We have continued our engagement with HMRC regarding the proposed changes to the FRS and submitted our comments and concerns to HMRC.
HMRC explained the nature and scale of the abuse of the FRS at meetings attended by representatives of the CIOT and other stakeholders, although much of this had already been reported in the media. CIOT members that responded to our requests for comments were unanimous in accepting that action has to be taken, but they were also of the view that the chosen measures may not curtail the abuse and will almost certainly result in a high degree of ‘collateral damage’.
We are surprised that HMRC had concluded that it cannot effectively challenge the abuse using the existing legislation and legal principles, and encouraged them to revisit those conclusions before implementing this proposal. It should be remembered that using existing legislation allows past underpayments of tax to be collected. Simply relying on new legislation does not.
We are concerned that the proposal will not prevent the abuse, and a number of mechanisms have already been mooted in articles and on social media. HMRC are aware of some of these ideas and will be devising anti-avoidance legislation accordingly. This is understandable, although adds further complexity to what is becoming an increasingly complicated simplification measure.
Nevertheless, we suspect gaps will remain and will be exploited. We are also concerned that some businesses might simply ignore the changes, and / or (particularly the abusers of the scheme) just liquidate any businesses subsequently assessed by HMRC.
HMRC’s explanatory notes provided estimates of the impact of the proposed changes, such as the number of businesses who might become ‘limited cost traders’, how many FRS traders will revert to normal VAT accounting etc. We felt that HMRC had underestimated the extent of the impact on the ‘innocent’, particularly for the service sector and mobile businesses.
The measure is also extremely complex so, even with an effective online tool, it will be difficult for many businesses to understand the nuances of the new rules. For example, understanding what are supplies of goods and what are supplies of services for VAT purposes is often unclear (software, gas and electricity, subscriptions etc), and therefore basing the definition of a ‘limited cost trader’ on the value of goods purchased is not straight forward.
Are there alternatives?
HMRC explained that they have considered numerous alternative measures to prevent the abuse, and we think some of these should be explored further, such as restricting the FRS to businesses required to be registered for VAT, or tightening up the associated business rule (if it is believed to be less effective than intended). We also question the long term prospects for the FRS in the light of Making Tax Digital, particularly if records of income and expenditure will need reporting to HMRC on a quarterly basis.
Direct tax issues
HMRC have not indicated whether they will also seek to prevent abuse of the Employment Allowance, which is a feature of many of the abusive arrangements. We suggest that HMRC takes a joined up approach to challenging these schemes, rather than acting in silos.