Time for a proper review of the MTD proposals

Key points

• Taxpayers, HMRC, agents and the government all have different ideas of what they want from a tax system.
• Are accounts necessary for the simplest businesses?
• It is a mistake for HMRC not to provide suitable making tax digital software for the smallest traders.
• Digitalisation has got to produce clear benefits for taxpayers as well as for HMRC.
• Could final adjustments be dealt with in real time rather than in a formal tax return?

The announcement that the introduction of making tax digital (MTD) will be deferred for a year has been generally welcomed by all in the profession. Most practitioners and their clients have enough to do simply to get back to some sort of normality without having to struggle with the intricacies of the new system which was heading down the tracks alarmingly quickly. We now have a bit more time before the MTD button is pressed: how should that time best be used?

Waiting for the postman

There will be those who argue that it is time to scrap the whole thing and retain the current system, warts and all. I understand that view but I think that it would be a mistake. We have all seen the benefits that well-designed online systems can bring. When I remind my children, who are used to next-day or even same-day delivery that mail order catalogues use to say ‘allow 28 days for delivery’ they look at me as if I was talking about how life used to be in the Victorian era. It must be right for the tax system to take advantage of the benefits that digitalisation has brought elsewhere.

Using the time wisely

I suggest, however, that it would be wrong simply to roll the current plans forward by one year. Indeed ‘suggest’ is not strong enough. It is imperative that there is a proper review of the MTD proposals before they are set in stone. A pause of one year might give us all a bit more time to prepare, but unless it is used to address some of the key issues which should lie at the heart of this fundamental change to the way the tax system is administered, the time will have been largely wasted.

So I would like here to stand back and look at the basic building blocks of the current MTD proposal and consider whether they are still appropriate as the foundations for the next generation. What follows is by no means a complete and coherent set of proposals for reform. It should be seen more as stimulus for debate and to help to focus minds on what are the real issues.

Not everybody will agree with everything I say (indeed I am refining my own views all of the time) and some will strongly disagree. But I think that we would all agree that we have to get this right for the future health of the tax system.

Who are we talking about?

It is very important to have in mind the population which will actually be most affected by MTD for income tax – unincorporated sole traders. The latest figures I can find (tinyurl.com/22r83862) show that there were about 3.5m sole traders in the UK of whom 3.3m had no employees. So in the main we are talking about a population of individuals working for themselves. I intend absolutely no disrespect when I say that these are generally not businesses in the sense that we might use that term – they are individuals doing jobs on a self-employed basis. We are talking about delivery drivers, mobile hairdressers, labour-only subcontractors, yoga teachers, painters and decorators, etc. I stress this because I think that we should be looking at MTD predominately from the perspective of these sorts of individuals working for themselves. Much of the debate has been skewed by looking at the issue from the other end of the telescope – substantial sole trader and partnerships concerns which would more easily be recognised as businesses by the man or woman in the street.

Many of the people involved in the shaping of MTD (both in HMRC and in the profession) will probably have been more comfortable with this perspective simply because they (I include myself in this) have greater experience in dealing with larger businesses. So as we move forward I really would like to see everything filtered through the lens of the smallest sole trader. Of course the needs of larger businesses must also be closely considered, but there is a real danger here of the tail wagging the dog unless we really get the focus right. I’m not going to deal with larger, more established businesses in the rest of this article until I come to my closing thoughts.

Who wants what from MTD?

So let’s look at what these three million-plus people and those who deal with them are likely to want out of a tax system, accepting that ‘we want nothing to do with it’ is not going to be an acceptable answer here. Different people will have different priorities but I would suggest that the following would be common themes for the self-employed population:

• minimum administration burden and as little extra cost as possible;
• understanding as far as possible how their tax is worked out;
• no surprises or things crawling out of the woodwork years later;
• the choice of managing your tax yourself or using an agent to do it for you; and
• one set of rules for all the taxes you pay.

HMRC’s bullet points would probably include:

• good quality reliable record keeping;
• prompt filing and payment of tax;
• accurate and complete tax reporting; and
• minimal use of HMRC staff time on routine compliance.

The government would probably say:

• consistent and reliable tax cash flow; and
• predictability of receipts and forecasting.

Agents would probably say:

• good quality reliable record keeping;
• the ability to do as much or as little as the client wants to assist in meeting their obligations;
• the ability to experience exactly the same IT systems and views as clients;
• no unnecessary duplication of effort;
• a working pattern through the year that does not create pinch points; and
• reliable HMRC systems and processes.

Is it possible to reconcile all of these various propositions? It will not be easy, but I don’t see any items in these lists which are fundamentally irreconcilable. They might well form the basis of a checklist to review future progress.

Who needs accounts?

Let’s start with a big question. I am stepping into highly controversial territory here, questioning something which has been a fundamental assumption of the tax system since the introduction of income tax. I can hear the (non-digital) pencils being sharpened already. But here goes. How necessary is it for sole traders to draw up annual accounts?

For those who are running recognisable businesses, incurring liabilities and employing staff, accounts are essential but do the sole traders that I am concentrating on here actually see any use for annual accounts? Do they sit back and review their financial performance on a year-on-year basis? Some may do, but I suspect that for the vast majority there is no need for an annual reckoning – what matters is the cash they have at the end of the week or month.

Put the question another way: if it were not for the need to file a tax return would they pay for a set of accounts to be drawn up? In many cases the answer would I am sure be no. But they might need some external verification if they need proof of income for a loan or mortgage. A review of lenders’ terms and conditions suggests that bank statements and tax returns are much more important here than accounts per se. (But see Aside.) So if sole traders have no need to draw up accounts to manage their own income why do we require them for tax purposes?

