Lords basis period hearing – too many unanswered questions, says CIOT

The Institute’s Head of Tax Technical, Richard Wild, told the peers that CIOT do not like the proposals as they stand: there are ‘too many unanswered questions’ and too many difficulties for affected businesses. However, he said, the measure could be improved and made easier for businesses to operate.

Wild also told the committee that CIOT was sceptical about whether proposals on notification by large businesses of uncertain tax treatment stacked up on a costs to benefits basis. HMRC would have done better to launch a broad call for evidence on tackling the legal interpretation portion of the tax gap, he argued.

Wild was among a number of witnesses from tax and accountancy bodies to give evidence to the House of Lords Economic Affairs Committee’s Finance Bill Sub-Committee on Monday 11 October as part of their inquiry into Draft Finance Bill 2021-22. Sharron West from the Institute’s Low Incomes Tax Reform Group also gave evidence. The inquiry is focusing on the two areas of basis period reform and uncertain tax treatment.

The peers asked about Making Tax Digital (MTD) for Income Tax alongside basis period reform as it is difficult to disentangle the two.

The Government announced this autumn that the mandatory introduction of MTD for income tax for sole trader businesses and landlords with ‘turnover’ (gross business income) over £10,000 per annum will now begin in the tax year beginning in April 2024 rather than April 2023. General partnerships will not be required to join MTD for ITSA until the tax year beginning in April 2025. The Treasury also announced that basis period reform is to be delayed by 12 months, noting that any changes will not come into effect before April 2024, with a transition year not coming into effect earlier than 2023.

The uncertain tax treatments proposal is designed to improve HMRC’s ability to identify such situations in relation to large businesses and to accelerate the point at which discussions on uncertain treatment can occur. This requirement will help to reduce tax losses caused by businesses adopting uncertain tax treatments, claims the tax authority. The objective is to reduce the legal interpretation portion of the tax gap (legal interpretation tax losses arise where HMRC and a taxpayer take different views of what the law means). The Government delayed implementation of the regime by 12 months to allow for a second consultation which took place between 23 March 2021 and 1 June 2021.

Monday 11 October – Evidence Session One

Witnesses at the first session were:

• Emma Rawson, Technical Officer, Association of Taxation Technicians (ATT)
• Jason Piper, Head of Tax and Business Law, ACCA
• Richard Jones, Business Tax Manager, ICAEW
• Susan Cattell, Head of Tax Technical Policy, ICAS

Making Tax Digital and basis period reform

Sub-committee chair Lord Bridges of Headley (Conservative) asked how important it is to reform the basis period before the introduction of MTD for income tax?

ICAS’ Susan Cattell said it was probably important to make some changes to the basis period rules to help MTD work. But she said that if full basis period reform does not go ahead, you need to extend the equivalence of 31 March and 5 April beyond the opening years of a business and to extend it to property income because ‘if you do not make that change at the very least, quarterly reporting for MTD will be very difficult’.

ATT’s Emma Rawson agreed with Cattell, saying it makes sense to get the ‘mechanics right’ of how you are working out the taxable profit; to get basis period reform in first and get MTD in after that. She would not want to see it done the other way round.

ACCA’s Jason Piper agreed with Rawson that the order of changes must be right. Piper observed that if you change the basis period with MTD software live and running, it means a whole set of changes for the software houses as well as for the users to try to work out how to interact with it.

ICAEW’s Richard Jones said: “You might want to leave a longer gap between basis period reform and MTD, just from the perspective that you have a transitional year for basis period reform and then you are straight into MTD. To give businesses a bit more time to get used it, it might be useful to have another one or two years’ gap, potentially.”

Baroness Harding of Winscombe (Conservative) asked if the Government’s deferral of the start date of MTD for income tax was enough. Jones replied that ‘a year helps, but the longer we have, and the longer businesses have, the more time they have to prepare’. Piper said it will still be ‘very challenging’, even with the year’s deferral. He told Harding that he would like more time for the first phase of change, for basis period reform and a longer gap between basis period reform and MTD. He noted that the last time basis periods were changed there was a two to three-year gap between legislation and the proposals taking effect. Rawson suggested that even an extra year between basis period reform and MTD coming in ‘will not be enough to unpick it all and make it work properly’.

Jones explained why he thinks basis period reform should not go ahead in its current shape and should only go ahead if HMRC are open to looking at it again and making changes that make it less ‘adverse’ for business. “For example, changing from a basis period means that you have to use up your overlap reliefs, if you have some, in order to move from a basis period to tax-year basis. Some businesses might not want to do that. They might want to save that for when the owners retire, for example. You have the transitional provisions, which allow businesses to spread profits over five years, but that might still not be enough. If you have a large profit in a particular year, it could be quite costly for businesses in terms of tax.”

