Making tax digital: Complications and risks
As a chartered accountant, chartered tax adviser and chartered IT professional, Donald Drysdale discusses complications and risks inherent in 'Making Tax Digital'. The views expressed below are his own and not necessarily those of ICAS.
In my previous article, Making tax digital: A business burden too far? I expressed support in principle for the introduction of a modern tax regime in which digital technology helps businesses comply with their tax obligations. However, I argued that there is no justification for imposing ‘Making Tax Digital' (MTD) mandatorily.
The digital record-keeping and reporting implications of MTD would be daunting enough on their own. But HMRC's six consultations, inviting responses by 7 November 2016, include other proposals that would fundamentally disrupt long-established accounting conventions and tax computational rules to accommodate MTD.
All businesses and their advisers need to be aware of the far-reaching changes being considered. Small businesses, most likely to be adversely affected by disproportionate burdens placed on them, should not miss the opportunity to respond. The consultation documents can be accessed here.
GAAP or cash basis accounting
Generally accepted accounting practice (GAAP) is the established way in which business results are measured. Until recently, GAAP-compliant financial statements formed the basis on which virtually all businesses were taxed, with the profit or loss usually adjusted for tax purposes to take account of specific requirements of tax law.
An alternative 'cash basis' of accounting has been available to many small unincorporated businesses since April 2013. This optional basis can be chosen where annual turnover doesn't exceed the VAT registration threshold (currently £83,000) - or twice that amount in the case of Universal Credit claimants. Businesses must leave the cash basis the year after their receipts exceed twice the VAT registration threshold.
Broadly, a business using the cash basis calculates its taxable income by deducting business expenses from business receipts, with no need to compute debtors, creditors or stock. However, there are restrictions on relief for interest and bank charges, certain capital expenditure, and sideways loss relief.
It is a moot point whether the cash basis offers genuine simplification. Options available to taxpayers tend to add complications, and businesses may need advice on whether or not to opt for the cash basis. Special adjustments are needed on joining or leaving the cash basis. Certain types of business are ineligible for the cash basis, and for others its use may be inappropriate. For example, GAAP-compliant accounts may be needed to demonstrate the viability of a small business when it needs to borrow or when it is to be sold. As HMRC acknowledge, businesses should seek advice from an accountant, and this of course has cost implications.
Cash basis changes proposed
Fundamental changes to cash basis accounting are now being considered. They include increasing the entry threshold, and reforming the capital/revenue divide to limit the disallowance of capital expenditure.
Moves are also afoot to extend the cash basis option to individuals and partnerships of individuals with unincorporated property businesses, individuals letting jointly, and certain non-UK resident landlords.
While some of these proposals may be welcomed by particular businesses, change itself imposes additional burdens. Many small businesses will need professional advice on the impact of the changes - perhaps re-visiting their decision whether or not to opt for the cash basis.
Other accounting reforms
In addition to changes to cash basis accounting, the consultations consider wider changes to the rules for taxing unincorporated businesses.
First is a proposal to dispense with basis periods and the concept of 'overlap profits'. Instead, all unincorporated businesses might be required to use accounting periods, similar to those that apply for corporation tax purposes.
Second is an optional simplified approach for unincorporated businesses not entitled to use the cash basis, allowing them to ignore many period-end adjustments (such as closing stock, prepayments and accruals) in preparing non GAAP-compliant accounts solely for tax purposes. This would affect the timing of recognition of their profits.
The tail wagging the dog?
Perhaps it's because I was trained on accruals accounting. Anyway, life seemed much simpler when accounts were expected to conform with GAAP and thus reflect a true and fair view of the financial affairs of a business.
The accounting principles on which GAAP is based have been developed over many years by accounting professionals in the UK and worldwide. They represent the considered views of professional bodies such as ICAS and their members.
Business accounts should provide meaningful information to all their users. It seems wrong to allow the tax tail (driven by HMRC's efforts to cut costs) to wag the accounting dog by encouraging many unincorporated businesses to turn their backs on well-proven accounting methods.
Behavioural risks of MTD
Payroll through mandatory online real time information (RTI) has discouraged many small businesses from creating jobs. In some cases it has persuaded them not to expand their operations. In others it has encouraged them to engage workers by alternative means that are not always legal and acceptable.
MTD might have a similarly negative effect, with many small businesses striving to remain below the de minimis limit or close down altogether to avoid the new regime. Others might appear to do so, whilst actually continuing in the black economy and evading tax.
Data security risks
Online is a perilous place for those who don't fully understand its dangers. Businesses forced into MTD against their will are likely to encounter unfamiliar concepts such as cloud computing, reporting through application programming interfaces (APIs), and linked online banking. By not knowing the ground rules they may place their business data, personal data and online identities at significant risk.
Security should be a concern for all businesses, and tax administration is a popular target for cybercrime. For example, experience with self-assessment has shown that even apparently competent accounting firms have been prone to having their government gateway credentials hacked.
Security scams are targeted to exploit vulnerable people and vulnerable situations. Small businesses compelled to use digital record-keeping and online reporting are unlikely to have sufficient management time or adequate technology skills to protect themselves.
Tax penalty risks
MTD's digital tax accounts will be pre-populated with information available to HMRC from other sources. Whilst supposedly reducing dependence on annual tax returns, this will expose taxpayers to greater risks of being assessed on wrong information supplied by third parties. Current proposals regarding appeals, repayments, interest and penalties are either unclear or unsatisfactory.
Large public-sector IT projects are notoriously difficult to deliver and many have been abandoned at horrendous cost to the taxpayer. For example the current Universal Credit project is running late and substantially over budget.
The government is investing £1.3bn in MTD, and yet its digital program seems far from robust. In the past month HMRC have lost their chief digital and information officer and the Government Digital Service at Cabinet Office has lost its executive director.
HMRC's timetable for implementing MTD is ambitious for them, and burdensome for businesses. There is a need to slow it down.
As in Pokémon GO, there are monsters to be found in the MTD proposals but many of the details are still fluid. In the light of consultation responses, the government will update its initial impact assessment of MTD and its potential costs and savings for businesses. It is crucial that businesses, individuals and agents with views on MTD should respond.
Article supplied by Taxing Words Ltd