For the first time in five years, the VAT gap has increased. The VAT gap is the difference between what HMRC assess to be the VAT liability and VAT receipts. It’s increased by a whopping 23% from £10bn to £12.3bn, equivalent to 8.4% of total VAT receipts for the tax year 2019-20. Those figures don’t reflect the full disruption of the pandemic which is expected to impact reporting for the 2020-21 period, but it does cover the period when the first mandate, the requirement to submit via HMRC’s API, under MTD for VAT came into effect. And that begs the question, why hasn’t the reform helped to drive down the VAT gap?
MTD and its relation to the tax gap
MTD was meant to "reduce the amount of tax lost to avoidable errors" and make it "easier for customers to get their tax right", the two biggest contributors to the tax gap being a "failure to take reasonable care", fundamentally due to carelessness or negligence, and "error", essentially mistakes made in preparing tax calculations and completing Returns. Both are now up, with "Failure to take reasonable care" accounting for £6.7bn or 19% of the total VAT gap, compared to £6.1bn the previous year, while "error"accounts for £3.7bn or 10% of te total VAT gap, up from £3.1bn.
HMRC’s explanation is that it is only slightly higher than was expected; in November 2020 it was predicted it would be £11.7bn or 8%. It also says that VAT gap estimates are “often revised” and usually retrospectively adjusted on an annual basis, so these figures are always approximate. In addition, the “VAT gap model includes an adjustment to account for the payments that are estimated to have been deferred in March 2020 due to the introduction of the UK government’s VAT deferral measure”.
But these reasons all fail to explain why the “failure to take reasonable care” and “error” figures have risen. MTD should have dealt with both so why didn’t it?
Firstly, the chief priority for many organisations at the time was to get compliant with the least amount of cost and disruption and so many chose bridging software as the easiest, quickest route to MTD compliance. This allowed them to use software to link their spreadsheet-based processes and submit to HMRC via an API. The downside was that this did not allow them to achieve many of the benefits identified under MTD.
In its evaluation back in March 2020, HMRC conceded bridging software made “the transition more difficult” for many and that it had “minimal impact on the scope for error” but that it was hoped, overtime, that these businesses would see the advantages of moving to more dedicated compliance software that would allow them to reap the benefits. The data we see in the 2019-20 tax gap supports that theory – the initial “teething period” has contributed to the tax gap.
Spreadsheets: the source of the issue
It’s this widespread use of bridging software and the inertia to move on from it that has proven to be a major contributor to the VAT gap because it has led to a continued reliance upon spreadsheet-based processes. Spreadsheets are highly susceptible to errors caused by human input, incorrect formulas, broken macros and the like. HMRC originally did not want them to continue in the MTD roadmap but bowed to pressure from the industry to include them. HMRC’s solution was to then introduce digital links to eradicate certain spreadsheet practices such as cut/copy and paste to reduce the likelihood of errors by linking calculations through to the final submission.
Does this mean we can expect digital linking to help bring the tax gap down next year? Well, aside from the fact steps taken during the pandemic could see the gap rise again, digital linking only addresses one cause of errors – transposition. It will do little, otherwise, to address the fundamental problem of accuracy i.e. the fact that most businesses still use Excel as their primary VAT reporting tool. Tax teams have to contend with a web of manual processes and multiple source systems. And it’s this high dependency on spreadsheets which makes them prone to error. Indeed, we found during assessments of more than 200 enterprise VAT processes prior to implementing AlphaVAT, that nearly 80% had spreadsheet errors, half of which had a meaningful impact on the accuracy of submissions. With many tax teams working to the wire, there isn’t much time for review and identification of these errors.
Eradicating errors and demonstrating reasonable care
To address the problem of errors in the VAT process, specialist VAT software which automates calculations and introduces sophisticated checks and validations, is needed. Bringing data onto a dedicated VAT compliance platform, cleansing it, applying HMRC compliant calculations and performing automated checks eliminates the problem of spreadsheet-based errors entirely. In addition, digital audit trails help the business to demonstrate compliance and prove that “reasonable care” has been taken. With tax teams freed from mundane data entry and processing, they can spend more time on data analysis to get insights from the data, conduct trend analysis and deliver more value to the business.
Ultimately, dedicated VAT compliance software, as opposed to bridging software, brings the benefits of increased accuracy, efficiency and control to the VAT process. It removes the need to dip out into spreadsheets, includes error and anomaly checks and provides an end-to-end digital audit trail. If you’re still using bridging software and would like to find out more about how a VAT compliance platform can improve accuracy and de-risk your Return as well as help you prove compliance, contact us for one-to-one demonstration or download the AlphaVAT brochure.