Making tax digital: examining the consultations

 

HMRC announced in 2015 that the UK tax system would be transformed by 2020 to establish one of the best digital tax services in the world. As part of this ‘making tax digital’ (MTD) transformation, HMRC has recently produced six condocs, with comments invited on each by 7 November 2016:

The main condoc highlights the government’s commitment to investing £1.3bn to ‘transform’ HMRC into one of the most digitally advanced tax administrations in the world. This bold vision represents a paradigm shift in how businesses interact with HMRC and how tax is administered in the UK.

 

The overarching aim is for the new system of tax administration to be simpler and easier for taxpayers (whether a small sole trader or large corporation), thus reducing the amount of time they spend on the administration of their tax affairs and freeing them up to spend more time developing their businesses. Does this stack up?

 

The new system will require the majority of business owners (including landlords) to maintain digital records for their businesses using compatible software and send summary updates to HMRC on a quarterly basis, along with further reporting within nine months of the year end. Is this HMRC’s way of cancelling New Year’s Eve?

 

Under current proposals, there will be very limited exclusions for the smallest of businesses and landlords, suggested as those with gross income under £10,000, and those who are genuinely unable to engage digitally, such as those in remote areas with unreliable internet access, or those unable to use IT equipment by virtue of illness or injury.

 

HMRC has also committed to gather in bulk information from third parties in a timely manner, pre-populating taxpayers’ digital accounts with third party data that HMRC already has. This is welcome and should reduce the burden on taxpayers to obtain and supply this information separately.

 

The penalty regime is also due to be revamped. In addition, taxpayers will be given the option of pay as you go (PAYG) tax, based on the last quarterly submission.

 

 

The proposals are due to be phased in over three years, with a voluntary pilot expected to start in 2017 and some of the smaller micro businesses excluded from the first mandatory phase. Even while drafting this article, the timeline has been pushed back further to give some larger unincorporated businesses a further year until 2019 to get systems in place. VAT is due to be included from April 2019 and corporation tax in 2020, but it is not completely clear when it will come in for larger or complex taxpayers, on which a further condoc is due to be written.

 

These new proposals herald the end of the annual tax return, as we know it, for individuals, partnerships, trusts and companies by 2020. However, since most returns are actually submitted online nowadays, and an annual submission remains, this may look like semantics.

 

The sentiment behind the vast digital development of the UK tax administration system is to be applauded. It would be hard to argue in principle against the introduction of a system which streamlines tax reporting obligations, if this reduces the time spent on tax affairs by businesses from landlords and sole traders to large corporations. This would be good for the economy. But is this what the proposals do?

 

There will be a period of grace for taxpayers to prepare for the new system – an acknowledgment that there are additional burdens. A limited pilot scheme is due to take place with volunteers for periods from 6 April 2017. The proposal is that the new system will be fully operational with effect from 6 April 2018 for income tax and national insurance, although not mandatory for ‘slightly larger businesses’ until April 2019, as recently announced by the financial secretary to the treasury, Jane Ellison.

 

It is currently unclear where the threshold for those businesses affected by the delay will be set; and whether there will be a knock-on effect on the proposed 2019 and 2020 dates for VAT and corporation tax respectively.

 

On penalties, HMRC is proposing a system with tinges of the motoring points system. This was suggested by stakeholders during the previous powers review, but was not endorsed due to inadequate IT systems at the time; it is now feasible, however, as we move into 21st century IT capability.

 

The condoc on tax administration suggests that late payment penalties will only be applied after a certain number of ‘offender points’ have built up, except in the case of the more serious offenders. This is encouraging, though HMRC will need to be satisfied through testing that its software can cope with this and taxpayers may need to monitor points received. It is also not entirely clear when the full penalty changes will come in for VAT. The default surcharge is here to stay for a while, presumably while systems are upgraded to cope with the legislative changes.

 

Large and complex businesses

 

Having a further condoc for larger corporates and other complex businesses is welcome. However, as MTD for corporation tax may be mandatory from April 2020, there is much potential complexity to iron out. This includes determining whether there will really be a benefit to business, HMRC and the wider economy from imposing MTD on businesses above the small level, given that most of these have in-house accountants and have been recording digitally for years, if not decades.

