UK Electronic Sales Suppression Crackdown Shows What Not to Do

Electronic sales suppression—business use of software to falsely change the value of a transaction on a digital record—might be the most effective form of tax fraud that people aren’t aware of.

A five-year probe in 2021 found electronic sales suppression, or ESS, devices in one-fifth of California restaurants. As early as 2003, Germany reported yearly tax revenue losses from ESS in the billions of euros, and there’s no indication ESS has diminished since then.

In November 2022, the UK issued guidance FS68, outlining a “come clean” program for ESS users to fess up or face steep penalties—while broadly defining what constitutes an ESS system. His Majesty’s Revenue and Customs—the UK’s version of the IRS—plans to continue this heavy-handed approach in 2024.

HMRC’s actions are problematic and have global implications. The Joint Chiefs of Global Tax Enforcement, which represents an operational group comprising Australia, Canada, Netherlands, the UK, and the US, announced an international probe late last year into use of sales suppression software.

Coordination and cooperation among the J5 countries in this enforcement space has been ongoing, and major action taken by one member sends ripples to the others.

A Dubious Standard

HMRC’s enforcement strategy involves a sweeping definition of ESS tools, which FS68 defines as any piece of software, code, or hardware that allows a business to hide or reduce the value of transactions. This marks a seismic shift from the kinds of language seen in typical US state ESS laws describing a piece of software that falsifies the electronic record on its own.

In the UK, software that’s incapable of deleting transactions apparently isn’t enough to guarantee it’s not an ESS tool—it also must work to obstruct any user who tries to delete transactions. This standard casts an overbroad net, capturing commonplace business tools such as Microsoft Excel, Google Sheets, and MySQL.

Also, HMRC can charge a business with a penalty if it’s found to possess, make, or promote an ESS tool. The agency explicitly disclaims the requirement that the ESS tool was used for a penalty to apply. It’s bad enough that the business could be charged for having Microsoft Excel, but it seems even proving it never opened the software wouldn’t be a perfect defense against the charge.

UK Impact

HMRC’s expansive interpretation of ESS tools transforms the landscape of tax compliance in a way that could have far-reaching implications for businesses across the UK and the J5.

Under this broad definition, businesses relying on legitimate software that would qualify as ESS tools would be in a gray area of compliance. The burden of proof could shift, requiring businesses to demonstrate their innocence rather than force tax authorities to prove their guilt.

The door is open for regulatory overreach. The risk of accidental misinterpretation or intentional misuse of these guidelines by enforcement agencies could lead to unwarranted audits and investigations. Under FS68, almost any business would have software installed that could give rise to an audit, if not charges.

Small and medium-sized enterprises that lack the resources to navigate complex compliance situations and defend against audits might feel the pressure most acutely.

These attempts to fight tax evasion also may discourage adoption of new technologies. A developer of any artificial intelligence-aided accounting system would struggle to prove the AI couldn’t be used to delete transactions and, further still, would actively restrict a user from doing so.

HMRC’s policies on ESS fail to balance effective regulatory drafting and enforcement with ensuring compliant businesses aren’t unduly burdened or discouraged from using technology essential to their operations.

A contactless chip and pin terminal at the checkout at an Aldi store on July 22, 2022, in Tarleton, UK.

Photographer: Christopher Furlong/Getty Images

J5 and Beyond

Concerns that the UK’s ESS framework could spread across the J5 aren’t just speculation. The first case of ESS in North America was discovered in Quebec in 1997, and Canada was at the forefront of enforcement against the practice. J5 members have shared information and strategized ever since, as designers and purveyors of actual ESS tools rarely restrict themselves to the borders of one country.

Canada has embraced technology to combat ESS. The Canadian Revenue Authority employs advanced analytics and data matching to detect anomalies indicative of sales suppression.

The Australian Taxation Office in the past focused on education and partnerships with businesses, working closely with software providers to ensure compliance. However, the ATO took a page from the Canadian handbook and adopted data-matching techniques to detect and investigate suspected instances of ESS.

There has been a more varied approach in the US, with individual states enacting laws and regulations on ESS that typically emphasize specific definitions and targeted enforcement.

Some states mirror the approach of Canada, focusing on use of ESS tools as proven through data analysis, rather than the mere possession of a tool that could be used for ESS.

Other states do make possession of an ESS tool illegal but generally define ESS tools as being purpose-built to falsify transaction records. Still, a tax revenue-hungry state following the HMRC playbook is plausible and concerning.

Outlook

HMRC’s expansive crackdown on ESS aims to safeguard revenue and competition, but the execution raises red flags.

The broad definition of ESS tools challenges the operational integrity of businesses in the UK and sets a precedent that could influence global tax enforcement norms. This approach risks ensnaring compliant businesses, stifling technological innovation, and creating an environment of uncertainty for businesses.

The effects aren’t necessarily confined to the UK. There is a direct international element to ESS enforcement, as manufacturers of software that could be deemed ESS tools risk running afoul of HMRC’s guidance in shipping innocuous pieces of code to customers in the UK.

As a member of the J5, the UK’s policies could influence international tax enforcement practices—especially in the realm of ESS.

Andrew Leahey is a tax and technology attorney, principal at Hunter Creek Consulting, and adjunct professor at Drexel Kline School of Law. Follow him on Mastodon at @andrew@esq.social

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