Rawson said a transitional year for basis period reform is okay for more sophisticated taxpayers but she is worried it is quite easy for unrepresented taxpayers to make mistakes in calculating their taxable profits for the transitional year or not claim relief that they are entitled to, and to end up in a position where their tax affairs are not right: “Then, to go from that position to MTD is probably problematic.” HMRC need to get a handle on the make-up of the taxpayer population that will be affected, she said.

Cattell told Baroness Noakes (Conservative) that there are two things for the Government to address in the next 18 months ahead of MTD and any basis period reform; she is worried about HMRC’s ‘very poor service levels at the moment’, and the range of software products available is ‘hopelessly small’. Piper said we need the legislation so that lawyers and the tax advisers can understand what is going to happen. And we also need the flowcharts and software requirements so that software houses can build something that reflects the legislation. Jones told Noakes that he would like to see the pilot programme on MTD for income tax expanded.

Noakes asked whether businesses might want to align their year ends more with the tax year compared with where they are now. Rawson said some businesses will move to 31 March or 5 April year ends because it will save them administrative work if basis period reform does go ahead – but not all businesses will be able to change, such as farming.  She said one thing that needs to be considered is extending the transitional provisions under basis period reform, which will allow you to spread excess profits over five years. She said: “We would like to see that people are not disincentivised from deciding to change their year-end now, in anticipation of the reform coming in because it makes sense for them, for their advisers, and for HMRC.”

Viscount Chandos (Labour) asked about particular trades and professions that will be mostly affected. Rawson said people in farming may struggle practically to change their year end, and they would be stuck with the work of having to apportion, and potentially estimate, profits. Hospitality is another industry for which March is unpopular, because it tends to fall around Easter time and they prefer to have their year ends in a quieter period.

Cattell is concerned about small rural businesses that have diversified. She said: “We are talking about relatively small businesses, without huge profits, having to do a disproportionate amount of admin, which will get worse with MTD. That will also get worse because of basis period reform, because they will not be able to switch to 31 March year ends.”

Jones remarked that business owners who have a yearly income of about £70,000, and in the transitional year end up getting taxed twice on part of their profits, could end up falling into the next income tax bracket. Piper added: “Possibly the only other thing to add is the rolling issue of Easter for hospitality businesses, particularly if you start moving to quarterly reporting and trying to estimate income over the period. There will be an ongoing issue with lumpy profits around that festival for some businesses.”

Moving on, Cattell said estimation in itself is a problem, but the other problem is that you would then have to re-file the return, and if your business is a partnership you would have to re-file returns for the individual partners. But she said there is a possible mitigation for that, which has been suggested to HMRC: people could be allowed to put through the amended information in the following year, so they would not have to re-file for the current year – they could do the amendments in the next year.

Lord Butler of Brockwell (crossbencher) understands that some companies will be taxed twice during the transition on part of their profits and that they can elect to spread that over five years. Jones said the longer the period, the greater the reduction in hardship if there is considerable double taxation. Cattell would like the option to spread over 10 years in ‘exceptional’ circumstances, which could then be defined by reference to a set percentage increase in the taxable profits. Rawson said if the basis period is to go ahead, HMRC must provide accurate statistics for businesses to use historic overlap provisions. She added: “Anecdotally, we hear from some members that when they have had to ring up and ask for them in the past, they have been given them, but others have had trouble getting them out of HMRC, so we do not have a clear picture.”

How much time do we have before it becomes very difficult to implement basis period reform effectively? asked Lord Bridges. Piper explained that software developers will look at about nine to 12 months lead-in time and then we would then have a season of running it in one of the pilot programmes - that ‘means we are looking at 24 months already to put it through’. But Cattell said the trouble is that if the software providers think that the basis period rules are going to change, even though the regulations for MTD have already been laid, they will not be developing the products.

Uncertain tax treatment

Baroness Noakes reflected that everybody has been critical of the uncertain tax treatment proposals.

But Richard Jones (ICAEW) welcomed recent changes to the proposal, such as reducing the number of triggers that would cause a notification and having a look at some of the notification thresholds.