 

In addition, it seems that the affairs of non-corporates with complex affairs may be brought into MTD by the delayed start date of 6 April 2019. While the delay of a year is welcome, some such organisations have extremely complex affairs and the date of inclusion could potentially still be too close, especially as this area is still to be consulted on. Such businesses tend to have complex systems and processes that take time to change.

 

For many complex individuals, the quarterly reportable income will represent a small proportion of their total taxable income. There is an argument therefore that such reporting is futile, especially where it represents an immaterial rounding difference to their total tax affairs. Hopefully, the next condoc will suggest that such cases should also be exempted from digital reporting.

 

Timings

 

The large number of questions in the condocs will need to be fully considered; and decisions taken and then integrated into the new digital system and HMRC procedures where appropriate. Only once this has been announced can businesses and agents seriously start to consider what changes they need to their systems and processes – and these will take time to address. HMRC seems to be setting an unrealistic target for all relevant parties to be ready for the implementation of the first compulsory MTD groups in April 2018, which is less than a year and a half away from the closure date of the consultation.

 

Information technology

 

HMRC has indicated that its own software developers have already started work on their side of the new system. However, the IT requirements of other parties need to be considered; for example, agents acting on behalf of a large swathe of taxpayers, as well as taxpayers themselves.

 

The condoc acknowledges that many small businesses and landlords do not currently keep digital records. These may require assistance, whether financial or practical, apart from those who genuinely find it difficult to keep and maintain digital records, who will be excluded once criteria are determined.

 

HMRC has told developers that software products must be available free of charge to businesses, along with free updates. This was the original intention with iXBRL, but as HMRC had no power to enforce this and provided no help to software companies, it took this on itself. Unless HMRC provides a free common platform to all commercial suppliers, it is unclear how HMRC can expect sufficient numbers of them to provide their basic products free of charge to individual taxpayers and businesses obliged to keep digital records under MTD. One possibility is to legislate that the software should be available to those with turnover under a certain amount, with the software requiring a fee once that threshold is reached. Such a system has worked in the US.

 

MTD will, by definition, expect a great deal from the various software packages. A voluntary pilot is due to commence on 6 April 2017, and it is understood that HMRC will engage taxpayers and agents to carry out user testing. This is vital to ensure that agent authorisation copes with the needs of agents and their clients. It also needs to ensure it can work without a client having to set up a government gateway account – something that can be fraught with problems, especially for non-UK clients.

 

The examples in the condocs are pretty basic, simple businesses, but even they make significant demands on required interfaces and other functionality. For example, will all software work in the case study ‘Richard’, who provides and submits his quarterly updates to HMRC himself and then utilises a tax agent at the year end? And then, of course, there are the more complex cases.

 

The condocs suggest that HMRC is confident that software will be sufficiently advanced to highlight individual problems. For example, the first condoc (at parag 3.28) highlights a point where ‘Eve’ mistakenly includes a deduction for depreciation in her calculation, which her software highlights for her. Will all software packages be this advanced and hence fully MTD compatible? Will such error messages be presented in a user friendly way, so that individuals who are even less literate in accounting, tax and IT can learn, understand and subsequently act on them?

 

How can agents help their clients?

 

Agents are hardly mentioned within the condocs, a significant concern given the large proportion of self-assessment, VAT and corporate tax returns they currently deal with. Many clients have already made it clear they will want their agents to deal with MTD on their behalf. Worryingly, it is not completely clear to what extent an agent’s role in the new digital system has been considered. Although not all taxpayers have agents, a large proportion, from individuals and small business owners to medium and large partnerships and corporates, do rely heavily on their agent.

 

Any changes that give rise to a change in the agent’s role will in turn affect the taxpayer, potentially negatively. It is not clear from the condoc which tasks agents will be able to undertake under the new proposals and, practically, how they will go about doing it. This makes it difficult to respond to the condocs and start preparation.

 

Worryingly, it is not considered in the condoc whether an authorised agent will be able to provide the full range of services under MTD to their clients; it mentions making the submissions in para 2.18, but not the maintenance of digital records for clients. Surely HMRC does not expect every landlord and business to start maintaining digital accounting records themselves, irrespective of their circumstances, within the timelines given. In any case, what is the difference between a large company employing an accountant to do this and a small business or landlord asking their agent to do so?

