VAT, Simplification and Making Tax Digital

Sustainable business
By Susan Cattell, Head of Taxation (England and Wales)

2 August 2017

The timetable for MTD for VAT has been confirmed. Susan Cattell considers the OTS review of VAT and how it might be affected by MTD.

Making Tax Digital for VAT

ICAS has welcomed the new timetable for Making Tax Digital for business. Businesses below the VAT threshold now know that they have until at least 2020 to prepare for going digital. However, the focus has moved to those who will be within MTD for VAT from April 2019.

Under the new MTD timetable:

  • only businesses with a turnover above the VAT threshold (currently £85,000) will have to keep digital records and only for VAT purposes;
  • they will only need to do so from 2019;
  • businesses will not be asked to keep digital records, or to update HMRC quarterly, for other taxes until at least 2020.

VAT concerns

Whilst most VAT returns are already submitted online, currently only 12% of returns are submitted direct from software. Many businesses cannot submit returns direct from software because of the complex nature of their VAT calculations, particularly for partial exemption. Spreadsheets are widely used.

ICAS understands that HMRC believe that it will be possible to integrate digital record keeping so that VAT quarterly updates can be generated and sent direct from the software the business (or agent) uses to keep their records. However, it is unclear how they intend to achieve this by April 2019.

The MTD announcement suggested that a pilot of MTD for VAT will only begin by the end of this year and will start with small-scale private testing, followed by a wider live pilot in Spring 2018. Many large companies need 18 months to two years to make changes to their IT systems so are likely to find it challenging to switch to filing direct from software by April 2019.

It would undoubtedly assist businesses to file direct from software if some of the most complex aspects of VAT could be simplified.

Addressing VAT Complexity

The Office of Tax Simplification (OTS) has been conducting a review of VAT and is expected to report its recommendations in the autumn. The OTS is considering a range of areas of VAT complexity; it is also interested in views on the possible impact of MTD on simplifying VAT. ICAS responded to its call for evidence.

ICAS noted that Making Tax Digital is unlikely to offer simplification, in itself. However, MTD could have been used as an opportunity to address some of the main areas of complexity in the VAT regime, that impede the use of software to submit returns. Unfortunately, this is unlikely to be feasible given that the timetable for MTD for VAT (which in any case looked unrealistic) has now been confirmed.

Given that most businesses already file quarterly returns for VAT, so that the suggested benefits of MTD are less obvious for VAT than for direct tax, it would have made sense to defer MTD implementation for VAT to allow time for sensible simplification of the rules to be built in to the process.

It will be interesting to see whether the OTS can identify any ‘quick’ wins which it might be possible to implement in the time available and which would facilitate a move to filing direct from software.

Partial Exemption

Partial exemption calculations are one of the most commonly cited reasons for using spreadsheets and being unable to file direct from software. One aspect being considered by the OTS is whether some ‘accidental’ partially exempt businesses could be removed from partial exemption altogether.

ICAS believes that the de minimis amounts should certainly be raised – one suggestion from the OTS. They are out of date and exclude businesses which should be able to take advantage of them. For example, many farmers who have diversified (and fall within the OTS’s ‘accidental’  partially exempt businesses) are forced into partial exemption because the limits are too low.  The VAT registration threshold is updated each year but the partial exemption amounts are not regularly reviewed or updated. They should first be brought up to date – and then periodically (not necessarily annually) reviewed and updated.

An alternative approach could be to consider an exclusion from partial exemption based on a percentage rather than a fixed amount. If the residual recovery rate of a business exceeded a fixed percentage, say 90 or 95%, the business would be treated as fully taxable. The level of the fixed percentage would need to be carefully considered and it would require work to determine whether and how far this would help to remove unintended partial exemption.

Special Accounting schemes

The OTS is investigating whether all the special accounting schemes such as TOMS and retail schemes are still widely used and necessary. It may be hard to accommodate some of them in a regime which requires filing direct from software. It is also difficult to see that VAT annual accounting will be compatible with MTD. As the OTS notes it can lead to poorer record keeping and unanticipated liabilities – both problems which MTD is specifically intended to tackle.

In contrast, cash accounting should be retained. It remains a very important simplification for small businesses, many of which do not receive payment until months after issuing invoices. Without it many would struggle to pay the VAT at the time the invoice was raised.

The VAT Flat Rate scheme (FRS) was specifically designed to provide simplicity and should be compatible with MTD – amongst other benefits it removes the need to consider partial exemption. However, its usefulness has been reduced due to the recent introduction of the ‘limited cost trader’ category to tackle abuse. It is understood that HMRC considered other approaches but concluded that they would not be effective. However, ICAS said it would have liked to have seen other alternatives tried, for example using legislation to tackle promoters/organisers of the abusive usage of the scheme.

FRS is still attractive to those outside the limited cost trader category – although they may have problems with the calculations required to determine whether they are limited cost or not. Traders within the limited cost category can remain within (or join) the scheme but simplicity now comes with a higher cost which may deter many from joining and cause some businesses to leave the scheme and revert to the normal (complex) VAT rules.

Other areas

The OTS asked whether other sectors had particular VAT issues, not covered in its interim report, which it should consider. ICAS suggested that it should investigate the VAT treatment of the public sector which suffers from numerous distortions and complexities. ICAS produced a paper on VAT and the Public Sector in 2014 which included a detailed analysis. More recently ICAS also made a 2017 Budget submission which considered costs and value for money – and included some suggestions for actions to address some of the problems.

Many public sector bodies may have difficulty filing direct from software by 2019. In part, this is down to the VAT complexity which affects the sector. However, it is also the case that many large organisations in the sector may be using different accounting systems for different activities, using spreadsheets to bring data together before filing.

What next?

Simplification of VAT has moved into sharper focus with the confirmation of the implementation date for MTD for VAT. Unfortunately, with Brexit also on the horizon and likely to require changes to the VAT regime, it seems unlikely that any major simplification can be achieved in the time available. Brexit may in fact allow more radical change after 2019.

In the meantime, the OTS recommendations will be eagerly awaited, as will more information from HMRC on how it intends to integrate spreadsheets and move to a position where all businesses will be able to file direct from software, by 2019.


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