Susan Cattell (ICAS) agreed that there have been some improvements in that the number of triggers was reduced and there were also a few other improvements, such as increasing the level to £5 million. But she complained that a third trigger was brought in ‘at the last minute’ in the draft legislation which she regarded as less targeted and highly subjective. She also expressed concern that the projected yield is very, very small compared with the size of the businesses within scope and compared with the size of the legal interpretation gap (£4.9 billion in the 2020 edition of the tax gaps publication). She said this measure should have been targeted at quite a small minority of uncooperative businesses rather than all large businesses.

Emma Rawson (ATT) said that if we are going to tackle the legal interpretation tax gap, we need to look at ‘the more fundamental things’ – that is, the complexity of the legislation, and the quality of guidance.

Jason Piper (ACCA) remarked that the more risk averse a large business is, the more disclosures they are going to make but the fewer they probably need to make. Cattell said HMRC needs to give a ‘definitive list’ of what people have to consult with HMRC about otherwise you do not have a ‘level playing field’.

Lord Butler of Brockwell asked whether HMRC have enough customer client advisers. No, said Cattell. Rawson warned that some companies that could fall within the scope of this reform and are not part of that programme will not have a CCM. Not everyone who might be subject to this trigger even has a CCM in the first place, she said.

This led Lord Bridges to remark: “I find it ironic that it is called ‘uncertain tax treatment’, but it strikes me, from what I have been hearing, that it is just increasing the uncertainty in the current format.”

Monday 11 October – Evidence Session Two

Witnesses at the second session were:

• Richard Wild, Head of Tax Technical, Chartered Institute of Taxation (CIOT)
• Sharron West, Technical Officer, Low Incomes Tax Reform Group (LITRG)
  
  

Making Tax Digital and basis period reform

CIOT’s Richard Wild said the extra year that has been given on MTD and basis period reform will be a great help but cautioned that it is important to map out the different stages between now and 2024 and to ‘sense-test’ that to make sure that is still a realistic timeframe.

LITRG’s Sharron West said the reasons why a delay to MTD was needed included software not being ready and lack of pilot testing. Basis period reform would also benefit from the 12 month deferral. However, she said, pushing both things back by a year means they still bump up against each other. “The transitional year for basis period reform then leads straight into the beginning of Making Tax Digital,” she noted. LITRG’s view, therefore, is that ideally there would be an extra year between them (by delaying MTD a further 12 months), to allow time for the basis period changes to bed in properly. This would particularly help the unrepresented taxpayers and small businesses that LITRG look out for.

Wild explained that the delivery of MTD has been deferred a number of times, but ‘it will not go away’. That is why we have had the tension between the short consultation timescale and the intention to plough ahead with MTD, he said. Wild acknowledged that the tax profession is still trying to ‘grapple with those issues even now’.

West complained that a lot of the rules are not yet firmed up sufficiently for HMRC to be able to communicate constructively, adding that at present ’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’. West would like to see communications about basis period reform ‘sooner rather than later’. She suggested that HMRC should trawl its database and identify from Self Assessment returns which taxpayers might be affected and might want to change their accounting date. We want to see HMRC making a big effort to contact these people directly and not just rely on mailshots, agents and general communications, she said. She suggested a pop-up window on HMRC’s online tax return software, to raise awareness of MTD and basis period reform. She added: “When HMRC sends people the letter to tell them that they need to do a tax return every year, their notice to file, a particular paragraph in it could tell them that these changes are coming.”

Wild added that putting things on GOV.UK for people to read does not get to the right target audience. You need to send things directly. He is worried about capacity in the agent market. He said: “Agents keep telling us that they will retire before MTD is introduced, so if basis period reform comes in at or around the same time, you will have a slight shrinkage of the agent market but still a shrinkage in any event.” On basis periods, tax advisers will need to wait and see whether the reforms go ahead before they have those detailed conversations with clients.

On HMRC, Wild said that when we look at previous major changes - when MTD for VAT was introduced, for example, or when we were dealing with Brexit - we saw HMRC’s service levels fall. Telephone waiting times increased. Post turnaround times all increased. “It is hard to imagine that there will not be a similar experience when we see the next lot of major changes,” he said. West added that for unrepresented taxpayers, HMRC have an extra support service. It needs to make sure that that will be adequately resourced to help people who are trying to deal with it all themselves.

Viscount Chandos is worried about the risk of individuals and smaller partnerships - and it is more smaller partnerships, given the tax year end – ‘having all the stress and not a lot of support’.

Baroness Noakes asked if basis period reform is a simplification. Wild said CIOT did not see it as a real simplification, rather it seemed to be trading one set of complexities for another. “[W]e are introducing a system that needs you to apportion profits between different accounting years, if you do not align your accounting year end with the tax year, and that requires you to undertake estimates that you then need to correct at a later point. So you need to interact with HMRC more than you did under the current rules. For the businesses that are affected, the outcomes of these basis period proposals could actually be worse than the existing rules.”

