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Introduction

This chapter explainsÌýtheÌýVAT gapÌýbyÌýoutlining the main components and how they are estimated, as well asÌýdescribingÌýthe key methods,Ìýmodel adjustments,ÌýdataÌýsourcesÌý²¹²Ô»åÌýuncertainty ratings.ÌýÌý

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°Õ³ó±ðÌý³Ù´Ç±è-»å´Ç·É²ÔÌýVATÌýgapÌýmodel estimates the tax gap by comparing the total theoretical VAT liability with the amount of VAT received by HMRC.Ìý°Õ³ó±ð VATÌý°Õ´Ç³Ù²¹±ôÌý°Õ³ó±ð´Ç°ù±ð³Ù¾±³¦²¹±ôÌý³¢¾±²¹²ú¾±±ô¾±³Ù²âÌý(VTTL)Ìýis calculated using independent macroeconomic data, primarily from the Office for National Statistics (ONS), on expenditure that is subject to VAT. VAT rates are applied toÌýthisÌýexpenditure data, using detailed commodity breakdowns, to derive the amount of VAT that should be collected in theory,Ìýassuming full compliance.Ìý

°Õ³ó±ðÌýVAT gapÌýmodel covers the full VAT system and includes VAT on final consumption that is irrecoverable, such as VAT paid by households, unregistered traders and exempt or partially exempt organisations. Legitimate deductions and reliefs, including refunds and adjustments required by the VAT system, are subtracted fromÌýtheÌýgrossÌýVTTLÌýto arrive atÌýtheÌýnetÌýVTTL. Actual VAT receipts are then subtracted from this netÌýVTTL, with the remaining differenceÌýrepresentingÌýthe VAT gap.

The VAT gap is updated and revised as and when new data become available, or new methodologies are developed. HMRC publishes a revised historical VAT gap series once a year in the ‘Measuring tax gaps’ publication, incorporating both new and updated data and methodological improvements together. The VAT gap preliminary estimate for tax year 2024 to 2025 was published at Autumn Budget 2025 and a second estimate was published alongside Spring Statement 2026.Ìý

This top-down approach providesÌýan objectiveÌý²¹²Ô»å internationally comparable measure of the overall VAT tax gap and produces a long, consistent time series. However, because it is based on aggregate data, it does not directlyÌýidentifyÌýthe underlying behaviours or customer groups driving non-compliance.ÌýÌý

Step by step calculationÌý

1. Assess the total amount of expenditure in the UK economy, by estimating the total final consumption of taxable goods and services.

2. Estimate the gross VAT total theoretical liability (VTTL), gathering data detailing the total amount of expenditure in the economy that is subject to VAT.

3. Deduct any legitimate reductionsÌýoccurring throughÌýschemes and reliefs (to derive the net VTTL),Ìýsubtracting any legitimate refunds.

4. Calculation of VAT receipts.

5. Subtract actual VAT receipts from the net VTTL. The residual is the estimated net tax gap.

6. CalculationÌýof theÌýportionÌýofÌýtheÌýVAT gap that is non-payment.

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Stage 1: Assess theÌýtotal amount of expenditureÌýin the UK ±ð³¦´Ç²Ô´Ç³¾²âÌý

The VAT gap model adopts a top-down approach to measuring total expenditure by drawing on independent macroeconomic data from the ONS, primarily sourced from the National Accounts.ÌýÌý

ThisÌýdata providesÌýa comprehensive measure of final consumption expenditure across the UK economy, disaggregated by commodity and sector. °Õ³ó±ðÌýVAT gapÌýmodel uses these expenditure series as the starting point for estimating the VAT base,ÌýidentifyingÌýthose components of expenditure that are subject to VAT.ÌýÌý

°Õ³ó±ðÌýnetÌýVTTLÌýis the amount of VAT that should be collected in theory,Ìýassuming that thereÌýisÌýno fraud, avoidance, or losses due to errorsÌýor non-compliance.Ìý

°Õ³ó±ðÌýnetÌýVTTLÌýincludes irrecoverable VAT, which is the VAT paid on ‘finally taxed expenditure’ which cannot be reclaimed, for example by those not registered for VAT.Ìý

