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.
In its first week of hearings it held two evidence sessions, each divided into two parts:
Session 1 part 1 – Robin Williamson (LITRG); John Whiting (OTS); Richard Murphy (Tax Research UK)
Session 1 part 2 – Kevin Hart (Business Application Software Developers Association); Kevin Dady (IRIS Software)
Session 2 part 1 – Tina Riches (Smith and Williamson & CIOT); Michael Steed (Kaplan and ATT); Rebecca Bennyworth (ICAEW)
Session 2 part 2 - David Lyford-Smith (ICAEW IT Faculty)
The full transcripts are not yet published but will in due course be posted on the Committee website here. Further sessions will take place next week including with HMRC (see Forward Look, below).
Who is on the sub-committee?
Lord Hollick (Chairman) (Labour; businessman, esp. media companies; founder of IPPR)
Lord Bilimoria (Crossbench; chartered accountant; British-Indian entrepreneur; chairman of Cobra Beer)
Baroness Bowles of Berkhamsted (Liberal Democrat; former chair of European Parliament Economic and Monetary Affairs Committee; patent attorney)
Baroness Drake (Labour; trade unionist)
Lord Flight (Conservative; former Shadow Chief Secretary to the Treasury; investment adviser)
Baroness Kingsmill (Labour; solicitor in personal injury, trade union and employment law; former Deputy Chairman of the Monopolies and Mergers Commission)
Lord Leigh of Hurley (Conservative; Chartered Tax Adviser; former party Treasurer)
Lord Tugendhat (Conservative; former European Commissioner; former Chairman of Chatham House)
Lord Turnbull (Crossbench; former Treasury Permanent Secretary and Cabinet Secretary)
Lord Wakeham (Conservative; chartered accountant; former Energy Secretary and Leader of the House of Lords)
Lord Wrigglesworth (Liberal Democrat; businessman; former deputy chairman of the Government's Regional Growth Fund Advisory Panel)
Session 1 part 1 – Monday 6 February – ‘Tax Commentators’
Witnesses: Robin Williamson, Technical Director of the CIOT’s Low Incomes Tax Reform Group (LITRG); John Whiting, Tax Director of the Office of Tax Simplification (OTS); Richard Murphy, Director of Tax Research UK and a Professor of Practice in International Political Economy, City, University of London.
Questions posed by committee members during this session included:
How involvement has the OTS been in the plans to make tax digital?
Are the proposed changes coherent and will they increase the revenue take?
Is the level of computer sophistication among small businesspeople sufficient to deal with this?
Is it right that the Revenue will not make any use of quarterly reporting figures?
Probing their divergent views on cash accounting
Will the proposals narrow the tax gap? (Peers were sceptical.)
Is the income threshold of £10,000 too low?
Will quarterly reporting reduce or increase the number of errors?
Robin Williamson suggested an exemption to mandatory digital reporting until a business’s turnover reaches £83,000, which is the VAT threshold, on the basis that most VAT payers will be more familiar with doing tax digitally. He added that people will naturally gravitate towards digital quarterly reporting, as has occurred with online income tax self-assessment, if it they find it good and reliable, He also raised the prospect of disabled people having to buy assistive technology to comply with MTD, which means HMRC is possibly going against its public equality duty.
Williamson said the Department for Work and Pensions’ cash basis is similar to, but not the same as, HMRC’s cash basis, in that it operates on a monthly rather than an annual principle. “The business will be reporting monthly to one department and quarterly [under MTD] to another. The whole thing will be so confusing that the business is bound to come unstuck somewhere.” He said the profession could better learn what sorts of errors HMRC believes are being made by small businesses, if it would finally publish the report it promised last summer on the investigation it carried out into record-keeping by small businesses, which closed in 2015.
