Select Committee on Public Accounts Sixty-Seventh Report


The Committee of Public Accounts has agreed to the following Report:



1. In 2000-01, the Inland Revenue collected £148.7 billion in taxes and duties, and £62.8 billion in National Insurance contributions. It paid out £4.7 billion of Tax Credits. Figure 1 shows the development of the revenue over the last five years.

Figure 1: Inland Revenue net tax receipts and Tax Credits payments

Net receipts (see note below) and Tax Credits

£ billion






Income Tax






Payment of Tax Credits






Corporation tax






Capital gains tax






Inheritance tax






Stamp duty






Petroleum revenue tax






Windfall tax






Total tax receipts (£ billion)






Source: National Audit Office analysis of Inland Revenue data

Note: Shown net after allowing for tax reliefs and allowances, and for repayments (2000-01 £11.9 billion)            

2. Each year, the C&AG reports on the work he has carried out to examine the management of the tax system by the Inland Revenue (the Department). On the basis of his Report on the 2000-01 accounts[1] and a supplementary note[2] from the Department, we examined the Department on its management and control of Tax Credits, including controls over Tax Credit payments made by employers on behalf of the Department.

3. Tax Credits are available to people with children, or disabled people who work 16 or more hours a week. Around 1.2 million people were receiving an average of just under £80 a week in Tax Credits in March 2001.[3] About 30% of Tax Credits were paid by employers to their employees based on awards made by the Department. Employers recouped the cost from tax and National Insurance they collected before they paid them over to the Department.

4. In the light of our examination, the Committee draws the following overall conclusions:

  • Employers, as agents of the Inland Revenue, are paying out over £1.3 billion in Tax Credits each year. The Chairman of our predecessor Committee expressed concern that there was no provision for the Comptroller and Auditor General to have statutory access to employers who act as paying agents for the Department. Hence the Comptroller and Auditor General is not able to obtain direct assurance about the payments at the point they are made. To provide independent assurance to Parliament that Tax Credits are properly paid, the Comptroller and Auditor General needs access to employers' records.

  • The Department do carry out some checks to assess the accuracy of the payments by employers to their staff, but these checks have not been sufficient to provide the necessary assurance that Tax Credits are properly paid. They have not found it practicable to reconcile the total amount of Tax Credit paid by each employer with the amount the Department had authorised. The Department are making further efforts to reconcile the Tax Credit payments for subsequent years.

  • These problems highlight the inappropriateness of expecting the Comptroller and Auditor General, in auditing the Departments' arrangements for the administration of Tax Credits, to rely exclusively on the Department's own checks on employers' records, without any facility to validate those checks by inspections of his own.

5. Our further conclusions and recommendations are as follows:

  (i)  To demonstrate that Tax Credit funds held by employers have been properly applied, it is important for the Department to continue to refine their risk assessment processes so that they can target their compliance work on employers and applicants to best effect. The Department quantify the error rates they detect. They should report those error rates with their annual accounts, together with their analyses and the trends that they show.

  (ii)  Improvements in Departmental checks on employers' records would enable the Comptroller and Auditor General to gain more assurance from them, but he would still need to do sufficient work to ascertain that the Inland Revenue's controls are effective, as he is required to do under the Exchequer and Audit Departments Act 1921.

  (iii)  Such selective inspection of employers by the Comptroller and Auditor General should not add significantly to the existing burden of administering Tax Credits.

  (iv)  The inspections would call for expertise in the examination of payment systems and controls, though within a tax environment. Such work is within the competence of auditors, as in other specialised environments, and is distinct from the work of Inland Revenue tax experts on the executive management of the tax system. The technical complexity of tax administration should not therefore preclude effective external audit of Tax Credits.

  (v)  The Department should ensure that the new Tax Credit schemes to operate from April 2003 provide for direct reconciliation of the total amount paid by each employer with the amount authorised by the Department.

  (vi)  The Department have not been able to estimate how many people are eligible for Tax Credits. To enable them to do so they need to complete their analysis of the Family Resources Survey quickly. They should then use this information to assess and report upon the effectiveness of their efforts in getting Tax Credits to those entitled to them.


