Representatives of HMRC defended the Making Tax Digital project to the Economic Affairs Finance Bill Sub-Committee after stakeholders had criticised the breadth and timing of the plans in previous Committee sessions.
The Finance Bill Sub-Committee of the House of Lords Economic Affairs Committee produces (usually) just one report a year – on the aspects of the draft Finance Bill that it thinks most warrant scrutiny. This year the sub-committee has decided to focus entirely on Making Tax Digital (MTD) and the draft legislation that will apply to small businesses and residential landlords.
The reports are below and are split by topic discussed on each day. Where peers are mentioned they have expressed an opinion as part of the Committee and not as a witness.
Session three (part one)
Witnesses on the benefits of MTD, what should be done to encourage businesses to adopt more digital ways of working; and concerns about the implementation proposals.
Lord Flight suggested that if there is to be an exemption from MTD for a period where high-speed broadband coverage exists, why not have an option as to whether or not to move to digital, he asked.
Roger Southam, member of the Administrative Burdens Advisory Board, is worried about taxpayers facing a ‘cliff edge’ of being either fully compliant or not, which for a lot of small businesses is a scary prospect. To go through a digital learning curve at the same time as having to deliver HMRC’s requirements is a very big ask especially as businesses do not know the available software systems as yet. Larger firms are the ones most likely to have digital solutions and the majority of those guys will not be in a position to meet the deadline currently envisaged, he said.
Michael Parker, Head of Tax, National Farmers’ Union, said about four per cent of his members have no internet connection and about 80 per cent have upload speeds of less than two megabytes per second. The proposed digital exclusion exemptions are very narrow, he said. Indeed, for a partnership it appears that each partner must be digitally excluded, despite the fact that the records will be kept on the business premises. Coming from an accounting background in the past, he is aware that picking up records four times a year is probably more expensive than doing it once a year.
Edward Woodall, Head of Policy and Public Affairs, Association of Convenience Stores, said 40 per cent of its members said that they do not have access to high-speed broadband at the moment, and the 19,000 rural shops have big challenges in relation to mobile data as well. Automatic enrolment and real-time information were introduced at a far slower rate than making tax digital, and took into account the size of PAYE and the size of the business.
Lord Turnbull said the ‘start at the bottom’ approach to MTD is in contrast with the rollout of RTI and auto-enrolment and, as a result, ‘ridiculous. He said the costs per unit for small businesses are certainly higher as a proportion of the business than larger ones. He said no one would invest in a business on the kind of 10 year payback suggested with MTD.
Parker said farmers work over an annual cycle or longer, so the final return will still be the one where all the adjustments go through, both in valuations and in allocation of costs and income. Cash reporting is one of the suggested changes to facilitate making tax digital but issues preclude farmers from doing this, such as if users have a production herd and are on what is known as a herd basis, or they claim farmer’s averaging to mitigate the volatility of their profits.
He explained: “As we touched on, they [farmers] have diversifications. Some of those will be property business, essentially the letting of some cottages or land, and other things they may have done, such as renewable energy that is exported to the grid. For VAT purposes, that is one business; they operate it as one business, but for income tax purposes and MTD they have to separate income and expenditure. It seems to me that if they cannot align year ends - a property business has to be to 5 April—they could have multiple making tax digital quarterly updates. We could quite easily go from one annual self-assessment to perhaps 15 updates, which does not seem more efficient or simpler to me.”
On the costs of MTD for businesses
Lord Tugendhat suggested that MTD may be blamed by shoppers for pushing up prices in shops.
Southam said a standard cost model shows that savings for small business as a result of MTD will come 10 or 12 years down the line, but the burden and the ‘sheer cost’ of getting there is ‘huge’. The free software will help them to comply but they will need to buy in some services. Some will not even have the equipment to start with, so they will be buying hardware as well as software, he said. “If people can get away with increasing prices to cover the cost, they will”, he said.
Woodall said HMRC’s estimate that the average cost will be £280 per business for the convenience sector is a significant underestimate. That is probably a minimum for accountancy fees, because, like farming, his sector largely outsources to accountants. He said: “Having spoken to a few accountants who work for people in our sector, they have not said it will quadruple costs, but certainly they see a 25 per cent increase in accountancy fees.”