John Whiting said that the OTS was involved a ‘little more’ at the start of the policy-making process now. He said OTS happens to be doing a project on simplifying and streamlining the corporation tax computation, which will ‘play well’ to MTD. The OTS has recommended cash accounting because it believed that for appropriate sizes and types of businesses it was an obvious simplification. However, tax-motivated incorporations as a result of MTD worry Whiting: “Perhaps this is an extra push to incorporate my business, some may think; it will then be two further years, at least, before they have to come into making tax digital.”
Whiting would have been happier with MTD if it built on the success of existing systems that are doing electronic filing, such as for a VAT-registered trader, and potentially ‘broadening them out’. He said MTD will ‘probably’ help to close the tax gap; it will also encourage people to do more accurate claims but possibly ‘encourage a few more people into the hidden economy’. He cited the results of surveys by CIOT and the ICAEW which suggested that the sophistication to deal with MTD is not there at the smallest end of SMEs, ‘with the fall back that, if they are in doubt, people will get paid advice’.
Richard Murphy said that experience had taught him that people who are forced to prepare accounts in a short period of time tend to make a lot more errors than people who have a little more time to get the thing right. There will be an inclination for people simply to dump in estimates to meet a deadline for submission when there is a penalty attached to not filing, he said. Also, he thought, there is a ‘significant’ risk that MTD will force some people into the hidden economy, in part because of the low £10,000 registration threshold. He was concerned at the encouragement the system provides for the adoption of cash-based accounting. Cash accounting encourages a business to think that it is doing really well when it does not pay its creditors, he argued. It does not include a capital allowances estimate, for capital expenditure, and it will not include the offset for pension contributions, he explained.
Murphy explained his estimates of the cost to business of the proposals. “The cost that HMRC estimates of complying with making tax digital is £4.36 a submission, which is 35 minutes for a person paid the national minimum wage. That is in no sense plausible. My estimate, based on the fact that 65 per cent of self-employed taxpayers and 78 per cent of small companies now use an accountant, is that the real cost will be about £1.8 billion—£305 per taxpayer.” He cited his own analysis that estimated that the cost to business of preparing the submissions would be £1.71 billion, to which he added his estimate for software of £67 million, which adds up to £1.777 billion. He also estimated that it will increase turnover for accountants by £1.4 billion.
While Peers mostly focused on interrogating the witnesses their remarks did provided an insight into the committee’s thinking. Early on the Chairman, Lord Hollick, noted that the topic had “certainly struck a chord, because we have a heavier than usual postbag.” Baroness Kingsmill was sceptical as to whether the changes were coherent. Baroness Bowles looked forward to playing with a tax digitalisation app, “because I think I am one of the people who could score by managing to feed in all the irritating things that I tend to staple somewhere and lose by the time I think about my accountant.”
Lord Turnbull, the former Permanent Secretary, appeared bemused that HMRC was planning to do quarterly reporting and yet not make any use of the in-year figures, nor levy penalties. “If that is the case, will people not simply put in their revenue figures, not bother much with all their invoices and then package them all up in the last quarter to get the annual figure right?” he asked. He also wondered: “Why are we not making more use of VAT, who pays it and how they account for it? Why do we not build on that and make the two things the same?” He thought that a big mistake had been made in 1972, when VAT was given to Customs when it should have gone to the Revenue - “then the two could have been brought closer together”.
Lord Flight concluded that while “[t]he whole justification for these proposals appears to be that they will narrow the tax gap” he had heard nothing persuasive to suggest it would achieve that aim. “To me, the whole process is an expensive and undesirable waste of time, and is not at all to the benefit of small business.” Lord Bilimoria suggested it demonstrated “HMRC’s complete lack of commercial reality”. “If HMRC puts in a threshold of £10,000, and thinks that it will make it easier for business by asking it to do things five times a year instead of four times a year, it does not understand business. This is nonsense. It is not living in the real commercial world.”