6. Part 3 of the C&AG's Report[4] examines developments on Tax Credits since the Department gave evidence to the Committee in April 2001. Tax Credits are part of the government's programme of tax and benefit reforms to make it worthwhile to work. They are available to families and single parents with children, or disabled people who work at least 16 hours a week. As at March 2001 around 1.225 million individuals were receiving an average rate of just under £80 a week in Tax Credits. From April 2000, employers could pay the Tax Credit awarded by the Department to applicants with their wages. Employers could then recoup the cost from the tax and National Insurance they had collected, before paying them over to the Department. Some 30% of the £4.7 billion Tax Credits paid in 2000-01 were routed via employers and mainly funded from the PAYE tax deducted from other employees.

7. During consideration of the Tax Credits Bill in 1999, the Chairman of our predecessor Committee asked the Paymaster General whether the C&AG would have access to employers to obtain direct assurance about Tax Credit payments made on behalf of the Department. The Chairman drew attention to the fundamental principles of Parliamentary control over public expenditure under which Revenue Departments pay tax revenue gross into the Consolidated Fund. Expenditure is then approved by the House through the annual voted Supply Procedure. The Tax Credit legislation in 1999 amended the Exchequer and Audit Departments Act 1866 so that in respect solely of Tax Credits, the gross pay-over requirement was replaced with a net pay-over requirement.[5] The cost of Tax Credits is not therefore voted by Parliament. The previous Chairman expressed concern that the new arrangements represented a significant weakening of the system of control over public expenditure that had served the House well for over a century.

8. The previous Chairman also expressed concern that the accounts through which the Tax Credits would be reported to Parliament were not on a statutory basis, unlike the accounts for practically all other expenditure. Furthermore, there was no provision for the C&AG to have statutory access to employers who would be taking on the new role as paying agents for the Department. Hence he would not be able to obtain direct assurance about the payments at the point they were made, as part of his independent audit on behalf of Parliament.

9. The Paymaster General's response emphasised that the new support was seen as part of the tax system - not as benefits - and that the level of individual Tax Credits would be set by regulation laid before Parliament. The total expenditure would be in the Department's accounts and also the national accounts. Under subsequent legislation the Departmental accounts were made statutory. The Paymaster General said that the Government would be unwilling to see the NAO added to the many inspectors that could visit employers because of the burden upon them, and expressed the preference that the C&AG should derive assurance by examining the Department's programme of checking the operation of PAYE and National Insurance by employers. The Paymaster General also said that if this caused major difficulties the government would reconsider the question of the C&AG's access.

10. This Committee's Report in March 2002 recorded that the Department expected to be able to give the C&AG sufficient assurance about employers' operation of the Tax Credit scheme during 2000-01.[6] For that year, therefore, to satisfy himself that employers acted in accordance with regulations, the C&AG would have to take assurance from the Department's compliance visits to employers as well as from Departmental reconciliations of year-end returns of payments by employers, with the amounts authorised by the Department.[7] As we explain in paragraphs 14 to 16 below, these reconciliations which were eventually concluded in April 2002, proved less than satisfactory.


11. We asked the C&AG about his need for access to the employers who pay Tax Credits on behalf of the Department. He told us that essentially Tax Credits were a form of payment and the external auditor should have access to the books and records of the organisations which made those payments. The C&AG did not have the same access to the people who paid the Tax Credits, because they were employers, as he had to government departments which made other payments. He stressed that the external auditor of any activity needed direct access to that activity. To get a full understanding of the way the Tax Credit system worked, he needed access to employers, which he could use when he saw advantage in doing so. It was up to the external auditor to determine the mode, method and occasions on which he exercised access powers. He emphasised that he would of course use those powers with circumspection and care, and would not seek to go to every employer every year. He concluded that he needed access to be able to report adequately to Parliament on the disbursement of public money.[8]

12. The Department expressed concern that letting auditors visit employers, even if they went with the Department's own compliance staff, would be a problem as the National Audit Office were not experts and would detract from the work of the Inland Revenue.[9] This is to misunderstand the role of auditors, who independently audit the systems and procedures in question, which is their field of expertise.

13. The Department told us that they were content to discuss with the C&AG how best to give him the assurance which he sought, but their concern was that the intervention of a further party would increase what employers saw as a burden.[10] The C&AG's staff would be quality assuring the efforts of the Department in ensuring that employers were operating Tax Credits correctly.[11] The C&AG's view, on the other hand, is that he would be securing direct assurance on the payment of Tax Credits by employers, effectively as agents for the Department.


14. The C&AG's Report for the previous year, 1999-2000, had highlighted the lack of management accounting information on Tax Credit awards made and recommended that the Department should produce this information as a matter of routine.[12] Nevertheless, the Department were unable to obtain details of award notifications sent to employers during 2000-2001 that were needed to reconcile payments made by employers to those authorised.