LITRG thought that it would be a simplification measure for low income taxpayers. West said: “It will make it much easier for self-employed people to understand how to pay their tax on their profits. It will encourage most people to end their accounts to 31 March or 5 April. It will tie in with the tax year and it will make it much easier for them to understand and comply with MTD, with the quarters being calendar quarters, when you need to do your quarterly updates.”

Seeking to reconcile the two views, Wild explained lots of unrepresented businesses already use the tax year and so will not be affected by the change. He said it would be easier to assess the impacts on businesses if HMRC could provide the proportion of businesses affected and whether they are represented or unrepresented.

West told Baroness Harding that the proposal to spread profits brought into charge in the transition year over five years is ‘good’ and ‘a reasonable length of time’. But it does bring complications, because you are then expecting people to be able to work out the best situation, whether to pay tax on all extra assessable profits in the transitional year or whether to spread it over what their profits are likely to be in those later years. Wild also thought that five years is ‘fairly reasonable’.

West warned that additional profits that will be taxed, whether fully in the transitional year or spread, are not extra income, so there is no extra cash around for people. They have not made these extra profits and they do not have the income from them. They are just tax profits that need to be caught up as part of the transition, she said. She worries that people will not understand that when they see their tax bills going up and have additional tax to pay when they have not had the additional income in that year.

Responding to the chair, Wild summarised CIOT’s view as being “that we do not like the proposals as they currently stand, but if they were changed so that, for example, as Sharron said, you did not add on the extra portion of profits, or you did not include that within your total income, or you could make an estimate but not have to revise that estimate further down the line, if you thought about these things and made the process easier for businesses to operate, we would be more in favour of the proposals. As it stands now, from our point of view, there are too many unanswered questions and too many difficulties that we foresee for businesses that are affected.”

Uncertain tax treatment

Sharron West said this measure is not within the scope of LITRG’s work.

Richard Wild, for CIOT, told Lord Butler of Brockwell that HMRC have taken on board concerns about uncertain tax treatment in the consultation process but the new trigger 3 has introduced quite a lot of uncertainty and subjectivity into the proposal. He said the measure will not achieve its stated purpose of reducing the legal interpretation gap and improving compliance by high-risk businesses, adding that he would like more clarity about what the legal interpretation tax gap ‘actually represents’.

Lots of large businesses already have an open and collaborative relationship with HMRC, and feedback CIOT have received suggests that some businesses will end up ‘overdisclosing’ because they do not want the reputational risk of not being seen as compliant, Wild told the committee. He speculated that you may end up with HMRC being flooded with disclosures and therefore not able to ‘see the wood for the trees’ and even if it does achieve the results that it has set out to achieve, it will have reduced the legal interpretation tax gap by just one per cent. He called for greater clarity on the guidance and for HMRC to clearly set out what businesses need to provide as part of that disclosure and making it possible for agents to do disclosures on behalf of their clients.

The committee also asked the witnesses about their views on HMRC’s consultation processes. West and Wild both expressed support for the tax consultation framework, provided that it is adhered to. However, said Wild, both the measures under discussion had leapfrogged stage one of the process to start at stage two (uncertain tax treatment) and stage two-three combined (basis period reform). On uncertain tax treatment the original consultation should have been a call for evidence or a stage one consultation that said: “there’s a legal interpretation tax gap. It’s currently £4.9 billion - what could we do to reduce that gap?” You would then get lots of suggestions from businesses and professional bodies, he said, but instead, HMRC have ‘leapt a bit too far into the process’.

Lord Bridges asked whether the ‘real problem’ was complexity, and therefore, “rather than coming up with this blanket approach, the Government should look for many ways in which we can simplify and therefore clarify what tax is meant to be owed by businesses?” Wild agreed that was part of the problem. HMRC do risk profiling in respect of large businesses and Wild suggested that HMRC need to spend more time going in and spending time with large businesses which have a higher risk level, and finding out a bit more about what they are doing and teasing out these transactions, rather than making everybody else have to disclose them to HMRC.

Asked by the Chair if the proposal is ‘salvageable’, Wild concluded: “You could salvage it by perhaps doing some of the things that I mentioned, such as making the guidance clear, making the process straightforward and resourcing HMRC so that it is worthwhile” but he remained sceptical whether the cost-benefit exercise stacks up.

The transcripts of both sessions are linked to from this page.

By Hamant Verma, CIOT Senior External Relations Officer