Basis period reform - peers call for more work on impact

The Lords Economic Affairs Finance Bill Sub-Committee report looks at two main areas: basis period reform and notification of uncertain tax treatment and makes substantial criticisms of the Government’s approach on both.

More broadly the sub-committee, whose members include former cabinet secretary Lord Butler of Brockwell and former ICAEW President Baroness Noakes, says that HMRC’s approach to changes to the tax system ‘has been found wanting’, calling on the tax authority needs to do more to clarify the rationale for change, and to consult properly on changes. The peers call on the Government to commission an independent report into HMRC customer service levels and capacity to implement change.

To reach their conclusions the sub-committee took evidence from a range of witnesses including representatives of Chartered Institute of Taxation (CIOT), Low Incomes Tax Reform Group (LITRG) and Association of Taxation Technicians (ATT). The final report cites CIOT in 22 places in the main text, ATT 9 times and LITRG 11 times. (There are further citations in the footnotes.)

Basis period reform changes how partners and sole traders calculate their taxable profits each year if their accounting period does not follow the tax year. The separate notification of uncertain tax treatments measure will mean, as a large business, you will need to tell HMRC if you adopt an uncertain tax treatment.

Key recommendations

Key conclusions and recommendations of the report, ‘Basis Period Reform and Uncertain Tax Treatments’, published on Wednesday (15 December), are:

Basis period reform

• Consider the consultation on basis period reform ‘flawed’. It is unclear why four years after the original consultation the new and different basis period reform proposals were published in haste.
• Welcome the Government’s recognition that further work needs to be done on the impact this reform will have on businesses which cannot align their accounting periods with the tax year.
• Recommend that, for those businesses which do not have a 31 March - 5 April year end, Making Tax Digital should be deferred until at least 2025-26.

Uncertain Tax Treatments

• All businesses affected by this measure must be supported appropriately by HMRC. All such businesses should have access to a customer compliance manager within HMRC.
• With businesses required to notify HMRC when they take a view on the law that differs from HMRC’s ‘known view’, the Government must ensure that HMRC has sufficient resources to ensure its published guidance is updated on an ongoing basis.
• Before any third test of uncertainty is included, an evidence-based evaluation of the measure should be carried out and that, if it shows that the requirement is not delivering the benefits that HMRC expects, then the notification requirement should be repealed in its entirety.

In relation to both reforms, and more broadly

• Recommend that the Government commission an independent report into HMRC customer service levels and capacity to implement change.
• Recommend that in future all consultations involving a significant reform of the tax system should begin at ‘Stage 1’, which requires the Government to set out its policy objectives and ask for feedback on options for achieving those objectives. The Sub-Committee invites the Government to make a renewed commitment to that effect.

More on the basis period recommendations

Peers do not recommend that basis period reform should be abandoned now even though they do not consider that a compelling case has been made for it, either as a simplification or as an essential prerequisite for introducing Making Tax Digital for income tax.

The report notes that ATT welcomed the delay in basis period reform and MTD for income tax announced in September 2021 but felt that there is still going to be ‘too much change in too short a period of time’. Sharron West of LITRG also welcomed the deferral, the report notes, but said ‘our feeling is that the whole system would benefit from possibly being pushed back another year’.

The report cites ATT’s view that the current rules are familiar to many and that once a business is established, they are ‘fairly straightforward’ and logical to apply in practice but added ATT appreciates that applying the current rules may be more complex for the unrepresented taxpayer.

The report also notes CIOT’s surprise at HMRC’s impact assessment and that the Institute considered that the estimates about one-off costs were ‘unrealistic’. The peers noted the OBR’s statement that, in the short term, basis period reform will raise revenue. Irrespective of the ‘fiscal illusion’ that may exist in the long term, in the short term those businesses affected will pay extra tax.

In the section on estimation and apportionment, peers acknowledge the concern expressed in oral evidence by CIOT’s Richard Wild’s about anyone using a tax year other than 31 March or 5 April and his view that for those businesses that are affected, the outcome of these basis period rules could ‘actually be worse’ than the existing ones. LITRG’s urging of HMRC to make it as easy as possible to change accounting date is also noted, as is ATT, ICAEW and LITRG’s keenness to ensure that if businesses do make the change before the transition year, they will still be able to spread the excess profit.