15. The Department therefore undertook a separate exercise to interrogate the Tax Credit database for details of awards made, and then tried to reconcile these figures with payments made by employers. The results of that exercise are summarised in the supplementary note that the Department sent to the Committee. We are grateful for this note and we welcome the candour of the Department's admission that currently it is not feasible to tie up the aggregate amounts of Tax Credit paid, as declared by employers in their annual returns, with the amounts authorised by the Department. This is mainly because employer payroll cycles do not coincide with the tax year; there are errors in identifying the employers' schemes when authorising individuals' Tax Credits; there are errors by employers in completing their returns; and errors in keying data into departmental systems. The Department recognise that the first year of payment via employers was a learning experience, and that they had not made as much progress as they had hoped. They accepted that there would still be problems for 2001-02 and over the next few months they would be discussing with the National Audit Office the full details and findings of their exercise and their proposals for further work in this area.[13]

16. The Department noted that in investigating these issues, their Internal Audit and operational staff had found no evidence of anything other than genuine error. They were sure that the work they planned to undertake over the next few months would help to reduce further problems and would put their assurance about employers on a sounder footing. The Department offered to report back to the Committee on progress later in 2002.[14] We look forward to that progress report.

17. The C&AG reported that he had difficulty in obtaining satisfactory information relating to visits to employers by the Department's compliance teams due to weaknesses in their management information. There is therefore uncertainty about the number of visits which included cases where Tax Credits had been paid and how many checked. The C&AG considered that there was a need for detailed information on the results of compliance visits to employers. This would enable an early evaluation of risk and targeting resources on key areas. In addition, a lack of detailed data meant that the Department could not estimate level of error where employers had paid Tax Credits incorrectly. The Department told the C&AG that their random reviews would enable them to estimate amounts at risk from non-compliance in the future.[15]

18. The Department also told the C&AG that for 2002-03 they should have a better reporting system for their compliance work which should enable them to say when credits were looked at and whether there were problems. Nevertheless, we are not convinced as to the balance between compliance work on individual applicants and that on employers, and the Department promised to let us have a note on the staff numbers deployed on these two areas.[16]


19. Between the start of the Tax Credit scheme in October 1999 and November 2001, around 49,000 cases relating to individuals had been referred to the Department's Compliance Co-ordination Unit. Of these 22,500 were not followed up because of a lack of evidence or because the case was considered to be insufficiently high-risk. This suggested that the risk scorecard, which was the source of 37% of the 49,000 referrals, needed to be further refined. 3,600 of the 26,500 cases examined were closed without necessary work being completed, due to staff shortages.[17] The C&AG's examination of a sample of cases confirmed that the investigations had been thorough. In 226 cases, however, overpayments identified had not been properly reported to the Department's debt recovery team, resulting in a failure to recover some £114,000,[18] which the Department admitted was their fault.[19]

20. The amount of errors made when the Department processed Tax Credit applications was low in proportion to the aggregate amount paid. Nevertheless, the Department need to analyse their quality assurance results to identify and address the types of error most likely to lead to significant under- or over-payments. The absence of management information meant that the Department could not evaluate the relative cost-effectiveness of different sources of referrals to compliance teams. The C&AG recommended that the Department should routinely identify the yield from each source so that they could target resources effectively. He also said that they should assess the appropriateness of the risk scorecard criteria that led to referrals and continue to keep these under review to make sure that the scorecard remains an effective tool. We endorse these recommendations.[20]

21. The Department emphasised that a major purpose of the risk scorecard was to get staff administering this new system used to analysing the risk. Across all of their compliance activity, they tried constantly to refine their indicators and their analysis of risk. They told us that the Department for Work and Pensions did not apply the kind of risk based approach to benefits that are applied to Tax Credits. The Inland Revenue applied the sort of compliance approach that they had found worked well for tax.[21]


22. We enquired about the take-up of Tax Credits and were told that the Department could not know how many people were eligible until they had the results of the Family Resources Survey. The Department had a dedicated team of analysts working on tax credits and they expected to have eligibility figures towards the end of 2002. Take-up was of the order of 1.3 million.[22]

23. The Department did not expect a material number of people currently taking up Tax Credits to fall out of the system as the new Tax Credits were introduced from April 2003. One change would be that fewer would actually be paid by the employer, as many would be paid by automatic credit transfer to a bank account. We suggested that this should increase take-up and accuracy, because there would not be an intermediary to make mistakes. The Department hoped so, but could not guarantee it until they had had a good look at the detail.[23]