Southam said one of the elements he is trying to get HMRC to look at was to break its estimate down by business types, using the SIC codes at Companies House to analyse by business type and get a better figure than the £280 average for each grouping.
On the digitally enabled
Lord Wrigglesworth is a landlord of a number of convenience stores and various other small businesses. He said they are digitally enabled, although ‘on the other hand, one can see that getting the software, having the training and implementing all this is going to take time’.
Woodall said that 53 per cent of independent retailers do not currently have electronic point of sale. They do not have a till that scans. They might appear to be digital, but they cannot match that up with their accounting procedures. There is still a gap and that has to be taken into account in the timetable.
On business rates
Woodall said a business with a rateable value below £12,000 is exempt from business rates altogether, so for the smallest businesses there is quite a significant amount of support on business rates. For the smallest businesses there is not the same protection in making tax digital. The witnesses all said they have not really considered a comparison between the furore over the revaluation of business rates and the MTD threshold.
On the threshold
Lord Hollick the cost of implementing this for a small business with a £10,000 turnover is probably not very different from a business with a £30,000 or £50,000 turnover. Therefore, it represents a very penal cost on small businesses, which they will struggle to recover.
Lord Bilimoria, a fellow of the ICAEW, said most business will lose money as a result of MTD. He cited the Federation of Small Businesses which in its evidence to the Government prepared a schedule that indicated that for businesses with a turnover threshold of £10,000 the average cost to the SME would be £2,770; with a threshold of £43,000 it would be £1,960; and with a threshold of £83,000—the VAT threshold—it would be £1,050. He cited UK200Group which looked at the overall pattern of their clients across firms and found that one in six used the ‘shoebox method’.
Neither Southam, Woodall or Parker suggested a different threshold figure, rather they focused on the need for a general delay. Parker explained that he pressed for complexity within small businesses to be recognised. That does not necessarily conflate with turnover. Southam added that the trial finishes in April as ‘the real thing comes on stream, so there is no time to assess how the trial has gone;[and] there is no measure of what happens if the trial does not get 400,000 businesses’.
Session three part two
Douglas Haig is Vice-chairman and Director for Wales of the Residential Landlords Association. Haig said his members were not particularly positive about the MTD but they can certainly see a long-term benefit as long as it is phased in over time. He said most landlords would opt to stay on a cash basis, as opposed to an accruals basis.
On timing: His members are being partially taxed on our turnover now, as opposed to profit, he said. That is on top of a number of other things that are happening, with legislation for the private rented sector and continued divergence between the devolved Governments.
On awareness of MTD: There is an incredibly low awareness level among its members at this point, partly because most small landlords do not consider themselves as being in business. HMRC will probably find that some landlords prefer to do it and adopt it very quickly but the average age of a landlord is around 55 years old.
On the software: Being able to upload things through spreadsheets is key, he said. There was talk about connecting it with the software, but if there is a template that people can fill into a spreadsheet, such as a CSV file, and they can upload that, it will certainly help many of his landlords.
On whether MTD will lead to some small businesses migrating to the shadow economy: Haig said that about 60 per cent of members said either that they are no longer looking to grow their portfolios or that they are looking to exit the market altogether. He is concerned about a drift to the hidden economy. “This would not be the nail in the coffin at all, but it is another piece of legislation and another level of cost that is being added to what our members have to deal with”, he said.
On HMRC’s consultation process: He would very much like to see an increase in the exemption threshold to try to bring many smaller landlords out of the requirement to be in the regime. In fact, 22 per cent of landlords do not make any money out of it.
