Tax gap


There’s been widespread scepticism around HMRC’s claims that MTD will help to substantially ‘close the tax gap’, the discrepancy between the amount the authority is owed and what it receives. The gap itself is substantial. During the year 2016-17 it stood at £33 billion although it has fallen in real terms from 7.3 percent of annual revenue in 2005-6 to 5.7 percent in 2016-17.

The decrease that has been largely attributed to HMRC’s efforts in supporting tax payers to pay the right amount of tax with £30.3 billion additional tax secured in 2016-17 by tackling errors and clamping down on tax evasion and tax avoidance. It is worth noting that ‘failure to take reasonable care’ was the largest contributor to the tax gap at £5.9 billion, while £3.2 billion was attributed to ‘error’, suggesting that any initiatives which will improve compliance processes and reduce compliance risk could make a sizable dent in the figures.

It’s for this reason that HMRC has calculated it can claw back £1.9 billion from 2021 to 2022 through MTD. But dissenting opinions point to the variables and even assumptions HMRC has made in arriving at this figure. The Office for Budget Responsibility has twice verified this assertion to be a ‘reasonable and central’ estimation but it has also scored it with a ‘high’ uncertainty rating. This is due to the fact that the success of MTD is largely reliant on third party software capabilities and HMRC achieving MTD within the given timeframe. The fact that the introduction of MTD for CT and Income Tax has been further delayed, to beyond 2020, would suggest that the MTD timeframe is in jeopardy.

In deciding to introduce MTD for VAT ahead of the other taxes, HMRC are targeting VAT where the actual tax specific gap is proportionally larger at 8.9%, and amounts for £11.7 billion of the total tax gap for 2016-17.

Software scope

HMRC has claimed that MTD would help to reduce the tax gap because “keeping records digitally will result in more timely and accurate record-keeping, helping to prevent errors associated with manual processes”. This should help to prevent the record keeping errors associated with ‘shoe box’ or manual record keeping, the compliance errors associated with paper based or spreadsheet calculations and the transposition errors encountered when information is transcribed from one format or system to another. However, this conclusion is based upon assumptions over the way MTD software will function.

“The nudges and prompts that will be incorporated into the Making Tax Digital compatible software developed by third party software providers will help eliminate common errors, giving businesses greater certainty that they’ve got their tax right first time, reducing the need for unwelcome compliance interventions which are expensive and burdensome for both HMRC and its customers.”

The problem is, that as the House of Commons Briefing Paper Number 7949 on ‘Making Tax Digital’ issued in December 2018 states, there is no compunction on software providers to provide this type of functionality. They can meet the minimal requirements and still be considered in scope and be approved as a supplier by HMRC.

The methodology originally used by HMRC to calculate the impact on the tax gap assumed digital data capture, software that would use ‘nudges’ and ‘prompts’, and spreadsheets being replaced by integrated bookkeeping and reporting packages. Evidence from software providers suggests that HMRC’s analysis had not adequately considered the fact that none of these benefits are required by MTD for VAT.”

This puts the anticipated clawback of £1.9 million further at risk should tax payers not seek solutions that go beyond basic compliance. However, many businesses are looking to gain more from their MTD investment and are transforming their processes and systems to reduce risk and increase efficiency.

Look for function over form

So, as a business looking to embrace digital transformation and automate the production of the tax calculation and return directly from source data, whilst benefiting from inbuilt logic and diagnostics to avoid the risk of errors and mistakes in the process, how do you find a solution that provides this level of functionality?

Ideally, the software solution itself needs to be developed as a dedicated offering, providing you with a choice of products designed to suit your compliance needs and the transformation path. Some will want to go straight to the end game, others will want to evolve their process as the MTD digital link requirements tighten.  

The initial MTD requirement is for keeping digital records and providing a digital link between the VAT return calculation e.g. spreadsheet and the API submission of the VAT return; this does not require any ‘nudges’ or ‘prompts’ to be built in. However, the solution should provide the tax payer with an interface, or compliance portal, where they can view past, present and future obligations, payments and liabilities helping them to monitor deadlines.

After the soft-landing period has ended (April or October 2020, depending on whether or not the business is in the MTD deferral population) there must be digital links between all stages of the process from source to submission, thereby creating an end-to-end digital tax process. This is an opportunity to move the user away from spreadsheet dependency, taking data collected at source into the tax calculation software to achieve the kind of ‘integrated bookkeeping and reporting’ system described in the House of Commons paper.

Once the end-to-end digital solution is in place, with the calculation engine integrated into the compliance portal, the business can gain complete control over their compliance process. There’s the opportunity here for business to benefit from robust tax calculations, supported by diagnostic reports to surface errors, warnings and alerts, and a portal providing a status overview of obligations, due dates and their status, and a summary of payments and liabilities for all VAT Registrations. Again, there’s no compulsion for MTD providers to provide this today.

This kind of functionality, envisaged by HMRC but not mandatory, will benefit the business by giving it greater control over the process. Solutions such as AlphaVAT, built from the ground up, will confer this type of additional functionality on the business. It not only meets MTD requirements but also the broader ambitions of HMRC.