24. The Department told us they were doing a number of things to bridge the gap between eligibility and take-up. In addition to advertising campaigns they were working with employers to help them raise awareness of the new Tax Credits. They were also helping representative groups such as the Low Income Tax Reform Group, the Citizens Advice Bureau and a charity called Tax Aid, to raise awareness of the availability of the new Tax Credits.[24]


25. The new Tax Credits will operate from April 2003, and over a four-year period the cost of setting up and administration is estimated at £1 billion. The Department said that the computer system is eight times bigger and more complicated than that for Self-Assessment. It is a much more significant structure than Working Families Tax Credit.[25]

26. The C&AG reported on the procedures the Department had established to manage the risk of non-compliance and fraud, with their staff as the first line of defence. Using risk assessment procedures, they identified cases where non-compliance was most likely and targeted their enquiries accordingly. The Department's Special Compliance Office is responsible for investigating cases where significant tax evasion or fraud was suspected. The Department estimated for the year 2000-01 its compliance activity had identified additional tax liabilities of £4.5 billion (compared with £5.4 billion for 1999-2000).[26]

27. We enquired about the extent and management of fraud on Tax Credits. We were mindful that just as some landlords had fraudulently claimed housing benefit for their non-existent or with collusive tenants, some employers might seek to defraud the Tax Credits system. The Department told us that they had already prosecuted two employers for collusive activities with their employees that had led to loss of Tax Credit funds. Of the 131 cases working towards prosecution in the Department's Special Compliance Office, 13 involved apparent collusive activities on the part of employers. However, the reconciliation work referred to in paragraph 17 above did not find substantial large-scale frauds by employers. The Department felt that they had evidence of the level of fraud detected and were always trying to identify employers at risk. Further, the Department considered that their current study of 3,250 cases, although small, would give them a better idea of the scale of the problem.[27]

28. We pointed out to the Department that when the Customs and Excise gave evidence to this Committee on tobacco smuggling, they estimated fraud overall as between £6.4 and £7.3 billion which was much more than the Inland Revenue's estimates. The Department said that they did not know why their fraud estimates were so much lower than those of Customs and Excise or the Department for Work and Pensions. They emphasised that they had a robust fraud strategy and had appointed the director of their Special Compliance Office as the Departmental fraud champion. They were seeking to achieve a much better understanding of the risks and the amount at risk. For this purpose they were conducting various piecemeal studies and they had appointed a leading academic economist last year as the director of analysis and research who would be leading the analytical work. They recognised that they needed to do more to scope and scale the fraud problem than they had in the past.[28]

29. The Department noted that the C&AG was conducting an investigation into fraud in the Department for Work and Pensions, Customs and Excise and the Inland Revenue, which they thought would be an invaluable exercise. They noted also the long-standing compliance problem of balancing the need to get Tax Credits to deserving claimants as soon as possible while preventing fraudulent claims.[29]

1   C&AG's Report, Inland Revenue Appropriation Accounts 2000-01 (HC 335 XVI, Session 2001-02) Back

2   Ev 1-4 Back

3   C&AG's Report, para 3.4 Back

4   C&AG's Report, paras 3.2-3.5 Back

5   The Tax Credit Act 1999 Section 5(2) amended the Exchequer and Audit Departments Act 1866 Section 10. Back

6   23rd Report from the Committee of Public Accounts, Report on Inland Revenue Appropriation Account 1999-2000 (HC 631, Session 2001-02), paras 31-32. Back

7   C&AG's Report, para 3.25 Back

8   Qq 76, 107, 155 Back

9   Q 49 Back

10   Q 52 Back

11   Q 59 Back

12   C&AG's Report, para 3.29 Back

13   Ev 1-4 Back

14   Ibid, para 18 Back

15   C&AG's Report, paras 3.26-3.27 Back

16   Q 119; Ev 20-21 Back

17   C&AG's Report, paras 3.16-3.18 Back

18   C&AG's Report, para 3.19 Back

19   Qq 144-145 Back

20   C&AG's Report, paras 3.30-3.32 Back

21   Qq 13, 83 Back

22   Qq 61-67 Back

23   Qq 71-74 Back

24   Q 75 Back

25   Qq 80-82 Back

26   C&AG's Report, para 2.5 Back

27   Qq 115-116, 142 Back

28   Q 152 Back

29   Q 141 Back

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