On benefits to business, MTD closing the tax gap, tax-motivated incorporations and penalties
Lord Tugendhat said HMRC’s intention is to create a system whereby ‘tax becomes part of the rhythm of business’ but the proposals go much further by mandating how businesses are to be run. He said: “You think it might not make more sense to align the tax administration system to the operations of the business world, rather than require businesses to organise their operations to fit your model.” He said the business community’s reaction to mandation could be ‘very similar’ to the furore on business rates at the moment. He challenged HMRC’s view that there was no new tax under MTD. “Your own figures say that, by 2021, you are trying to get £625 million extra out of the sector. I think there is a figure around indicating that by one more year it will be up to £2 billion. I think you are trying to get another £1 billion out of the sector.” Lord Bilimoria said HMRC is asking people to submit returns every quarter that are not linked to a payment being made in that quarter, and that could be seen by business as an extra burden.
Jim Harra, Director-General, HMRC Customer Strategy and Tax Design, said MTD will close the small business error and carelessness tax gap, which was £5 billion for small businesses in 2014-2015. In its Autumn Statement update, the OBR said MTD was still on course to deliver the benefits that it had sought. He does not believe that MTD will either help HMRC to tackle the hidden economy significantly or contribute to it significantly. Harra remains unconvinced that businesses would deliberately keep their income below a £10,000 threshold in order to avoid MTD because it is quite a low level of income. He added that it is unlikely that people will go to the inconvenience and expense of incorporating just to gain what will be a temporary advantage. HMRC has a track record of successfully mandating online filing, for example with corporation tax, VAT and PAYE. He hopes many exempt businesses will do MTD voluntarily because they find it beneficial and easy.
Theresa Middleton, Programme Director, HMRC Making Tax Digital (Business), defended the £270 transition cost per business. She said it takes account of the need to learn how to use the new method and some businesses will seek more accountancy advice and there will be costs ‘for some’ to purchase hardware or software if they are not eligible for free software. Many businesses will, for the first time, have much earlier sight of their tax bill, she enthused. The only penalty regime around the quarterly update will be a late-filing one, and HMRC will consult again in the spring on that
On why April 2018 is the start of mandation
Baroness Drake is concerned that there will be £1 billion of transitional costs on business on a system that is currently untested. “The experts, will have had a year-plus to practise [during the trail], but the business does not get very long at all.”
Lucy Pink is Deputy Director for Tax Administration Spending and Reform at the Treasury. Pink said the Infrastructure and Projects Authority was called in to scrutinise the delivery and the timetable and assured the Treasury that it was deliverable.
Harra said little evidence has been provided to HMRC about what people would do with the increased elapse time if it was granted.
On the £10,000 threshold
Lord Turnbull wondered what is wrong with taking £83,000 as the starting point, exempting below that, and then over the next five years gradually bringing in more and more people.
Harra said about 80 per cent of the error and failure to check with reasonable care gap is in businesses with turnover of less than £83,000. The £10,000 level takes about 2.6 million businesses out of MTD. The Government is still considering whether MTD threshold should be £83,000 as with VAT, and it will make their decision and announce it before the legislation is laid.
On the software
Baroness Kingsmill said the software industry has given evidence to the Committee that they have found it very difficult to provide clear software to HMRC because they have not had a proper specification from the tax authority. Ultimately we are giving those software operators an opportunity to make money out of captive people, she said. Given that it is a public service, and HMRC is part of the public sector, why on earth are you not just putting out a free app, she asked.
Harra said a government designed free app would be HMRC stepping into the market. “Our experience tells us that the more we step into that market and offer free government services, the more they will not meet everyone’s needs or be flexible enough”, he said.
Middleton explained that the app will generate the quarterly update, which is the big time saving for the small business. People can choose to share it with their agent or not. They trust their agent more than they trust HMRC and more than they trust their software supplier, so we expect that agents will be an important source of support and advice. We want to embed in the software that is being produced by the industry as much help, prompts and advice as possible. We are seeing some established players and some new entrants with an enormously wide range of models, show interest in providing software. The software industry is able to be more flexible and more responsive, and can provide a much more tailored and personalised service than HMRC could ever provide.
On quarterly reporting
Lord Leigh of Hurley, a chartered accountant and member of the Chartered Institute of Taxation, said for quarterly accounts to be meaningful, particularly for tax, there will have to be accruals estimates, with things like deferral of income, with ‘quite a bit of time spent on them for them to be meaningful’. He fears that buy to let landlords might take huge deposits from their customers because of MTD, proportionate to their business, which would distort the quarterly accounts. Lord Flight wants HMRC to ‘at least’ suspend quarterly reporting. He said that while they are not P and L, they are other series of figures which people might confuse, thinking that they are related to their tax bill. Nearly everyone will have to employ accountants just to do their returns online, he said.