 

Businesses frequently use agents because a business owner’s time is better spent on running their businesses. Agents will often have expertise that the business owner does not have. Discouraging the use of agents could store up problems for the future, increase costs and frustrations, and potentially reduce the size of the economy and the tax take.

 

In cases where a client decides to do some of the record keeping himself, software selected by a client must be able to interface with that of the agent, so software aimed at agents must be capable of importing from a variety of MTD compliant software aimed at businesses.

 

Currently, agents can submit an annual tax return electronically on behalf of a client for whom agent authorisation is not in place. Under HMRC proposals, however, it appears that agents will need to have client authorisation in place with HMRC before being permitted to make any submissions on behalf of a client.

 

It is also unclear whether existing authorisations will continue to be effective. Mention is made of clients authorising their agents through the gateway. Clients will merely ask agents to do this on their behalf, which may be problematic. Few represented clients will want the hassle of doing this themselves.

 

It also is unclear whether HMRC fully understands the complex web of engagements that clients and agents have, particularly on the corporate side. Different agents may be dealing with distinct aspects for different periods, so a system where a new agent ‘trips’ existing engagements will not work. Ideally, HMRC will throw some resources at this area so that the current system is moved en masse to the new one, with adequate continuity. Agent authorisation cannot be put in the ‘too difficult’ box; it must be sorted if MTD is to have any hope of succeeding.

 

The condocs repeatedly state that quarterly reporting, combined with a year-end summary or adjustment, will not cause additional work. In the case of an organised taxpayer with very straightforward tax affairs, few if any allowances and reliefs, with work arranged evenly across the year, this may be a reasonable assumption. It could realistically involve them splitting their records into four quarterly ‘chunks’ and associated confirmation, with a further final confirmation at the end of the year.

 

However, for represented clients, who often have more complex affairs, this is unlikely to be the case. Where the agent makes the quarterly submissions, the volume of interactions each year with clients will rise. As a minimum, this is likely to include the transfer of data, queries, sending collated data back to the client for approval and the client confirming their approval prior to submission every quarter and also after the year end.

 

Potentially, this is five times as much contact. This will be more time consuming for both the client and the agent. Logically, this will be more expensive for the agent and these costs will be passed to clients, unless slick fast interchange systems can be developed, which means systems costs. This could be the last straw for some small sole traders used to managing their affairs with a single annual return, who could decide to cease trading.

 

Certain professions may need to adjust their administrative working practices to manage the changes; for example, barristers’ chambers will need to start providing information relating to barristers’ work-related finances on a quarterly basis instead of annually. This is likely to create far more work.

 

The consultation examples provide the case of ‘Richard’ who completes his quarterly updates, but engages an agent to ‘finalise his income tax and national insurance contribution positions himself’. Paragraph 1.10, entitled ‘A seamless journey for business’, notes how Richard checks his own updates before sending them to HMRC and receives the benefit of an in-year estimate of his income tax and NICs position. Such an estimate may well be fairly meaningless for those with, say, seasonal businesses.

 

Many taxpayers would not be comfortable checking the accuracy and submitting their own updates. Many know their limitations; those that do not may be acting in ignorance. A recent Treasury Committee hearing heard from a business owner who seemed confident of making their own submissions; however, when asked if they were using the cash basis they were unable to understand the question – which, as the committee member responded, was interesting evidence!

 

The condocs (including the case studies) focus heavily on small businesses and taxpayers with low levels of income; and, in particular, para 1.7 of the main consultation notes that HMRC has listened to the concerns of small businesses and made adjustments to ease the transition for them. However, there are plenty of other groups for whom MTD will have a significant impact; for example, trusts and medium and large businesses, including both partnerships and companies.

 

Paragraph 1.8 notes that those with corporation tax liabilities will not be included in MTD until April 2020 and para 7.23 acknowledges that that corporates may have specific requirements, especially considering their obligations under the Companies Act. We will have to await the further consultation on this area to find out more.

 

Trusts have not been considered in detail by the condocs. The only mention is in the third document, which states that the simplified cash basis will not be available to trusts. Trusts, especially those for the disabled, should not be discriminated against.

