two years only
  • accelerated liabilities - ie yield from timing adjustments not included in direct yield
  • pre-return work - value in terms of additional liabilities from HMRC's response to requests for rulings, clearances, pre-return valuations and from other pre-emptive adjustments

We have also made a number of adjustments to the baselines to reflect changes to HMRC organisational structures.

The assumptions detailed above allow us to produce a set of baselines and grow these at 4 per cent per annum to provide an estimate of compliance yield across the SR2004 period. Performance above these baselines is deemed as contributing towards PSA3 achievements.

This approach covers the majority of the Department's operational compliance work. The main areas not covered are the Debt Management initiatives announced at Budget 2003, aimed at tackling the non-payment of tax and NICs debts and from failure to file tax returns. The Department has developed databases to record the yield achieved in individual cases, to assist in monitoring the performance of these spend to raise initiatives. Only performance above a 2002-03 baseline (these initiatives started in October 2003) is counted as contributing towards the PSA target.

Data

Data on amount of compliance yield raised by HMRC is collected by HMRC operational staff and recorded on Departmental management information systems. A new system was set up to capture information covering debt management.

Operational driven legislation

Compliance yield from legislation will be counted where measurable evidence can be provided. The department has plans in place to evaluate the effects of the main pieces of compliance driven legislation put into effect since PBR 2004. This will require a set of analytical approaches and data that are appropriate for the individual measures prescribed and will be subject to rigorous peer review within HMRC and discussions with HMT before being scored.

Reporting

Progress towards the target will be reported annually.

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PSA Target 4: By 2007-08, increase the percentage of Self Assessment returns filed on time to at least 93 per cent

Technical Note

This target covers individuals, partnerships and trusts in the Self Assessment tax system.

By 2007-08, we will increase to 93 per cent the percentage of individuals, partnerships and trusts who are due to file Self Assessment Tax Returns by 31 January in the relevant tax year and do so on time.

To ensure that there is no perverse outcome in seeking to meet the headline target, we shall do so without detriment to the on-time payment and filing performance of employers and companies or to Self Assessment on time payment performance.

These without detriment measures are:

  • Self Assessment paid on time, 89.8 per cent.
  • Employers returns filed by the due date, 80.7 per cent.
  • Employers paid by the due date, 61.25 per cent.
  • Company returns filed by the due date, 79.4 per cent.
  • Companies paid by the due date, 59.9 per cent.

The measure

Data to calculate the percentage of SA returns filed on time is drawn from Departmental management information systems and achievement calculated using the formula:

Percentage returns filed on time = Returns submitted on time/Returns issued

The following notes are relevant to the calculation:

  • there is no legal obligation for an individual to file a return unless they have been served with one and so 'voluntary returns' are not included in the baseline
  • the baseline includes all returns issued, both full return and shorter version, between April and October, which are thus due by the following 31 January
  • there is an adjustment to the returns issued made in respect of returns that were not received, ie those which have been unclaimed and returned to the Department
  • For ITSA, where the filing date is 31 January, ‘on time’ is normally taken as close of play on 1 February after which penalties can be imposed

Validation

The Department’s data systems are subject to validation by the National Audit Office every two years. Specific data systems and results may also be reviewed by the Department’s Internal Audit Office as part of their annual programme, agreed by the Departmental Audit Committee, following a risk based planning prioritisation exercise.

Reporting

Achievement against target is reported annually.