In response, Middleton said businesses below the VAT threshold will be using the cash basis, so there is no requirement at all for them to make adjustments at the quarterly update point. ”There is no requirement to produce quarterly accounts. If the business wants to produce them for its own purposes and send us the results, it can do so. We are not just testing it with digitally savvy people who are already using apps and Facebook; we are testing it with a full range. At the moment, we are trying to oversample the more difficult group.” It is not HMRC’s expectation that every business will need an accountant to help it to do either its quarterly return or its end-of-year activity, in the same way that businesses do not all use one now, even though they nearly all file online.
Lord Wrigglesworth said that HMRC is going to start pilots in six or eight weeks’ time, yet representatives of the software industry told us in their evidence that they do not yet have the technical specifications for the software that the tax authority is asking them to provide
Middleton said the latest date that HMRC has been told by a software firm that it expects to be ready is October. HMRC’s plan is to put on GOV.UK the list of products, which will grow quite quickly over the course of the next few months. Only software that meet the requirements it has set, so they will work with its systems, meet its security standards and satisfy questions about cloud-based versus desktop, will be included.
On who is really driving the initiative and its urgency
Lord Bilimoria cited a members’ survey by Chartered Institute of Taxation, which found overwhelmingly that £83,000 should be the threshold, not £10,000. Further, it says that 87 per cent of its members consider the £10,000 exemption to be too low. “If you are consulting and taking the advisers into account, surely you should be listening to them—let alone the burden on businesses?” he said.
Harra responded that the ‘design’ for MTD came from HMRC. There is a particular focus on small businesses, for two reasons, he said: they represent 51 per cent of the tax gap and the small business population is growing significantly, ‘so the upward pressure on the tax gap is inherent in that population’.
Middleton added that the proposals have evolved since the initial announcement in the spending review 2015. HMRC has talked to businesses and their representatives, including organisations such as the Chartered Institute of Taxation.
On public awareness
Lord Wakeham said: “Listening to a lot of your answers, I am full of admiration for what you are doing, but it sounds to me like mission impossible”
Middleton said that as soon as HMRC knows the group that will be mandated from April 2018, it can start to ramp up its communications and marketing. She will make a push on the construction industry, especially.
On security concerns
Lord Hollick told the witnesses that it would be sensible for HMRC to take their time and test it thoroughly with, ‘say 10,000 or 20,000 users, a cross-section of all the population you are talking about’ and then see its impact and its utility – and therefore not have to use modelling or derived information. “You are offering me, as a small business, four opportunities to make those errors instead of one. I am not sure that I am convinced that that is going to reduce the error rate”, he added.
Harra said HMRC provides a single point of contact for ‘customers’ to report spoof sites or phishing emails, and to query whether emails and texts that purport to come from HMRC really do. HMRC has dealt with more than 700,000 such queries this year to date. It has set a specification for security standards that must be built into the software products that the industry supplies. HMRC will be testing their products against its services to make sure that they meet security specifications. He declined to tell Baroness Kingsmill if HMRC would underwrite any losses that arise as a result of the failure of software products.
On people failing to make the transition
If businesses find it difficult to make the transition, they do not have to fear being penalised, Harra said. He did not have a figure for Lord Leigh when he asked about the cost for HMRC of storing five times the amount of data that it has at present. Harra expect all businesses to comply, not least because HMRC’s last random inquiry programme demonstrated that 31 per cent of small businesses were getting their tax wrong in some way.
HMRC’s aim is that, whenever a taxpayer needs help, either because they need help to understand how to enter something in their records when making their quarterly update, or because something was played back that they want to understand, as far as possible HMRC want the software, the online support and our YouTube videos, etc, to help with that, and, ideally, not a person to person contact [telephone call], but ‘we will have to test that during the trial, he added.