Making Tax Digital: Compliance and administration
Philip McNeill, looks at the potential shape of digital tax administration and compliance under the new system in the HMRC consultation Making Tax Digital: Tax Administration.
This is the most elusive of the consultations on making tax digital. Little concrete detail is given: this is postponed to the realm of ‘further consultation’.
The focus is HMRC’s ‘Promote, Prevent, Respond’ compliance strategy, aiming to:
- Promote compliance by designing it into the system and processes
- Prevent non-compliance at or near the time of filing, and
- Respond to non-compliance through a well-designed approach
A radical change is the indication of a future ‘penalty points’ system for late returns.
The exact model is up for discussion: a preferred approach would include one penalty point for each late return, with an unspecified financial penalty on reaching four points. It would take 24 months of full compliance to wipe the slate clean.
VAT default surcharge would go. The new system would apply to all returns for income tax, VAT, Corporation tax; IHT would retain its own system.
Penalty points would apply to late quarterly updates.
There are number of potential anomalies: it is suggested that penalty points should be per default date, rather than per return. So, a late VAT return and a late quarterly income tax update due on the same date would register one penalty point: but if due on different dates would attract two points.
Inaccuracy penalties (of schedule 24 FA 2007) would continue, and apply to the year-end submissions.
Right first time
‘MTD will help more customers get their tax affairs right first time’. (para 2.4). This is a very broad statement.
While ‘right first time’ is laudable, how is it to be achieved? HMRC’s answer is that requiring taxpayers to use accounting software, which has inbuilt prompts; and channelling taxpayers through digital tax accounts, where HMRC can make available targeted information, will reduce errors.
But does this assumption stand up to challenge?
Double entry - Since 1458
Goethe called it ‘one of the most beautiful discoveries of the human spirit’: and for well over 500 years, double entry book-keeping has been the rock on which business, banking and trading have relied.
Double entry book-keeping underpins the integrity of a set of business records, and the tax submissions and accounts prepared from them. Computerisation revolutionises the way book-keeping is done, but it doesn’t change the nature of debits and credits: the two-way double entry check that maintains precision.
MTD risks conflating two concepts: ‘integrity of records’ – that is the basic double entry checks that cash, bank and ledger accounts balance; and ‘tax analysis’ of the records – that all taxable income is included and only tax deductible expenses are claimed.
Integrity of the records depends on discipline, in recording, reconciling and in business behaviour. Tax analysis depends primarily on knowledge.
Digitalisation alone doesn’t result in ‘integrity of records’. Spaghetti in, spaghetti out.
In most cases, integrity of the records will need someone with a command of double entry book-keeping.
Will MTD close the tax gap?
October 2015 saw the publication of the official Tax Gap figures for 2015. (The 2016 figures must be due of the press shortly, and presumable will show a similar trend.)
MTD is designed to reduce the tax gap. Most recent published figures are available on the GOV.uk website.
In 2015, the tax gap was officially about £34 billion. VAT accounted for 41%; income tax, National Insurance, CGT and Corporation Tax for 38%. Some £16.5 billion, or over 48%, is attributed to ‘SME’ businesses.
In terms of behaviour, 46.3% (£15.7 billion) is attributed to criminal behaviour – criminal attacks, evasion, and the hidden economy; 8% is ‘avoidance’, 14.5% ‘legal interpretation’ and 12% non-payments. The remaining 19.2% is failure to take reasonable care (11.5% - £3.9bn) and error (7.7% - £2.6bn).
Criminals don’t keep to the rules, so it’s hard to see how MTD will impact criminal attacks, evasion, and the hidden economy.
People who will drive an empty waggon out of the UK, to ‘prove’ that significant quantities of alcohol have been exported, so that they can sell the supposed contents of the lorry in the hidden economy, free of VAT and duty, are hardly likely to pay up under MTD.
Will MTD help with tax analysis?
Given that digitalisation alone won’t fix the book-keeping, will it help with tax analysis? What is the potential impact of built in software prompts, free webinars and tax tool kits?
HMRC assert that accounting software with prompts and nudges will reduce errors. Does this stand up to analysis?
The impact here is going to depend on the size and structure of the business and the nature of the taxpayer. It may also depend on cost.
For large businesses, with dedicated accounts staff, it seems unlikely. There is also the practical problem that point of data input nudges and prompts are likely to be ineffective where tax and accounting treatment differs.
Tackling errors – small and medium sized business
Moving on to smaller businesses, we enter a very diverse market.
For those with agents, the same arguments apply as for larger business. Professional review keeps errors to a minimum. One professionally-reviewed digital submission nine months after the year-end without quarterly updates, looks a winner compared with four (or five) submissions without professional review: but current proposals require quarterly figures for every unincorporated landlord or business with over £10,00 gross income.
Given the cost implications of assisting clients with quarterly updates, or potentially unscrambling self-submissions at the year-end, lack of professional representation could be the stark option for some small businesses.
Small business is messier
The nearer we move to micro-business, the more complex the situation becomes. Life is messy. From ‘I’ll paint your house if you give me that car’, to the sole trader throwing a business toner cartridge into the supermarket shopping trolley with the grocery shopping, it is very unlikely that there will be an appropriate digital ‘prompt’ because the accounting software won’t know.
It can’t predict that Uncle Brian bought the brake pads for Joyce’s pick-up on his credit card, in return for a crate of beer. So, the brake pads are a genuine business expense, but there is no expense in cash or via the bank to match.
High volume, low quality data?
At micro-business level, prime-time needs to make money: book-keeping comes lower on the list. Spending more time and money on record keeping (which at this level MTD will certainly bring) is not high priority.
There is potentially a choice between a reasonably priced, once a year service from a professional agent, who plugs the gaps in incomplete records; and self-submission, where it is eminently possible to submit digital garbage, where even the usual balances and check of reconciling cash and bank have been overlooked.
It is unlikely that HMRC will have the resources to correct high volume, low quality data where the tax yield from an enquiry would be low, and the client would be unable to pay.
Partnership, estimates and discoveries
There are other proposals for change in the Consultation, though little detail is given. Partnerships; estimated assessments; compliance powers, all these are likely to face changes.
For example, on estimated assessments, HMRC’s powers to raise a determination under self-assessment would be replicated and applied to year-end declarations.
But, as regards time limits, we are told ‘the safeguard that customers should be able to supersede the determination if the customer completes their End of Year declaration within 12 months of the determination, ‘will be ‘replicated’.
This is only one leg of the current rules: the time limit is the later of 12 months from the issue of a determination or three years from 31 January self-assessment filing date.
But if there is no longer a self-assessment filing date, have we reduced the timeframe from three years to potentially just 12 months?
Workloads and timeframes
How are these changes going to impact workload, and how is compliance activity likely to impact strategy? If a client self-submits for four quarters, and the accountant needs to re-write the figures at the End of Year submission, have we just flagged to HMRC that the client has incomplete records?
If quarterly submissions are late, then the penalty clock could be ready to strike even before the End of Year update. Who is going to chase interim submissions?
Getting involved - influencing the outcome
The impact of all these changes is likely to vary greatly between different businesses and accounting practices. Your view is vitally important.
HMRC is running webinars specifically for agents, the next one is on Tuesday, 25 October 2016. You can register for these, as well as for face to face and other events on the GOV.uk website.
To be part of the ICAS response, please let us have your comments at firstname.lastname@example.org and complete our short poll below.