The expenditure data series used in the calculation areÌýmainly constituentsÌýof National Accounts macroeconomic aggregates. All National Accounts data used to construct VTTLÌýestimates are consistent with theÌý.Ìý

The ONS do not provide a single measure ofÌý‘total VAT-liable expenditure’.ÌýInstead, the model draws on a range of National Accounts components,Ìýprimarily household final consumption expenditure, alongside spending by government, non-profit institutions serving households (NPISH) and elements of capital expenditureÌý²¹²Ô»å combines these to construct a comprehensive measure of total expenditure in the UK economy.ÌýÌý

A number ofÌýstreams of expenditure contribute to the tax base, with most VAT deriving fromÌýÌý(that is, household consumption). The main expenditure categories that comprehensively cover VAT liabilities are:Ìý

• household consumption

• non-profit institutions serving households

• government capital and current expenditure

• capital and current expenditure from the VAT traders in the VAT exempt sector

• housing capital expenditure

ThisÌýdataÌýisÌýavailableÌýat a detailed commodity level (for example through Consumer Trends and Supply-Use tables), which allows expenditure to be mapped to the VAT system.ÌýÌý

In practice, this means thatÌý‘total expenditure’Ìýin the VAT gap model is not a directlyÌýobservedÌýseries, but a constructed aggregate derived from multiple National Accounts inputs, adjusted to reflect the scope of the VAT base.ÌýÌý

More information about the can be found on the Office for National Statistics website.

Stage 2: Estimate theÌýgrossÌýVATÌý°Õ´Ç³Ù²¹±ôÌý°Õ³ó±ð´Ç°ù±ð³Ù¾±³¦²¹±ôÌý³¢¾±²¹²ú¾±±ô¾±³Ù²â

The gross VTTLÌýis calculated by multiplying the total amount of expenditure in the economy (also known as VAT-able expenditure) by theÌýappropriate VATÌý°ù²¹³Ù±ð²õ.

Appropriate VAT ratesÌýare applied to this expenditure to derive the gross VTTL.ÌýSubsequentÌýadjustments are made to reflect the structure of the VAT system, including exemptions, zero-rating and legitimate refunds, to arrive at the net VTTL. ThisÌýrepresentsÌýthe amount of VAT that would be expected in the absence of non-compliance.ÌýFor the purposes of calculating the gross VTTL, only the standard and reduced rated expenditure are used.ÌýSubsequentÌýadjustments are then made to account for the specific features of the VAT system, including exemptions,ÌýreliefsÌý²¹²Ô»å refund mechanismsÌýto arrive at the net VTTL,Ìýthe amount of VAT that would be expected in the absence of non-compliance.

The total VAT-able expenditure for each sector is combined toÌýrepresentÌýan overall annual figure for the economy.

To derive the amount of VAT within the VAT-able expenditure, the expenditureÌýis multipliedÌýby the VAT fraction (the ratio of the VAT charged on the VAT-able expenditure to the total expenditure).

Stage 3: Deduct any legitimate reductionsÌýoccurring throughÌýschemes and reliefs (to derive theÌýnet VTTL)Ìý

The net VTTL is calculated byÌýdeducting any legitimate reductions from the gross VTTL.

The net VTTLÌýis the difference between VAT due on taxable supplies made by registered traders (‘output tax’) and VAT recoverable by traders on supplies made to them (‘input tax’).

°Õ³ó±ðÌýVAT liability for the relevant categories can be estimated directly from ONSÌýNational Accounts data. The mainÌýexceptionÌýis theÌýVAT exempt sector. Businesses making exemptÌýsupplies areÌýgenerally unableÌýto reclaim all the VAT they incur on outputs.ÌýToÌýaccountÌýfor this irrecoverable input tax,Ìýthe model usesÌýa separate, internalÌýHMRC surveyÌýto refine the accuracy of VAT captured in intermediate consumption for exempt sectors.ÌýThis is usedÌýto estimate theÌýproportion of VATÌýthatÌýcannot be recovered.Ìý

A further adjustment is made for businesses which are not registered for VAT andÌýcannot reclaimÌýinput tax. This uses a combination of data from theÌýDepartment for Business and TradeÌý²¹²Ô»å HMRC information on the distribution of turnover below the VAT threshold to estimateÌýtheÌýrelevantÌýlevel ofÌýexpenditure. ThisÌýforms part of theÌý‘Deductions’Ìýwithin theÌýVAT gapÌýmodel,Ìýdetailed in the following section.