At the conclusion Lord Wakeham attempted to find agreement on the main findings of the session. “First, you have indicated that digital taxation is probably the right way forward, if it can be done properly. Clearly, however, there needs to be a delay in doing it, because we do not think that we are up to it at present. We think that the level of turnover needs to be substantially higher than has been indicated, and that quarterly reporting will not necessarily produce any great advantages and has lots of disadvantages. Am I right to assume that those are the principal things that have come out of what you have said?” The witnesses did not dissent but suggested that the committee should also suggest starting with the largest businesses (Murphy), modernising HMRC’s standard cost model (Whiting) and more support for assistive technologies (Williamson).
Session 1 part 2 – Monday 6 February – Software Providers
Witnesses: Kevin Hart, Head of Payroll and Third Party Integration at B&CE (The People's Pension), Business Application Software Developers Association (BASDA); Kevin Dady, Group CEO, IRIS Software Group
Asked whether the software industry was ready for MTD, Kevin Hart said: “There is commitment to be available for the timescale that HMRC is targeting, but that commitment is very dependent on HMRC being able to deliver clarity of information and services.” Pressed further he said: “We are not ready; it is hand in glove and we need HMRC to be as ready for us.” Kevin Dady said HMRC recognised very recently - in the last few weeks - that the pace of information flow between itself and suppliers needs to pick up. His firm have a reasonable degree of certainty about what HMRC wants his systems to do, he said, but what it does not have is ‘line of sight’ of how they interface or integrate with HMRC’s systems.
IRIS wrote to 17,000 accounting practices on MTD and had 900 returns:
Eighty-six per cent of the accountants felt that the changes were not achievable by 2020
Only four per cent of the respondents agreed with the £10,000 income threshold
A total of 48 per cent thought that the VAT threshold, at £83,000, should be the threshold adopted
Dady said it would be ideal to have more time to pilot the system. Hart said there was “a gentlemen’s agreement between BASDA and HMRC that for small changes we needed a minimum of six months’ notice, but for large-scale changes we needed 18 months. That is on receipt of specifications… so that we can factor them in and undertake appropriate development and testing. Timescales have shrunk from a development perspective. They are shrinking quite rapidly at the moment. It is fair to say that it would have been ideal if we could have been in the position that we were running at the beginning of April and had a full year’s experience, so that we had four solid quarters of submission experience. The very nature of this process is that it is compacting it down, in a number of cases, to two - no more than three – quarters’ experience.”
On costs Dady said the accountancy customers he has spoken to expect to increase their fee structure by ‘anywhere between 10 per cent and 20 per cent annualised’. Dady said IRIS has not yet decided whether it will offer a freemium product and if it does, it will be for companies that do one or two invoices per year and make a tax return on a quarterly basis. Hart agreed with Baroness Kingsmill that it would be easier if HMRC had a free app that people could download to enable them to get on with MTD.
Hart agreed HMRC’s estimate of £280 of costs per business was not realistic. “If anyone requires educational support, particularly from a training perspective, and has to go to some sort of paid training, £280 will disappear in a morning seminar,” he said. He expects MTD’s average cost per business to be ‘at least double’ £280. He said it was critical that HMRC gives certainty around Excel ‘fairly early’, given that 50 per cent of his accounting customers use it or nothing at all.
Can HMRC meets its April 2018 target? Dady thought it could but “[i]t needs to accelerate its dialogue with the whole supplier community, and we need a very vigorous pilot period. The beta pilot has been announced from April 2017, only seven or eight weeks away. I understand that the target audience for that period was 400,000 taxpayers. Maybe this is my problem, but I do not understand today how HMRC will attract those 400,000 taxpayers.”
Session 2 part 1 – Wednesday 8 February – Tax advisers and accountants
Witnesses:Tina Riches, National Tax Partner, Smith & Williamson, and deputy chair of CIOT’s Digitalisation and Agent Strategy Working Group; Michael Steed, Co-chair of ATT’s Technical Steering Group and senior tax consultant at Kaplan Leadership and Professional Development; Rebecca Benneyworth, ICAEW council member and chair of HMRC’s Digital Advisory Group.
