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Making tax digital: taking stock

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Recent surveys by ICAEW and CIOT/ATT show a move away from spreadsheets and manual records to MTD-compliant software, combined with a significant increase in practices viewing digitalisation as an opportunity, though with concerns over costs and productivity. HMRC reports that more than 4m VAT returns were filed through MTD and more than 1.4m businesses have now signed up. The combination of new software and apps, MTD and the Covid-19 lockdown has caused a step change in digitalisation. There is now an opportunity to reflect on what has been achieved and on what could and should happen next.

Five years ago, on 18 March 2015, George Osborne announced the death of the tax return. The ambition was bold: millions of individuals would have information automatically uploaded into new digital tax accounts, a minority with the most complex tax affairs would be able to manage their account online and businesses would feel they were paying a simple, single business tax. Eight months later, in the Autumn Statement, we learned more about ‘making tax digital’ (MTD) and the controversial word at the heart of it: mandation.

Mandation triggered a raft of concerns around costs, administrative burdens, the appropriateness of digital technology for some businesses and the likely benefits. HMRC believed that MTD would reduce accounting errors, thereby making a significant additional contribution to the Exchequer (HMRC puts the loss of tax revenue attributable to avoidable error at more than £9.9bn for 2017/8) while businesses and individuals would be able to deal with their tax digitally and control their tax affairs closer to real time. The tension between these concerns and ambitions resulted in significant variations to the original timetable; notwithstanding that, considerable progress has been made.

Over the past five years, software and apps have developed at an unprecedented pace. Accounting packages that link with bank accounts have become mainstream and apps enabling an image of a purchase invoice or receipt to be captured, imported, matched to a bank or credit card entry and analysed automatically have become increasingly effective. Agents have seen these new digital tools as an opportunity to enhance their services to clients. MTD has acted as a major catalyst for software developers, businesses and agents and in recent weeks, the Covid 19 pandemic has reinforced the advantages of cloud-based technology, enabling clients and advisers to engage despite lockdown and facilitating a real-time, proactive service when clients most need it. The pandemic has also driven more payment transactions online, dramatically reducing the use of cash and forcing a rethinking of business dynamics.

MTD for VAT has now been live for a year and that milestone, taken together with recent surveys by ICAEW and CIOT/ATT plus an evaluation by HMRC and the Covid-19 lockdown makes this is a good time to take stock.

Surveys and evaluation

The ICAEW survey of 500 small and medium sized firms was conducted at the end of 2019 and followed a similar survey in 2018. Over the year there was a 79% increase in clients providing VAT records maintained using commercial software combined with a 47% decrease in spreadsheet use and a 65% decrease in the use of manual records. 88% still had some clients maintaining records using spreadsheets while 73% still had clients with paper records. 73% of the practices surveyed saw digitalisation as an opportunity (up from 46% in 2018) but on the downside, 22% saw costs increase by more than 25%.

Only 11% of respondents to the CIOT/ATT survey said that MTD for VAT had reduced errors; 72% noted no difference and 17% reported an increased error rate. Productivity within the practices that responded increased in 14% of the sample while 31% reported no difference and 55% reported a decrease. There were some very striking figures on cost burdens, with under 10% of respondents saying that transition costs were at or below HMRC’s estimate; only 8% estimated that ongoing costs would be at or below HMRC’s expectation.

ICAEW, CIOT and ATT all urge government to review the implementation to date before rolling MTD out further. ICAEW reiterates the view it has expressed from the outset (which I share), that the shift to digital should be gradual and not mandated, with individual businesses taking decisions based on their own commercial needs.

HMRC’s perspective, set out in its evaluation published alongside the March 2020 Budget is, perhaps understandably, different. The forecast reduction in the tax gap from MTD for VAT through a reduction in errors is put at £1.2bn by 2023/24 with steady state savings of around £300m a year. The evaluation notes that by 9 March 2020 more than 1.4m businesses had joined the MTD for VAT service and more than 4m VAT returns had been filed using MTD-compatible software. Over £41bn of payments had been processed and more than £13bn of payments issued through the system. More than 33,000 agents created an Agent Services Account. In addition, a small-scale pilot of MTD for income tax has been running since April 2017. HMRC quotes a Thomson Reuters poll which found that ‘51% of respondents reported having simplified or more efficient processes, with 32% saying they now have more accurate VAT returns. Additionally, 19% said they also have better visibility of their tax liabilities’. HMRC also quotes a 2018 study by the Enterprise Research Centre which found that for microbusinesses, web-based accounting software delivered productivity increases of 18%.

In practice

The ICAEW and CIOT/ATT surveys and the HMRC evaluation broadly reflect what I have seen happening in practice.

