Is the black economy a false economy?

A recent survey confirmed the black economy is alive and well in the UK. It showed four out of five people were willing to pay someone cash for working on their property. The incentive for one party is to avoid tax and for the other a cheaper price and not having to pay VAT.

This reflects a mix of the pursuit of a lower price and cynicism about the tax system due to the well-publicised ways big companies avoid paying tax in the UK. The cost of the black economy to the Treasury has been put at £2 billion a year, but as it’s activity that isn’t recorded, this is probably not much more than a guess.

What is clear is that it’s thriving, and the recession and its squeeze on incomes probably made people more willing to seek a lower price than a legitimate tradesman would charge. This is probably inevitable in a domestic situation, but for a business bending the rules this way can be a false economy. The test is always whether the gains justify the risk, and for a business that is not always the case.

If you decide to pay someone in cash you need to think of the consequences. In the first place you might find yourself in a situation where because they aren’t charging VAT there is no mechanism to reclaim the VAT on materials – unless you buy them on their behalf. You’re also dealing with a situation where if something goes wrong you have no protection against shoddy workmanship or materials. You are also likely to be dealing with someone who ends up not insured if something goes wrong. These are all risks you can weigh up.

Another problem is that if you don’t pay a legitimate business, how are you going to be able to write off what you spend against tax? This isn’t a problem for things that can go through petty cash, but if you’re withdrawing hundreds of pounds to pay someone, you need to be sure you can explain where the money’s gone. If not, you end up saving someone else from paying tax, but not being able to claim what should be a legitimate business expense.
As a business, as opposed to an individual or domestic household, you’re supposed to know the rules. If someone comes to work for you who has no tax code or P45, you’re supposed to deduct tax at the basic rate, retaining that until you know what to do. If you fail to do so, you could end up liable for the tax with no way to recover it. If someone says they’re self-employed, they should have evidence that this is the case. Contractors should have a certificate to show they’re recognised by HMRC as self-employed. Other people should issue an invoice with an address, and you should keep that for your records along with their national insurance number. If you can show you had cause to believe they were self-employed, if tax isn’t paid it’s their responsibility not yours, so far as HMRC is concerned.

Some people see this as an ethical issue, and there are wider issues about how fair or unfair the tax regime is. But from a business point of view it always comes down to a simple question of measuring reward against risk, and whether the gain is for you, or for the person trying to avoid paying tax. Do that calculation and the offer may not be as attractive as it looks.

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