These concerns have led the peers to consider that the difficulties that estimation and apportionment of profits pose for those businesses which cannot, or cannot sensibly, align their accounting periods with the tax year were not thought through adequately in the design of the basis period reform. Peers welcome the Government’s recognition that further work needs to be done on how the adverse effects of basis period reform on these businesses might be mitigated. But they are concerned that tackling this complexity may itself generate further complication to the tax system. This may have led to the Sub-Committee’s recommending that when this work is completed, but before final decisions are reached about the way forward, there should be a reassessment of the additional compliance costs which businesses in this position will bear because of the reform.

On overlap relief, the report cites the CIOT’s view that a business or its agent should be able to obtain or check overlap figures with HMRC and CIOT’s call to encourage HMRC ‘to explore whether this can be done through the business’s Digital Tax Account, via APIs [Application Programming Interfaces] into third party software, or prepopulating into tax returns. ATT’s view is included in the report, that there could be people who have very successful businesses now but have very low overlap profits to set off, maybe because they were loss making in their early years or just not very profitable. There could be some quite substantial tax bills for some affected taxpayers, warned ATT. And the report draws attention to LITRG’s proposal that in cases where HMRC has no overlap information for a taxpayer, it would be helpful if they were to proactively tell them (and their adviser if they have one) to allow them additional time to try to confirm their overlap position.

Drawing on all this evidence, the sub-committee recommends that by 5 April 2022 HMRC should commit publicly to providing details of overlap relief from their records for those businesses that need it and, where a specific record is not available, reconstruct the amount available from the information HMRC has.

The sub-committee looked at the impact on tax liabilities of the change, expressing concerns about the additional liabilities some businesses could face on transition to the new rules. Under the reform, excess profits of the transitional year will be treated as income. The report cites the oral evidence of LITRG’s West, that: “The additional profits that will be taxed are not extra income, so there is no extra cash around for these people. They have not made these extra profits and they do not have the income from them.” People will not understand that, she said. LITRG also feared this could also have an adverse effect on their entitlement to benefits.

The sub-committee wants the Government to consider CIOT’s suggestion of ring-fencing the excess profit and treating it as a one-off receipt (including when the profit is spread) and taxing it at the individual’s marginal tax rate ignoring that excess profit, rather than treating it as additional income.

The sub-committee recommends that the Government and HMRC review the resources required for basis period reform and MTD for income tax, to maximise the chances of a smooth implementation. This reflects comments made to the peers by CIOT’s Wild that previous major changes such as the introduction of MTD for VAT and dealing with EU exit had seen HMRC service levels fall. Wild also told the sub-committee of his related concern about capacity in the agent market.

On preparation for change, the report cites Wild’s view, for CIOT, that ‘putting things on GOV.UK for people to read does not get to the right target audience. You need to send things directly’. It cites the oral evidence of West, for LITRG, that most unrepresented taxpayers do not know that MTD is happening and are ‘blissfully ignorant’ of the problems they will have to come to terms with in 2024. She added that HMRC should make a ‘big effort to contact these people directly and not just rely on mailshots, agents and general communications’.

Such concerns led to the peers recommending that HMRC contacts directly all taxpayers with accounting periods which are not aligned with the tax year to alert them to the change and its implications for them, and to inform them of what support is available. Additionally, that HMRC should issue comprehensive guidance about basis period reform by 5 April 2022, including details of how unrepresented taxpayers can obtain support, and make a helpline number available.

More on the uncertain tax treatment recommendations

The sub-committee highlights the view of CIOT and IFS’s Tax Law Review Committee (TLRC) that this measure had plainly needed to return to Stage 1 to be re-thought and ‘that by starting off at Stage 2 we had leapt a bit too far in the process than we should have done’. Such feedback led peers to state their disappointment that the Government did not make better use of the opportunity afforded by the delay to this measure to bring greater clarity as to why the new requirement is needed.

The sub-committee is clear that a Stage 1 consultation should have been undertaken in relation to this measure. This, they note, could have considered alternative ways of addressing uncertainty within the tax system rather than focusing on one specific proposal.

On whether the case for change was made, the sub-committee cites a remark from CIOT’s Wild, that there is a ‘bit of mystery’ surrounding what the legal interpretation tax gap actually represents, and that there was little detail about how it is calculated and what it includes. The peers also note Wild’s questioning of whether the amount of additional compliance that would be needed, for businesses and HMRC, was justified by such a small reduction in the legal interpretation tax gap of just one per cent, and his encouragement for HMRC to spend more time with these large businesses, which have a higher risk level, before implementing the policy.

