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HMRC is under significant pressure to increase its tax take in the wake of the pandemic. The national debt stood at £303.1bn as of March 2021 and corporate tax receipts, already on the decline, will be hit by rebates as companies seek to reclaim money from loss making periods.

VAT returns are likely to therefore attract more scrutiny as we go forward. VAT is the second highest contributor to the UK treasury making it a prime source of tax revenue but it’s also the worst offending business tax in terms of the tax gap and a major cause of lost revenue. The VAT tax gap stood at 7% in 2020 (equivalent to around £10bn) with the biggest causes listed as a ‘Failure to Take Reasonable Care’ and ‘Errors’, responsible for £8.6bn.

Small wonder, then, that the tax authority is now beginning to ramp up its compliance activity.

HMRC opened 102,000 compliance investigations in the first quarter of 2021, up by over a third from the previous quarter of 35,000 and almost quadruple that of the second quarter in 2020 at 27,000, according to reports. Compliance yield went up by 29% to £14.2billion in the first quarter of 2021. The tax authority is also focusing enquiries on specific areas, such as R&D tax reliefs for STEM companies, suggests the AAT.

Yet this is not just the end of a hiatus caused by COVID. The expectation is that, as HMRC continues towards its vision of a fully digital tax regime, it will intensify its efforts, concentrating resources on increasing the range, depth, accuracy and speed of the data it collates. As its data analytics capabilities increase, we can expect deeper dives into accounting practices and a move closer to real-time assessment. New insights into the data will enable HMRC to focus on outliers for investigation. This could mean it unearths unwelcome surprises that businesses are ill prepared to defend against, increasing the risk of fines and penalties.

Investing in technology

Speaking at a PublicAffairs Committee meeting back in November 2020, HMRC Chief Executive, Jim Harra, said “We are becoming much more effective at targeting our compliance interventions”, revealing this is top of the agenda. HMRC has already invested over £100m in Connect, its system run by a team of specialists in HMRC’s Risk & Intelligence Service (RIS). Connect directs resources more efficiently and improves case selection across the compliance spectrum. It’s able to cross-reference tax records with other databases such as bank accounts, companies house, tax returns and social media to establish undisclosed or fraudulent activity as well as to identify common errors in returns.

The Treasury has committed another £100m and a taskforce of 1,250 to HMRC’s compliance efforts and this will see it build out its technical capabilities still further with investment in machine learning technology. Arming the tax authority with such analytical capabilities is akin to equipping it with superpowers, according to PWC, as this will give unprecedented insights and allow HMRC to build their own detailed picture of your company, its activities etc

HMRC are embracing machine learning to identifying outliers based on what they determine to be incoherent behaviour or unexpected results. For companies, this means it will be essential to align the tax narrative to the underlying business data in closer to real-time but also to pay attention to how their tax narrative compares with similar organisations in the same sector etc. If you stand out then there is the risk of increased levels of scrutiny and audits.

Today’s approach

HMRC currently uses a one-to-many strategy to identify and issue warnings to businesses that may be at risk of non-compliance, encouraging the majority to self-correct while the tax authority focuses investigations on a fifth of cases. Large businesses continue to be seen as the low-hanging fruit, with HMRC actively investigating around half the UK’s largest businesses at any one time. Indeed, it recently stated that compliance yield of £36.9bn for 2019-20 was artificially high due to “a small number of very large, one-off successful cases” and that this simply levelled off in 2020-21 to £31.3bn.   

But it’s not just the businesses that are in the firing line. The move towards personal accountability means that it’s the senior management that are increasingly at risk of fines when discrepancies are discovered. HMRC’s premise behind the design of the regime being that personal accountability provides a greater incentive to get tax right. But without some levelling up of the status quo to enable companies to increase their tax awareness in line with HMRC, surprises will happen and potentially senior heads will roll.

Future plans

Last summer HMRC announced its intentions to build a modern tax administration based upon a fully digital tax regime. This will see taxpayers use a single digital tax account so that rather than treating all three business taxes separately, data will be shared over a single platform. Indeed, HMRC’s compliance strategy is already moving in this direction, as when conducting a review it tends to view all the taxes together rather than in isolation.

The aim of the tax reforms are to make it “easy to get tax right and harder to get it wrong” through the smarter use of data. Putting all tax obligations together increases transparency, providing HMRC with a bigger picture so that it will be able to focus its interventions and catch businesses earlier in the cycle, preventing erroneous reporting. But because it will have access to a wider data set, HMRC will be able to scrutinise businesses more cost effectively, and that means businesses of all sizes can expect to be caught within its sights.

The implications for you

Ultimately, as HMRC’s data analytics capabilities increase, we can expect deeper dives into accounting practices and a move closer to real-time assessment. To keep pace, tax and finance teams will need better visibility of financial affairs so that they know the company’s tax stance at all times. They’ll need to be able to marry up the tax narrative with the story being told by the figures and to do so across the different regimes so that they can demonstrate they have taken reasonable care.

To do this they’ll need to be able to quickly spot any errors and anomalies by running rapid checks on source data, be able to view and analyse their tax data to compare periods and perform trend analysis to understand their tax position and project future liabilities, and to answer any queries on demand by using a digital audit trail. A digital trail significantly reduces the time and effort needed to respond in the event of an audit as all checks and adjustment are logged and recorded, creating a precise track record of the entire Return.

To achieve this, businesses will probably need a digital process that address four main areas…

  1. Automatic extraction, mapping, cleaning and filtering of data from source systems to create a ‘single source of data truth’ that can be repurposed for any tax
  2. Centrally managing data to mitigate risks (ie SAO and BRR+) and provide oversight and governance
  3. Automating calculations for VAT, corporation tax etc in order to decrease the risk of manual error
  4. Capturing business intelligence through analytics software that can plug into existing processes and provide insights from the tax data pool to allow the tax team to readily respond to queries and be aware of the company’s tax position at all times

Our digital VAT solution, AlphaVAT, provides all of these capabilities and more and, because it is part of our AlphaTAX360 platform, can provide a centralised tax management system that aligns with HMRC’s digital plans.

To find out more about how you can begin to meet fire with fire and use AlphaVAT to demonstrate your compliance, take a look at our latest VAT webinar – A guide to digitalising VAT – or if you have complex VAT needs, book on to our Digitalising Partial Exemption webinar.