 

The condoc only considers principles for all sizes of partnership and does not consider the ‘detailed issues’ faced by larger and more complex partnerships. Individual partners will not be required to make their own personal quarterly submissions, on the basis that the required information relating to their partnership shares will be contained on the partnership’s return. However, a partner may well have to report other information, such as income from a rental property portfolio. In addition, a way for partners to query amounts submitted by the partnership is necessary.

 

The plan seems to be that these larger and more complex partnerships will be brought into MTD from April 2019. Why? Large partnerships tend to make tax provisions, have accounting systems akin to large PLCs and would be quarterly reporting profits that have little correlation to those on which a partner may eventually be taxed. Why not leave them out of MTD?

 

Certain simplifications have been proposed, such as around the revenue: capital divide for unincorporated businesses using the cash basis. However, to manage their own affairs, many taxpayers will need to learn more about accounting and the ever changing tax rules. This seems to negate one of the stated purposes of MTD – to simplify matters and reduce the time people spend on their accounts and tax affairs.

 

HMRC will need to have systems in place to cope with the potential volume of queries and advice required from taxpayers, especially before the year-end update deadline. Online help and webchat should help those that are IT savvy, though this will not solve everything. Previous initiatives have shown how HMRC needs to properly resource helplines that genuinely help taxpayers and agents with both tax technical and IT issues.

 

In addition, adequate HMRC staff will be required for the correction of both year-end declarations and tax returns for a period before tax returns are fully ‘abolished’. Incidentally, the document proposes that taxpayers will only be permitted 12 months to familiarise themselves with the new regime before penalties may be applied for certain failures. This seems to be an unnecessarily short time for such a radical change. Much seems to be expected from taxpayers by MTD very quickly.

 

The speed at which this is coming in and the threat of early mandation followed by penalties within a year seem to be the key problems. If these fell away, there is more likelihood that taxpayers and their agents would try the system out and try to make it work. If it is well designed, then take up will be good and concerns will fall away.

 

It would be worth HMRC phasing in the first stage more gradually and, once that is working well, to extend MTD. The voluntary pilot scheme could run as planned from 6 April 2017, assuming the necessary software and systems are in place – not just HMRC’s software, but the software and systems that agents and businesses use. But that is a tall ask.

 

The tax technical changes seem to be mooted as a later addition. However, this seems to be round the wrong way. Surely the extension of the cash basis and any other simplifications should come first. Get the fundamental rules right first, and then sort out how to collect the data.

 

Taxable profit could better mirror accounting profit, so that fewer tax adjustments would be required for smaller businesses. In addition, submissions or returns need to be for periods that the tax system recognises. One fundamental issue is that shoehorning reporting for quarters into a tax system that is based on annual calculations seems fraught with problems. The condocs allude to this; for example, when discussing how to spread personal allowances across periods and in reforming basis periods. Surely we should get such fundamentals right first.

 

Should we abandon the idea of quarterly accounting and reporting or switch to a quarterly tax system? The problem is that it takes a year for the earth to travel around the sun and consequently many things are on an annual cycle. Businesses that predominantly work flat out in some seasons and recover in the others would be penalised by a quarterly tax system. HMRC does not seem to have properly addressed this yet.

 

While most of the condocs have now been published and the topic in general has been discussed in the financial press, it is likely that there will still be a large number of taxpayers who will not be fully aware of the impact the changes will have on them, or practically, what they need to do. This is especially important for unrepresented taxpayers, reliant on HMRC to help them through the new processes, and for larger or complex taxpayers for which detail is awaited.

 

We all want this to work yet it does not seem to be quite on the right tracks yet. If HMRC decides to proceed as outlined in the condoc, I think the only solution is to not make it mandatory and, like self-assessment, gradually improve it over a few years. As it improves in efficiency, agents in particular and IT savvy businesses will join the club and others will soon follow.

 

Do respond to the condocs (available at www.bit.ly/2ct8vhE) by 7 November, either direct to HMRC or through your professional body. The CIOT and ATT are running a joint members’ survey (see www.bit.ly/2c80qn6). You can respond to that to help provide evidence for their response.