Areas probed by committee members during this session included:
Plausibility of the Government’s assertion that mandatory digital record-keeping will reduce the tax gap
Whether mandating digital records will put a lot of pressure on to small practitioners
Whether the £280 estimate of the average cost to business is reasonable
Whether the recently announced concessions go far enough
How prepared clients are for April 2018 and what help they will need
Whether the extension of the cash basis to property businesses is a simplification
Whether HMRC have listened to the views of professional advisers in this process
Tina Riches was sceptical of whether MTD will lead to substantially better bookkeeping because small businesses tend to know their incomes anyway. Small businesses probably under count their expenses and S&W tend to find that the errors are in HMRC’s favour, she said. Riches has encouraged her clients to use accounting software, but they needed ‘a lot of hand holding’ during the first couple of years, through the first complete cycle, and then intermittently after that. The expected extra interaction with clients as a result of MTD led her to estimate that the additional cost could be in the region of £2,000 plus VAT per client a year, far higher than HMRC’s estimate of £280. She said the £280 figure seems to be based on HMRC’s standard costing system, which is a government administration burdens method of costing, devised many years ago. The methodology does not seem to have been updated, she said.
Riches said: “We have suggested that if you are happy for people to use spreadsheets… it should be possible to copy and type the total figures into a tax package that can be sent off, rather than having to go through that tortuous electronic route, which, from our experience, can lead to even more errors.” Riches said the consultation on MTD has not been anywhere near as good as involved in the Self Assessment, the iXBRL and the RTI consultations. She added that VAT is due to come into MTD in 2019, which is the ‘worst year that VAT could come in to a new system… because we may be Brexiting’.
Michael Steed said it was ‘a bit optimistic’ to think MTD will lead to a substantial reduction of the tax gap (which is £36 billion), although there probably would be a reduction. Steed said that many small businesses, such as those in farming, are simply going to ‘throw it into my lap and the laps of people like me’. Most people think HMRC’s estimate that the average cost to business will be £280 in the year of transition is ‘wildly optimistic’, he said. On charge-out rates, he thought that would be about seven hours’ work for one of his average clients. HMRC estimates of £280 in the year of transition is wrong and Steed suggested that it will be between two or three times that, on his practice’s charge-out rate.
Steed was also concerned that any threshold will have a cliff-edge effect. “There will be people shooting to try to avoid it in some way or another, just like the VAT registration threshold,” he said.
On timing he suggested: “You could extend the timeframe in which you want this to happen, and have an opt-in process for maybe a year or two years—a bit like the new system for recording benefits in kind”.
Rebecca Benneyworth said the concept that under-declared income might come back to HMRC is ‘unlikely’. Just because you are using some software to record, ‘does it mean you are going to say to yourself, I’d better not leave out some of my sales?’ she said, ‘I just do not think that is plausible’. Benneyworth said that many small businesses that struggle to keep digital records, such as taxi drivers, will not receive leniency from HMRC because they do not meet HMRC’s definition of ‘digitally excluded’, chiefly they are not disabled or ‘off grid, as it were’. She is quite ‘proud’ that HMRC is doing MTD, but ‘we need a lot longer to do it’. She said that a lot of people use Facebook but they could not in a million years use accounting software.
Benneyworth accepted that the £280 figure ’feels a bit low’, but about half of the actual transitional costs—the main cost element identified by HMRC—is time spent by businesses to familiarise and understand what their obligations are going to be. While not disputing that more contemporaneous records are likely to be more correct, she questioned whether that necessarily means that people will declare more net income at the end of it. “For a couple of years, the in-year stuff will be very flaky,” she said. She suggested that businesses align their accounting period with VAT quarters or else a business person could be making nine returns a year to HMRC.