According to Emma Rawson, who gave oral evidence for ATT, there are more fundamental things (such as the complexity of tax legislation and the availability of HMRC support for taxpayers) that should be looked at if this part of the tax gap is to be tackled, the sub-committee notes. Such criticism has led the peers to state their disappointment that the measure remains neither appropriately targeted nor proportionate

On simplification of the tax system and the test of uncertainty, the report cites CIOT’s Wild saying some of the difficulties with the proposal follow on from the complexity of the UK’s tax system which makes it is quite difficult then to overlay objective tax rules on notification. The sub-committee remains concerned that the application of the proposed second trigger still imposes a significant burden on businesses in practice. There needs to be greater clarity for businesses seeking to identify a ‘known view’, it says.

The sub-committee recommends that, before legislating for a third trigger, an evidence-based evaluation of the measure in its current form be carried out to identify whether it does indeed deliver the benefits that ‘HMRC tells us it is expecting’. Peers also recommend that, if such an evaluation shows that the requirement is not delivering the benefits that HMRC expects, then the notification requirement in its entirety should be repealed.

On HMRC compliance, the peers report the evidence of CIOT’s Wild that compliant businesses may be likely to over-disclose uncertainties to avoid the reputational risk of not being seen as compliant leading to HMRC being ‘flooded’ with notifications and not being able to see ‘the wood for the trees’. ATT’s Rawson described the ‘risk of [HMRC] getting information for information’s sake’ that it was not equipped to deal with, the peers further note.

The sub-committee concludes that large businesses still find it difficult to get a sufficient level of engagement with their customer compliance manager (CCM), call for the number of CCMs needs to be expanded irrespective of the introduction of this measure and states that, if the measure goes ahead, the Government should commit to ensuring that every business affected has a customer compliance manager.

More on the broader conclusions and recommendations

In addition to the two main proposals looked at in this inquiry the sub-committee observes that its analysis “has identified common themes applicable to both proposals, some of which have also arisen in previous reports by the Sub-Committee.” These are set out briefly in a fourth chapter of the report.

The first is a failure to follow the tax policy framework. The sub-committee notes the CIOT’s view that the process works well “when the consultation process is followed in full” but concludes (along with CIOT and others) that the process was not followed in full with either of these measures. “Consequently,” say the peers, “proposals [have been] made which the Government has had to revise, often more than once, which causes unnecessary uncertainty and confusion. This “start—stop” approach to policy risks alienating the people who will be impacted by the changes; and diminishing the reputation of, and trust in, HMRC.”

As mentioned above, the sub-committee recommend that in future all consultations involving a significant reform of the tax system should begin at Stage 1. They invite the Government to make a renewed commitment to that effect.

The sub-committee also addresses the issue of resourcing of HMRC in broad terms, noting: “we heard concerns about current service levels which made tax professionals query whether HMRC was adequately resourced to take on the additional work required for basis period reform and MTD.” It quotes CIOT and ATT witnesses to this effect.

Describing the evidence about current service levels within HMRC as ‘troubling’, and anticipating that the additional demands on HMRC arising from the two proposals will exacerbate the situation, they recommend that the Government commission an independent report on HMRC customer service levels and capacity. The report should separately consider HMRC’s performance in terms of its existing commitments and responsibilities to taxpayers and what will be needed in terms of additional resourcing for it to be able to deliver basis period reform and MTD for income tax without any adverse effect on overall service levels, they conclude.

Finally the report looks at the impact on business in terms of complexity and bureaucracy, drawing on evidence on both proposals from a range of professional and business bodies to conclude that there is reason to expect an increase in administrative burdens for affected businesses.

The peers argue that significant changes to tax rules need a reasonable lead-in period so that businesses have the time they need to prepare. The scale of the impact of new proposals on businesses, especially small business, does not seem to be well understood by HMRC, they conclude, saying the Government should be more mindful of the need to factor in appropriate lead-in times in its policy proposals. It must help businesses prepare for change by providing them with a clear roadmap of what must be done, by when. Sub-committee chair Lord Bridges concludes that ‘failure to do this risks undermining people’s trust in HMRC’.

The report is available here.