While every attempt will be made to ensure that information provided is accurate at the time of publication, it should be treated as guidance only and does not constitute legal or professional advice. Tax law and guidance changes frequently and readers are advised to consult the current relevant product for the most up-to-date information on this topic. 

Chris Jones, Director of Tax Markets & Learning Solutions at Tolley, provide a summary of the responses that HMRC have given to the recent consultation exercise on making tax digital, focusing his attention on areas that have changed.

Those of us all too familiar with the struggle to get everything done by 31 January will have enjoyed the irony of HMRC having to meet their self-imposed deadline of 31 January to publish their response to the Making Tax Digital consultation. Like many taxpayers, they only just made it.

What was published?

Altogether 17 new items connected with MTD were published. Some of these are summaries of other documents or press releases, but stripping away those we are left with:

  • 6 consultation response documents, one for each of the consultations published on 15 August;
  • Draft legislation and Tax Impact Notes for digital reporting, cash basis and property profits.

The headlines

In summary the key points that were published are:

  • No requirement to keep invoices etc in digital form
  • Ability to keep records on spreadsheets
  • Increased piloting of MTD during 2017
  • Formal exemption for the digitally excluded
  • Extension of the cash basis

Using spreadsheets

The good news is that HMRC will permit the use of spreadsheets and will not require copies of individual invoices and receipts to be kept electronically. Of course businesses will still be able to use software to keep electronic copies if they wish. It is important to understand that the use of spreadsheets does not completely remove somebody from MTD requirements. It won't be a case of simply e-mailing the spreadsheet to HMRC every quarter. The information in the spreadsheet will still have to go through some form of MTD compatible software. There are a number of implications here.

Quarterly updating

In the first place quarterly updating is going to be based on the existing categories within self-assessment. This must mean that HMRC will require updates that split down income and expenditure into the categories in boxes 15- 31 of the tax return. So if the spreadsheet that your client currently uses does not have these same categories it appears that it will need to be modified to be compliant.

The response document (page 10) says:

"A business will need to ensure that their chosen spreadsheet functionality is able to meet all of the necessary requirements of MTD for business"

In other words, this means keeping digital records, providing quarterly summary information and the end of year activity. This means using the spreadsheet in real time to keep records. Many people of course already do this, but others don't and leave it to their agent.

There will be no requirement for the quarterly updates to include tax adjustments. These can be included if the taxpayer wishes, but tax adjustments can be left to the final end-of-year activity.

The software which allows the spreadsheet to produce the quarterly reports to HMRC will have to include a basic level of "prompts and nudges" and allow HMRC to send information to businesses about their tax liabilities. Quite what that means is not clear at the moment and of course there are no examples yet which we can look at. However, HMRC has confirmed that free software will be available to meet MTD requirements and that it is up to the private sector to produce this software.

Most businesses will still be required to make at least some changes in the way in which they record and report their financial information and will need to interact with HMRC digitally.

  • A large number of businesses who use spreadsheets currently on a real time basis can continue as is, albeit having to engage with the software for the quarterly reporting;
  • Businesses that are currently eligible to use 3 line accounts, those with turnover below the VAT threshold, will only be required to give quarterly updates of those three numbers.

The reporting timetable

There is no change on the timetable for quarterly reporting. The submission date for the update will be one month from the end of the quarter. If taxpayers will want their agents to prepare, or at least check the update information this will have a big impact on the working cycle of most accounting practices. HMRC's view is that there will be very little involved in making an update. They say:

"updates are intended to be quick submissions of receipts and expense data that reflects the trading recorded in a businesses' records. The month's submission period is not intended to be a lengthy window of time which a business starts to enter all its transactions in the digital records from paper. If a business has been keeping digital records "as they go" the update should be straight forward to generate and send".

"End-of-year" activity

The consultation response document says that:

"end-of-year activity has to be provided by the sooner of 10 months after the last day of the period of account or 31 January of the year of assessment in which the profits of the year of assessment for that period of account are chargeable to income tax".

Let's take the 12 months accounts to 31 December 2020. These will form the basis of assessment for the tax year 2020-21 in the normal way. 10 months from 31 December is 31 October 2021. Those profits are chargeable to income tax year 2020-21 and 31 January in the year of assessment in which those profits are chargeable is 31 January 2021. We have to take the earlier of those two dates, which means that the final report must be made on 31 January 2021, which is only a month after the end of the period of account. Is this correct? The reference should surely be to 31 January following the year of assessment in which the profits are taxed. This is evidenced by the fact that the deadline would be before the accounting year-end for those who prepare accounts to, say, 31 March.

The timetable

Almost without exception the feedback has been that the timetable is too ambitious. The big question on which we were waiting for an answer was whether or not there was going to be a relaxation in the timetable.

We now know that he core plan is unchanged with the introduction to MTD being phased in as follows:

  • sole traders in 2018
  • VAT in 2019; and
  • Corporation tax in 2020.

However, HMRC did announce that they would not impose any penalties for late filing of quarterly updates in the first year of operation of MTD for sole traders. In reality this seems to be saying to people: do your best in year one but make sure you get yourself organised properly for year two. If you were cynical you could say that this is HMRC in effect delaying the introduction of MTD for a year without actually having to climb down on the principle. Of course that puts professional advisers in a difficult position. The law is the law and we can't simply advise our clients to ignore legal obligations to file quarterly updates: HMRC would come down hard on any adviser who told his clients simply to ignore MTD for a year. We are going to have to help our clients cope as best they can.

Smaller businesses

There is no further progress on deferring MTD for smaller businesses. We know that those with turnover of less than £10K will be exempt and the government is still considering what level of turnover above that should qualify for a deferral. Views were mixed in the consultation and it is not clear yet where this will eventually land.

Large partnerships

HMRC had always suggested informally that large partnerships would only come into MTD at the same time as corporates but no details had been given. Now it is confirmed that partnerships with a turnover of more than £10m will not come into MTD until 2020.

Costs and benefits

There was widespread concern that HMRC's figures for the additional tax revenues generated by MTD and the cost/benefit analysis for the taxpayer didn't accord with adviser's perception on the true economic impact. HMRC has not changed its model for the yield of MTD, still saying that it will bring in £945m by 2020-21. It is now also saying that by 2021-22 it will have brought in a total of £2bn. That is the net impact of errors currently in the system being eradicated by MTD. Is the tax compliance error rate really that high at the moment?

There has been some shift on the cost/benefit to taxpayers, with HMRC now making it clearer that in the initial years there will be net costs and it is only from 2020-21 that taxpayers will start to see reductions in compliance costs. The net annual benefit from 2020-21 is now assumed to be £100m per year. As there are something like 6 million taxpayers who will be within MTD by that time, the average benefit will be something like £16 per year for each taxpayer and no one notice it.

What now?

Clearly MTD is going to happen and, despite some welcome changes and relaxations, fundamentally little has changed as a result of the consultations. So much of the current self assessment system relies on returns and how it will work in a world where the tax return is no more is still unclear.

Adapted from an article in Taxation magazine (9 February 2017) by Andrew Hubbard