Tax

Tax goes digital

Aug 01, 2018
With April 2019 inching closer, it’s time businesses prepared for the challenges Making Tax Digital will bring.

Twenty years ago, I qualified as a Chartered Accountant. 1998 also saw the first self-assessment deadline in the UK. We were just beginning to use computers in work, but it wasn’t a daily occurrence and most work was still done on paper and filed on paper files. Later that year, we got our first work laptops.

Fast-forward 20 years and technology is embedded in everyday life. The world of tax is heading in a digital direction. HMRC’s Making Tax Digital (MTD) project is just one part of its Digital Transformation project. A glance at other tax jurisdictions around the world tells a similar story.

The traditional role of the accountant focused on functions relating to the financial operations of a business and tax compliance. Today’s accountant is a business adviser dealing with an extremely rapid pace of change, particularly in the world of tax. The modern accountant needs to be ready to meet the challenge of change on an almost daily basis. Are you ready for the move to Making Tax Digital?

The project timeline

MTD was first announced by former Chancellor, George Osborne, in Budget 2015 with a bold declaration: “We will abolish the annual tax return altogether… tax really doesn’t have to be taxing, and this spells the death of the annual tax return.”

That was followed in December of the same year with the launch of the project’s roadmap, followed by the start of a consultation process in 2016. The project is based on the following cornerstones:

  • Tax simplified;
  • Making Tax Digital for business (MTDfB);
  • Making Tax Digital for individuals (MTDfI); and
  • Tax in one place.
However, the scope and pace of the original reforms resulted in the government announcement in July 2017 that businesses would not be mandated to use MTD until April 2019, and then only for VAT. Isn’t there something even more seismic happening in March 2019?

While it is laudable that the government showed its willingness to listen to stakeholders’ concerns, the beginning of MTDfB in April 2019 coincides with Brexit. The Institute’s Northern Ireland Tax Committee, which engages regularly with HM Treasury and HMRC on behalf of members, has highlighted this to government on a number of occasions. At the time of writing, the start date of MTDfB for VAT remains fixed at 1 April 2019.

Currently, the government is committed to not widening the scope of MTDfB beyond VAT – in its own words: “before the system has been shown to work” and not before April 2020 at the earliest. The MTDfB for VAT trial is currently by invitation only and is not expected to be more widely available until later in 2018. More worryingly, at present, there is only scant software with MTDfB for VAT functionality given the importance of software to the project’s success. 

Why make tax digital?

According to HMRC, MTD will reduce tax errors in real-time meaning a higher tax take. The most recent tax gap stats show that small businesses account for 41% of the UK tax gap. The tax gap is the difference between the amount of tax that should, in theory, be paid to HMRC and what is actually paid. In 2016/17, errors and failure to take reasonable care was calculated at £9.1 billion (almost 28%) of the £33 billion gap.
The idea is that businesses will be more likely to get their tax right “first time” with MTD. This means HMRC will, in theory, benefit from a resource saving as a result of less compliance interventions.

But will this really be the case and what’s in it for business? What is clear is that the mandation of digital record keeping and quarterly digital reporting will be of almost universal impact. Many are yet to be convinced that this will reduce both the level of administrative burden on businesses (particularly the smallest businesses) and the level of error cited by HMRC as being one of the major drivers in the mandation of MTD.

Whenever a new digital tax solution is introduced, it should attract willing users among businesses and agents alike. In short, it should be voluntary to begin with. If a voluntary approach is adopted, those creating the new system face the challenge of making it attractive and easy for its users.

To achieve this, the software developers are likely to set more realistic goals, aiming initially at those most likely to become enthusiastic early adopters. An iterative approach can then be used. By developing the system in this way, the developers can work to create a natural following among others eager to experience the advantages they might otherwise miss. Such an approach would also help focus attention on addressing HMRC service standards for taxpayers and businesses alike.

What is clear is that the digital transformation of the UK tax system should be a longer term objective developed in tandem with overall simplification of tax policy in the UK, and should not be seen as a substitute for legislative simplification. However, the MTD project continues – despite its obvious challenges.

Making Tax Digital for business – VAT

The regulations introducing MTDfB for VAT come into effect on 1 April 2019 and apply to any VAT-registered business with a turnover exceeding the current VAT registration threshold of £85,000. MTD applies to the first VAT return period commencing on or after commencement.

At the heart of the regulations are two core requirements:

  • Digital record keeping: businesses will be required to keep and preserve digital records; and
  • Electronic filing of VAT returns: to submit a VAT return, businesses must use information stored in their digital records combined with “functional compatible software” to submit VAT returns directly to (and receive responses from) HMRC.
“Functional compatible software” is defined as software that maintains the mandatory digital records, calculates the return and submits it to HMRC via an Application Programme Interface (API). An API is essentially a software intermediary that allows two applications to talk to each other. There are a number of options to meet this software requirement, including bridging software and API-enabled spreadsheets.

Making Tax Digital for business – other taxes

According to HMRC, MTD for other taxes will commence in April 2020 at the earliest, starting with income tax with effect from the first accounting period beginning after 5 April of the relevant tax year that it is introduced.