MTD for VAT spurred a step-change in migration from manual records to accounting software and apps. While there were already good products in the marketplace there is now even more choice and, more importantly, greater functionality available (though having 500 MTD compliant products in the marketplace makes comparison and selection challenging and this number surely cannot be commercially sustainable). The agent community put considerable effort into informing businesses about MTD and has done the heavy lifting in terms of training and hands-on support. I know from personal experience how much resource that has taken: while some clients have needed very little help, others have required a great deal. The ICAEW and CIOT/ATT survey findings on costs do not, therefore, surprise me at this point in time.

There was scepticism about HMRC’s initial compliance burden reduction claims and the revised impact assessment published in December 2017 showed a more granular picture, acknowledging that there would be net ongoing as well as transitional costs, particularly for small businesses. The cost burden, especially for the smallest businesses, does need to be taken into account when looking at the future of MTD, as indeed does the potential for efficiency and productivity savings: a balance should be struck that delivers something tangible for all stakeholders (including agents, who rely on the functionality of the agent services account).

While the ICAEW survey shows that use of spreadsheets has declined, many businesses still use them to keep perfectly good records and bridging software (with 185 products now available) is a pragmatic way to enable these businesses to comply with MTD with minimal disruption. The number still keeping manual records is striking, but as long as the regulations only require a business to have digital records at the point at which the VAT return is transmitted this is likely to continue, the issue being that some records will still only be digitalised quarterly rather than contemporaneously. At some point HMRC will presumably increase the pressure on this group, as a fundamental aim of MTD is to ensure that records are kept closer to real time, but I would hope that this will be done gradually, with the same welcome pragmatism HMRC has applied to the imposition of penalties.

The CIOT/ATT findings on productivity and error reduction again do not surprise me. While I remain sceptical about the forecast additional tax yield, I do believe that real potential exists to reduce errors and increase efficiency once the transitional phase is behind us. The prompts, nudges and proactive features of MTD software have yet to be delivered to the extent originally envisaged, but as the ICAEW survey shows, three quarters of the firms surveyed saw digitalisation as an opportunity (a significant increase on the previous year). In my year as ICAEW president, I visited a number of practices in the UK and elsewhere, and I was struck by the way many were offering a digital-only service to clients (at one, I recall being shown a small cupboard and told, with a shudder, that it contained the only paper in the office). Some provide a virtual finance director service: instead of receiving the traditional carrier bag of records in the last week of January, they offer clients adopting cloud-based software a real-time query service and regularly monitor the client’s electronic records to give cash flow and other bespoke advice. From the client’s perspective, such a service is far more valuable than the reactive, last minute unveiling of the tax bill alongside a set of accounts recording what is (in business terms) ancient history. Many firms were already on this road but MTD acted as a trigger for others, just as Covid-19 is currently acting as another strong catalyst for digitalisation.

Many accountancy practices have had to adopt very different ways of working because of Covid-19, with staff working from home and clients making contact electronically. This will undoubtedly lead to more investment in technology, from post scanning and electronic document management to remote access to client records and technical resources. It will favour firms whose clients use cloud-based software and who can therefore be supported more easily in this changed world.

Next steps

The first phase of MTD was about moving a tranche of businesses from a paper world to a digital world. Now is the time to consolidate, build confidence and ensure that those businesses utilise the technology not just to provide better information for tax compliance, but to obtain better and more timely information for their own commercial needs.

The measure of success for MTD is not the number of businesses filing through MTD compliant software – around 98% of VAT returns were already filed electronically – success will be a demonstrable decrease in errors, a demonstrable increase in tax yield and a demonstrable reduction in net business burdens. To achieve the last of these we need to see a demonstrable increase in efficiency and productivity as a result of digitalisation.

The next formal phase could perhaps be the extension of MTD for VAT to the entire VAT registered population or MTD for landlords. MTD for income tax is a much more complex undertaking as the consultation papers published in the summer of 2016 showed: there are still significant technical issues to resolve and my personal view is that we need two or more years of consolidation and planning before that major step is taken. During that time many more businesses will transition to digital purely for business reasons.

Now might also be the time to question whether MTD as currently framed is the only (or even the best) digital means of reducing the tax gap. Looking at the experience of e-invoicing to reduce the potential for under-declaring sales in other jurisdictions would be a worthwhile exercise (the ICAEW Tech Faculty’s recently updated paper Digitalisation of tax: International perspectives is illuminating). The Office of Tax Simplification has also considered the role of digital technology in its reports Tax reporting and payment: Simplifying tax reporting for self-employed people & landlords and Technology review: A vision for tax simplicity and made a number of recommendations.

I welcome HMRC’s commitment to continue its engagement with the professional and trade representative bodies. To capitalise on the opportunities digital technology offers, to maximise the benefits and minimise the burdens, we have to work in partnership.

My biggest disappointment with MTD is the fact that the potential to pre-populate digital tax accounts with information has only been partly realised. That would have represented a revolution in the way individuals engage with the tax system (and is one that has long existed in a number of other countries). There is also the opportunity to link information across departments to present citizens with a more joined-up experience. Hopefully this will be revisited at some point, because only when it has been will George Osborne’s original and laudable vision of the tax return’s demise be realised.