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  • Mr Paul Clifton

Making Tax Digital (MTD) fails to reduce the tax gap

One of the main reasons, according to HMRC, why MTD is being introducing is to reduce errors and therefore increase the amount of taxes collected.

Many businesses and individuals are being forced to ‘upgrade’ and pay for new software and systems to comply with the MTD rules.

Whilst some of the comments below relate to VAT, as this is the only tax system currently within MTD, the views expressed are just as relevant to other taxes, such as Income Tax and Corporation Tax, which will come within the MTD system shortly.

Tax gap

The tax gap is the difference between the amount of tax that should be paid to HMRC, and what is actually paid.

The gap between the amount of VAT paid and the VAT expected to be paid by HMRC has increased by £2.3bn during the first year of MTD for VAT. One of main justification for the MTD programme, according to HMRC, is to reduce the tax gap.

A recent HMRC report, measuring the tax gaps for 2019/20, reveals that after five consecutive years of a falling rate in the tax gap, there has been a slight increase in 2019/20.

The total tax underpaid or missing is estimated at £35 billion, which is 5.3% of total tax liabilities. This figure was 5.0% of total tax due in 2018/19, and that percentage has proportionately fallen for the previous five years, from 7.1% in 2013/14.

MTD is supposed to reduce the tax lost from these behaviours and bring in hundreds of millions of pounds of additional tax revenue. So far there has been no clear sign that the tax gap has reduced.

Reasons for the tax gap

Most (3.8%) of the 5.3% tax gap is down to criminal attacks, criminal attacks, tax evasion, the hidden economy and tax avoidance. Only 1.5% is attributed to carelessness and error. All MTD can ever hope to do is to pick up errors and carelessness, as the other categories are deliberate.

MTD is unlikely to reduce the number of taxpayer errors and most probably could even increase them.

New software and processes

Forcing taxpayers away from their non-digital, steady and reliable simple manual records, or their existing computer systems is not always advisable or clever. Digital computer accounting records could and possibly has resulted in more errors and mistakes.

This was made clear in the House of Lords Economic Affairs Select Committee Report published in November 2018 regarding the proposed MTD for VAT. It can be said that HMRC has ignored that report and pushed a head with digital recordkeeping and digital submissions of tax returns.

We have seen clients, who maintained perfectly good paper based accounting records or spreadsheet based cashbooks and ledgers, forced or encouraged to move onto Quick Books, Xero and Sage etc.

The recent TV adverts from the above software companies have only encouraged businesses and individuals to acquire new software to help them comply with MTD. Unless they understand their software and have procedures in place to review and check their records then as you would expect they can and do made a complete and utter pig's ear of their accounting records and VAT returns.

More errors

We are sure that you have heard the old adage of ‘garbage in [to a computer] equals garbage out [to HMRC}’.

Accountants have been explaining for years that computerisation tends to lead to over claiming of VAT on purchases because of software automatically calculating reclaimable input VAT when none was on the invoice.

Clients have moved on to software and claimed input VAT on pension contributions, insurance premiums, wages and salaries etc, where there is no VAT to reclaim, because the computer has calculated it based on some default process.

On many occasions, we have seen clients reclaim the actual VAT payment, that they have just made to HMRC from their last VAT return, on their next VAT return. This has arisen when processing the bank payment for the VAT amount paid. They have put the VAT payment into the VAT box on their software, rather than the net expense box. As they do not fully understand what each box in their software does, they are not always aware of the ramifications of what they have done.

Bank transaction based processing

Most modern cloud based software now works by importing and auto-coding and auto-VAT calculating transactions from automatic ‘bank-feeds’. Traditionally, people would use paper-based invoices to identify the VAT on business expenses by methodically working through invoices and bank transactions.

This suggests that wide-scale accidental overclaiming of VAT and expenses could be larger than boring old Excel systems or sitting down with a pile of invoices and manually processing them.

Auto-imported bank feeds etc are rarely fully checked by accountants and bookkeepers anywhere near as much as manually processed paperwork. It is so easy for clients to just click a button, import transactions, auto code, post them to their software and then send the VAT Return to HMRC.

Final thought

Why are HMRC so surprised that VAT and other taxes being collected, through radical changes in systems and processes, have fallen so much.

I am not saying that using computers and Making Tax Digital, per se, is a bad thing. I think it would be better to encourage businesses and taxpayers to use the MTD system because of its perceived benefits rather than forcing it upon them.

I’m sure you have heard the old story of the battle between the Sun and the Wind, trying to force the man to remove his cape from his back. The Wind blew and blew but could not remove the cape. The Sun was gentler and persuaded the man to remove his cape. The man could see the benefits of removing his cape in the hot weather. Maybe HMRC should do the same thing?

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