Turning to Peers’ remarks, Lord Tugendhat had ‘a great deal of sympathy’ for Tina Riches’ answer that ‘the pace at which HMRC is bringing this in, and the speed at which it will make it mandatory, is a recipe for all sorts of problems’. However, noting that, ‘in the long run we are moving towards an increasingly digitalised age’ he was keen to explore what, if anything, could be done ‘to start nudging small businesses down the digital route’. Lord Turnbull probed whether quarterly reporting was a necessary part of digitalisation.
Baroness Bowles had by now had a chance to test one of the apps on the HMRC website, “and was quite surprised to discover that the free version only allows me to do 10 scans a month. Of course, if I am a long hours, exhausted small business person - or even just the person I am - I tend to want to collect things and sit down when I have half a day or a day and do it all at once. I would be trying to do that to meet the three-month deadline. If the apps are going to come out in a way that rations you, it will nudge your behaviour not only towards digital but into a kind of ordered lifestyle. I quite like my ability to be disordered in some ways. If you are exhausted at 2 am after you have been cabbing around, you just do not want to be doing that.”
Lord Flight continued to be unpersuaded that the tax gap would be much diminished by MTD. He summarised: “What you are saying is that the tax gap capable of being realised is nothing like the £3 billion estimated, and it may be zero. Secondly, you are saying that the extra cost to companies will be miles more than the £280 suggested. On both those counts the whole rationale for the change disappears.” Lord Leigh went further, noting the view that under declaration would not change because of digitalisation, and wondering if there will be an increase in the tax gap ‘as people record more expenses that they would otherwise have missed with bits of paper flying around’.
Lord Bilimoria again put a businessman’s perspective. He could understand quarterly VAT returns: “It just comes out as automatic, and we can understand it from the Government’s point of view - cash flow, getting the money every quarter”. However having to do quarterly tax returns would be a huge burden: “Having to calculate tax once a year is burden enough, let alone having to do it every quarter. It is just impractical.”
Session 2 part 2 – Wednesday 8 February – IT expert
Witnesses: David Lyford-Smith, Technical Manager, ICAEW IT Faculty
David Lyford-Smith wrote a paper last year about the digitalisation of tax in different countries. He outlined what he had learned from his research:
For individuals, one of the key areas that we saw as most advantageous was the pre-population of tax returns with information that government already hold through various things, such as RTI
On rollouts, pilot studies and all the change management side of things, his studies showed that, if you changed rapidly, you would incur more costs for businesses, and if you ran pilot studies and practice runs for things it would go more smoothly.
Digital exclusion was never not considered at all, but it was sometimes underestimated and more complex than just people who perhaps have a disability or a lack of internet where they live
Building an agent strategy into the heart of the system is quite important. He said HMRC may not have its agent side programme ready until the autumn.
Lyford-Smith said the UK was in a difficult position for finding comparatives that can really be of the same size. Italy is one of the roughly 50 per cent of countries that has mandatory tax returns for all citizens, regardless of their employment or otherwise. Italy already has a pretty advanced network of commercial agents that help people to do their taxes. It is the ‘absolutism’ of the UK proposals, despite the consultation, that seems to him to be outside the experience of other countries. Lyford-Smith said a lot of Nordic countries’ digitisation of tax comes from their having higher levels of taxation and ‘high tax morale’.
Lyford-Smith agreed with Committee member Lord Bilimoria that digitalisation of tax administration is already so advanced in the UK that any HMRC savings are likely to be marginal. The witness said the tax gap was by majority made up of fraud rather than error and lack of sufficient care, and the larger part of it is tax evasion and avoidance behaviour. “There is perhaps more room to talk about the ability of detailed digital information to detect some of the compliance behaviour that can be targeted through analytical devices - data analytics and big data - that might be able to close some of that [tax gap]”, he added.
Blog by Hamant Verma, External Relations Officer, the Chartered Institute of Taxation. HVerma [at] ciot.org.uk