In our recent Taxation snap poll conducted in March we found two thirds of those questioned thought they were already compliant with the digital links mandate under MTD for VAT and over half said they were focused on ‘basic compliance’ rather than process improvement. But becoming preoccupied with compliance can see the business take its eye off the bigger issue: errors. Just because your process is compliant, it’s not necessarily correct.
Understandably, many businesses have been preoccupied with other concerns, such as monitoring the bottom line, and so there’s been a general sense of the need to get past the finish line with a solution that meets the criteria. Yet the criteria itself sets a minimum bar for compliance, with a digital link defined as “an electronic or digital transfer, or exchange of data, between software programs, products or applications”.
Open to interpretation
HMRC has deliberately made the digital links mandate open to interpretation to allow businesses to apply the criteria in a way that suits them. For example, those with very simple VAT processes can resort to using digitally linked spreadsheets while those with more complex processes may be better off looking at a dedicated VAT compliance platform. You can see which camp you fall into by taking our VAT Readiness Assessment.
But there’s a real danger that businesses who think they are compliant might not be. Just because you’ve got the necessary digital links in place and no longer allow manual transposition doesn’t mean you’ve eradicated the potential for errors: it’s perfectly possible to have a digitally linked compliant VAT process that contains mistakes, leading to the submission of an inaccurate return.
Spreadsheet-based processes are a great example of this as you can be compliant by using macros and formulas to digitally link cells but it’s a high-risk strategy. Tax Systems have been testing our customers’ spreadsheet-driven VAT returns vs our AlphaVAT compliance platform findings to check for accuracy. Our learnings, taken from 170 VAT recent implementations on behalf of medium and large corporates, revealed:
- Nearly all organisations had errors, 50% of which have a meaningful impact on submissions
- Reporting errors of £10m+ due to unrecorded manual adjustments
- Manual changes to formulas were breaking digital chains, resulting in businesses being unknowingly MTD non-compliant
- Organisatons had no digital audit trails or automated data checks to identify errors prior to submission
- 80%+ of compliance time spent was spent collecting data/ensuring spreadsheet integrity resulting in little time for review of the actual accuracy of the submisson
On top of this we found accuracy challenges when changes were made either to the spreadsheet or within the ERP system that were not then reflected in the spreadsheet.
Here are just three examples of how this can happen:
- Reversing signage. ERP systems signage can be inconsistent. Within VAT calculations, certain items require the sign to be reversed; perhaps where credit notes need correcting, for example. In these instances, we find that signage can easily be missed in an Excel formula; the simple inclusion or omission of a ’-‘ sign. Where this occurs and a figure that should be positive is in-fact shown as negative (or vice versa), that results in a “double error”, i.e. the error is twice as much as the value.
- Conditional formulas. We often see formulas such as SUMIF are used to calculate items, for example the sum of all values for a given tax code. However, as the complexity of reporting increases, so does the complexity of these formulas, resulting in an increased chance of errors. Not only is there a chance that they are wrong, but these types of formulas require substantial upkeep to maintain on an ongoing basis. If a new tax code is added, all formulas throughout a workbook might need updating to reflect this.
- Reverse charge. For businesses that must calculate reverse charge, we tend to see that ERP systems do not always cater for this at source. In many instances, we find “lookups” being performed, e.g. to another data table in Excel. Where these processes exist, we also find formulas are often incorrect and require maintenance.
On one project we worked on a large company was using formulas to calculate total sales. The ERP system was producing credit notes with the wrong sign so that these showed as a negative sum in the spreadsheet. From a digital links perspective, all was well because formulas were used to link the cells but then someone changed the ERP system to make the credit note values show correctly. The only problem was, they hadn’t corrected the formula as well, so then the value going into the Return was wrong.
This illustrates the problem of digital linking a process which has no checks and balances. If the process changes, the ERP changes or the VAT object changes then the spreadsheet needs to be updated in order to calculate the right values for the Return. A spreadsheet-based process while compliant will therefore require significant upkeep on an ongoing basis to ensure that the Return is correct.
Checks and balances
It’s also worth pointing out that it can be very difficult to retroactively search for an error in this type of process. There are no nudges or prompts built-in to flag anomalies such as negative/minus sums or unusual VAT rates or transactions that should be excluded. (Interestingly, these were part of the original remit for MTD for VAT software but were dropped by HMRC who came under pressure to accept spreadsheet-based processes due to their ubiquitous use.)
The digital audit trail capability is also very limited. While you can retrace your steps through the digital chain, there are no sign posts as to when a change was made which can be achieved by digitally time-stamping an event. This means that if you do submit an incorrect Return and it is queried by HMRC, searching for the anomaly can be like looking for a needle in a haystack.
Now that digital links have been mandated, HMRC may well look for proof of compliance. The tax authority is likely to be under more pressure to increase its compliance yield in light of the fall in tax take and the fact the Chancellor cannot conceivably hike taxes in the short term to cover the COVID deficit. These factors will no doubt exacerbate an already high tax gap of £31bn, one of the main causes of which with respect to VAT is the “failure to take reasonable care”. Being able to demonstrate you’ve made every effort to comply will therefore be high on the priority list of most businesses.
Proving compliance will require the business to show it has met the digital links requirements and has taken adequate steps to govern the process. Digital links are also likely to be brought in for other tax regimes under MTD, such as corporation tax, under HMRC’s 10 year plan for a modern tax administration. This means we can expect digital audit trails to become a staple way of showing how and when calculations were made to satisfy any queries.
So if being compliant isn’t enough, what should you be aiming for? HMRC has stressed that MTD isn’t just about moving from a manual to a digital process but rather making the “tax administration system more effective, more efficient, and easier for businesses to get their tax right”. It’s designed to deliver a wide range of benefits for both HMRC and the business which include reducing errors and productivity gains.
Those gains can only be achieved by adopting a ‘digital first’ rather than a ‘compliance first’ mindset. This means you need to regard compliance as ground zero; it’s the very minimum you should be doing and gives you the foundations to build upon. From there you really need to start to think about how the process can be improved.
Having a dedicated compliance platform in place can alert you to potential errors and provide you with a verifiable digital audit trail that identifies where and when changes were made. Issues can then be resolved so that the Return is right first time.
To find out more about how AlphaVAT, our MTD solution, can be used to ensure your process is both compliant and correct please contact us for a demo or sign-up for one of our A Guide to Digitalising VAT webinars to see how it compares to other methods of compliance.