SinceÌýthe calculation of irrecoverable input tax is complex, the level of uncertainty around input tax adjustments is larger than for the other elements.Ìý

The sum of the VAT liability arising from each of the expenditure categories gives an estimate of the gross VTTLÌýin each year. However, there are several legitimate reasons why part of this theoretical VAT is not actually collected. These can be grouped into 3 broad categories:Ìý

• VAT refunds

• expenditure of traders legitimately not registered for VATÌý

• other deductionsÌý

VAT refunds are made primarily to government departments, NHSÌýTrustsÌý²¹²Ô»å regional health authorities for specified contracted out servicesÌýacquiredÌýfor non-business purposes.ÌýSeveralÌýother categories of expenditureÌýfor which VAT can be refundedÌýcannot be separatelyÌýidentifiedÌýin theÌýcalculation of the grossÌýVTTL. The value of these refunds is taken directly from audited HMRC accounts dataÌýas part of the net VTTL calculation.

Traders who trade below the VAT threshold can legitimately exclude VAT on their sales. Expenditure on the output of these businesses will have been picked up in the total theoretical liability.ÌýÌý

Other deductions will capture other legitimate schemes and reliefs.Ìý

Stage 4:ÌýCalculation of VAT receiptsÌý

Figures for actualÌýVATÌýreceipts are taken from HMRC’s published tax receipts figures. The receipts are adjusted to reflect timing effects within each tax year, before being used in the model. A summary of HMRC’s taxÌýreceipts can be found on GOV.UK.

For the tax years 2019 to 2020 through to 2022 to 2023 the receipts figuresÌýinclude an adjustment for the payments which were deferred in 2020 under the VAT Payments Deferral Scheme, and those later further deferred under the VAT Deferral New Payment Scheme. This adjustment ensures that all payments (those already received and those expected to be paid) in respect of liabilities related to these years are properly captured in the VAT gap estimates.

Stage 5:ÌýResidual elementÌýto give theÌýVAT gapÌýÌý

Finally, subtracting the net VAT receipts from the net VTTLÌýgives the VAT gap. The percentage gap is calculated by dividing the VAT gap by the net VTTL. Receipts for the tax year (April to March) are compared with the total theoretical liability for the calendar year, assuming an average 3-month lag between an economic activity and the payment of the corresponding VAT to HMRC. Calculations forÌýnet VTTLÌýassume a 3-month lag between expenditure and actual VAT receipts. Hence, calendar year expenditure data equates to tax year receipts.

StageÌý6:ÌýAttributeÌýportionÌýof VAT gap to non-paymentÌý

HMRC produce an estimate of non-payment and apportion this as part of the overall VAT gap.ÌýÌýIn ‘Measuring tax gaps 2025 edition’ we improved theÌýmethodologyÌýfor the estimate of non-payment forÌýVATÌýforÌýallÌýtax years since 2018 to 2019. The newÌýmethodologyÌýis an estimate of eventual non-payment attributable to the year of tax debt creation. These methodological improvements do not extend back beyond 2018 to 2019.

Prior to 2018 to 2019 non-payment refers to tax debts that are written off or remitted in a tax year by HMRC and result in a permanent loss of tax.

Timing

There are inherent timing factors that affect the latest top‑down VAT gap estimates. The model relies on National Accounts expenditure data, which are published with a lag andÌýsubsequentlyÌýrevised as more complete information becomes available. For the most recent year, the VTTLÌýisÌýlargely basedÌýon observed data from Blue Book 2025, but the dataÌýremainsÌýsubject to revision. As a result, the latest estimates do notÌýrepresentÌýfully settled outturns.

In addition, VAT receipts data used in the modelÌýisÌýpublished monthly but may be revised as accounting adjustments, repayments or corrections are processed. Aligning receipts data with the relevant expenditure period requires timing adjustments, particularly aroundÌýyearend, which adds further uncertainty for the latest estimates.