While there will be some limited exemptions available from MTDfB for income tax and corporation tax, the detail of what these exemptions might look like is scant. Those with an annual turnover below a set amount and anyone unable to engage digitally are, at least, likely to be considered for exemption.

Once again, MTD requires digital record-keeping coupled with quarterly update submissions to HMRC followed by a final “end of year” submission.

Businesses can choose their periods of account and update periods, with a basic requirement that four quarterly updates must be submitted for each 12-month period. The deadline for making quarterly submissions is the end of the following month after the quarter-end date.

The final submission for an accounting period (which thereby finalises the taxable position for the relevant accounting period) is the earliest of either 10 months after the last day of the period of account or 31 January thereafter.

According to HMRC, free software will be available to businesses with “the most straightforward affairs”. However, there will be no free software provided for agents. This means that, in future, all agents will need to have commercial software.

HMRC tells us that it is working closely with software developers who will be providing software packages to support MTDfB. The questions remain: what software will be free? What functionality will it include? And who will it be available to?

The requirement to keep digital records does not mean that businesses will need to make and store invoices and receipts digitally. Businesses will still be able to keep documents in paper form, however transactions will need to be stored and compiled digitally at each quarterly interval. Businesses will also still be able to continue to use spreadsheets for record-keeping but again, these must be MTDfB-compliant.

The information submitted will be either three-line account information or the level of detail currently required as part of the annual self-assessment return.

In April 2018, HMRC launched a limited MTDfB pilot for income tax. Businesses can now send quarterly updates to HMRC and agents can now set up an agent services account and sign up to use software to send income tax updates on behalf of their clients. In time, HMRC will make the pilot available to all self-employed businesses.

For smaller businesses, the idea of a single software package that interfaces with HMRC’s systems to provide tax information in real-time may seem a realistic challenge once the initial hurdle of dealing with this change is overcome. However, when this approach is considered in the context of larger and more complex businesses and corporates, the challenges become clear.

What does my business need to do?

Agents and businesses should now seek advice on the best software fit and process for their particular business model.

The first recommended action is to review the current software package (if any) and assess if it is (or, in many cases, will be) MTDfB for VAT-compliant by 1 April 2019. Speak to your software provider as a first step.

Businesses should conduct an end-to-end review of the journey currently taken when submitting VAT returns, irrespective of whether or not this journey ends with an agent completing the online submission. The key is to ensure that the core MTDfB requirements of digital record-keeping and submission can be satisfied from April 2019.
If a business has an accounting period spanning their first MTD VAT quarter after 1 April 2019, that business may want to ensure that they have MTD-compatible software in place at the beginning of that period. This is likely to be in advance of 1 April 2019 to avoid changing their accounting software mid-year.

Having to change software part-way through a period would be very problematic with tax and business information spread over two different systems. This could also present practical difficulties in assessing important matters such as in-year results and profitability, and providing the requested information for the annual tax compliance cycle.

At the time of writing, this affords affected businesses little time to select, integrate and train staff on a new package if one is required. Those businesses first affected by MTDfB will be under enormous pressure to choose a suitable system within a very short timeframe. As a result, many will be left to consider making a change mid-way through their accounting period.

According to recent research from Intuit Quickbooks, 41% of small businesses are still unaware of MTD. What is clear is that Chartered Accountants can play a key educational and preparation role as the deadline for MTD moves nearer. But will the enhanced agent services HMRC have been promising for years be available in tandem with the introduction of MTDfB?

If you’re an agent, begin the conversation now with clients about what this change will mean for them and what you can do to help. 

Institute activity

From the beginning of this project, the Institute has engaged with members and HMRC as the proposals were developed, and it continues to do so. Submissions were made to all key MTD consultations. Members are also regularly updated on MTD developments via various Institute publications.

The Institute also recently launched its MTD Hub, which is aimed at helping members and businesses get MTD-ready. An MTD event is also currently planned for Autumn 2018.

Opportunities, and some threats

MTD will bring challenges and opportunities. The change-over will mean a complex mix of “old” and “new” filing dates, at least initially. Some businesses and practices may leave it too late to get their practice and staff prepared and trained, and make the necessary software decisions – if indeed the software is even ready in time.

Lack of client awareness and unwillingness to change might prove problematic, and many practices may be unable to recoup additional costs from clients through fees. The speed of implementation, coupled with other recent and imminent changes, may mean that MTD is last on the list for consideration.

MTD will be all about change management. So what is the benefit for businesses? MTD will force businesses and agents to carry out a review of their systems and processes. There will usually be room for improvement with any system, and changes could lead to efficiency savings.

Advisers will have the opportunity to engage with their clients on a more regular and real-time basis by moving away from being focused on the annual compliance cycle to embracing the role of business adviser. The adviser will be able to be more proactive in providing advice. Arguably, there may be scope for better spacing of fees and work throughout the year.

There will be a cost in updating and purchasing software, but the business may be able to avail of additional functionality and should be able to harness the benefits of cloud accounting.

Will Making Tax Digital make tax even more difficult? Watch this space.

Leontia Doran FCA is Taxation Specialist at Chartered Accountants Ireland.