Data issues and limitationsÌý

While the top-down VAT gap model provides comprehensive coverage of the VAT system, it has several inherent limitations. The estimates rely heavily on National Accounts expenditure data, which are compiled for macroeconomic purposes rather than tax measurement. As a result, expenditure categories do not always align closelyÌýwith VAT liability, and assumptions areÌýrequiredÌýwhen applying VAT rates to aggregated data.

This data isÌýsubject to regular updates and revisions by the Office for National Statistics (ONS), including those arising from annual Blue Book and Consumer Trends publications. Such revisions can have a material impact on VAT gap estimates, particularly for more recent years. WhileÌýthese revisionsÌýimprove accuracy over time, they are an important consideration when interpreting movements in the series.

The model produces a single aggregate estimate of the VAT gap and does not directlyÌýidentifyÌýthe behaviours,ÌýsectorsÌýor customer groups responsible forÌýnon‑compliance. This limits its usefulness for operationalÌýdecision-makingÌý²¹²Ô»å means it cannot on its own explain the drivers of changes in the VAT gap.Ìý

Revisions are an inherent feature of the model. Updates to ONS data, methodological improvements and changes to expenditure classification can all lead to revisions to historical estimates. Although these enhance coherence and accuracy, they mean that published figures are not fixed at first release.Ìý

The calculation of the VTTL is therefore kept under continuous review. However, it is not possible to produce a precise confidence interval for the VAT revenue loss estimates. This is because the VTTL isÌýlargely derivedÌýfrom ONS National Accounts data, whichÌýisÌýbasedÌýmainly onÌýsample surveys andÌýisÌýsubject to both sampling andÌýnon‑samplingÌýerrors. As ONS does not publish error margins for the relevant input series, the impact of these uncertainties on the VAT gap estimates cannot be quantified.Ìý

Finally, because theÌýVAT gapÌýmodel is residual in nature,Ìýcalculating the gap as the difference between theoretical liability and receipts. Any measurement error in eitherÌýcomponentÌýfeeds directly into the VAT gap estimate. This makes the model sensitive to changes in both expenditure data and receipts.Ìý

Sources of error

There are 2 main sources of error that may cause the true VAT gap to differ from the top-downÌýVAT gapÌýmodel estimates. The first arises from uncertainty in the underlying data. Measurement error or revision in expenditure data or VAT receipts directly affects the calculated theoretical liability and, therefore, the estimated VAT gap.Ìý

The second source of error is structural uncertainty arising from the assumptions required to map macroeconomic expenditure data to VAT liability. This includes assumptions about the application of VAT rates, the treatment of exemptions and reduced rates, and the allocation of expenditure between taxable andÌýnon‑taxableÌýcategories.ÌýSmall changesÌýin these assumptions can have a material effect on the resulting estimates.Ìý

SinceÌýtheÌýVAT gapÌýmodel isÌýaÌýresidualÌýmeasure, calculated as the difference between VTTL and receipts, it does not distinguish between different forms ofÌýnon‑compliance, such as error,ÌýevasionÌýor debt. Any discrepancy between theoretical liability and receipts is captured in the VAT gap, regardless of the underlying cause. This limits the interpretability ofÌýshort‑termÌýmovements and reinforces the importance of consideringÌýlonger‑termÌýtrends.Ìý

Uncertainty ratingsÌý

The uncertainty rating for the top-down VAT tax gap estimate isÌý‘medium’.ÌýThis reflects the model’s comprehensive coverage of the VAT base, its reliance on independent andÌýwell‑establishedÌýNational Accounts data, and its long and consistent time series. °Õ³ó±ðÌýmethodologyÌýis transparent, internationally recognised and less sensitive to sampling variation thanÌýbottom‑upÌýapproaches.Ìý

However, some uncertaintyÌýremains, particularly for the most recent years, due to the impact ofÌýsubsequentÌýdata revisions. The residual nature of the model also means that it is sensitive to measurement error in both expenditure and receipts.Ìý°Õ³ó±ð overall uncertainty assessmentÌýremainsÌýunchanged from theÌýpreviousÌýedition.