If we question the need for annual accounts what does that do to the whole concept of basis periods? Do we need them at all? Could we simply have a system under which information is provided to HMRC on a regular basis (quarterly or even monthly) without the need for the submission of annual accounts? Our whole upbringing as tax advisers screams out ‘no’ to this, but is that right? Does there actually need to be an annual reconciliation? If we assume that these sole traders will operate on the cash basis (which I think would overwhelmingly be the case) and we got the basic data flow working properly from day one what adjustments would be needed?

Let’s start with capital allowances – obviously they would need to be dealt with on an annual basis, wouldn’t they? I am not so sure. In the context of 100% annual investment allowance is there really any need for capital allowance computations – couldn’t purchases and sales of capital items be dealt with in exactly the same way as other items of income and expenses? Remember, here we are talking about individuals doing a job on a self-employed basis – we are not dealing with established businesses with premises and infrastructure costs. If we start from what makes sense from the traders’ point of view rather than how the tax system is currently designed we end up looking at things quite differently.

Driving away

What about cars, I hear you shout? You can’t write off the cost of the car all at once. True, and I can’t imagine that the government would ever allow that to happen, even if it is committed to simplifying tax administration. But surely it would be possible to find a mechanism for dealing with cars which encompassed not only the capital cost of the car but also the running expenses.

It is not that difficult to envisage a system under which the individual would enter the cost of the car when they acquire it and each month or quarter they would simply enter total milage and business mileage. I don’t think that it is an unreasonable imposition on a sole trader to spend a few minutes each month or quarter in recording these two figures. Everything could then be worked out automatically. Is it really too much to say that if somebody wants to obtain tax relief for the cost of motoring they should have to be able to have retain this evidence? Modern apps make this very straightforward.

Similarly flat rate deductions for use of home as office and other such expenses could be given automatically. I do not underestimate the problems here but again if we start with the mindset of what makes sense from the trader’s perspective solutions can surely be found.

Where does the software come from?

That then brings open the question of who is to provide the software to do all this. HMRC has deliberately decided not to provide the software tools for MTD on the basis, as I understand it, that it does not want to disrupt the commercial market. I think that this needs looking at again.

For the sole traders I am talking about here I see great advantages for taxpayer and the Revenue alike for HMRC to provide a proper interface for traders to complete everything online. This would have to be designed from scratch using all of the experience that commercial organisations have developed on how to design software that works from the user’s perspective, rather than designed purely for the needs of the organisation. I know that that is a hard ask and that many readers will be throwing up their hands in horror at this point (if they have not already done so) but it is not impossible. I have been impressed by some of the ways that HMRC has applied these sorts of design principles in some of the material which was produced for Brexit so I would not rule it out completely. Certainly I think that it is not right for HMRC to step away from providing tools to enable sole traders to meet their obligations.

What’s the point?

Making tax digital quarterly reporting has been seen very negatively by the profession because it appears to be a waste of time. If HMRC is not intending to do anything with the quarterly reports – which seems to be the current stance – and some sort of annual reckoning up will still be required, what is the point? In my view HMRC has consistently failed to articulate the actual purpose of those reports. The best I have heard is that they are there to ensure that taxpayers ‘do their homework’ by keeping their records and tax affairs up to date.

We would all agree that the standard of record keeping among the self-employed varies enormously. Some keep meticulous records and can keep track of every penny, while others stuff the occasional piece of paper in the shoebox – if they can be bothered to keep anything at all. So anything which improves record keeping is to be supported. But do the current MTD proposals do anything in this regard? I know that electronic record keeping will be mandated, but the way that this has been designed seems half-hearted.

Yes, there does have to be an electronic record of every transaction, but there is no requirement that this has to be a contemporaneous record. It is perfectly possible within the regulations as they stand for somebody to keep purely manual records and then transfer them to an electronic source after the end of the quarter. That seems to me to be neither one thing nor the other. Given also that HMRC has said that it will not be reviewing quarterly submissions, it is difficult to see what will be achieved by all of this. Indeed, I have seen on various internet forums, agents saying, only partly tongue in cheek, that they will submit ‘any old rubbish’ on behalf of their clients for the four quarterly updates and then sort everything out post year end. That approach, though perhaps understandable, serves no one’s interests.

Following where others have gone before?

HMRC is right to be concerned about record keeping and I can see the merits in a proper system of near real time information about transactions being supplied to HMRC. Not many years ago this would have seen as beyond the pale, but many regimes round the world have introduced some form of real time reporting and I have no doubt that this will happen in the UK before too long.

I believe that for sole traders with simple affairs the combination of real time reporting and some form of simple online interface could ultimately be seen as the natural way to deal with tax administration. It would be a significant change and would have to be implemented over a realistic time frame, but it makes more sense than the current proposals, which seem to me to have been fatally compromised from the outset. Let me explain why.

When do I pay?

Logically, the main reason for a more frequent updating would be to align reporting and payment. Indeed I suspect that when MTD was originally being designed there was a working assumption that payments of tax for the self-employed would be brought more onto a real-time basis. Irrespective of whether one approves of the idea, at least that would make sense. I imagine, however, that there was a failure of nerve on behalf of government and a sense that this was a bridge too far, so the idea of more regular payment was put on hold.

Clearly there have been suggestions since then that the idea will be pursued and, had Covid not intervened, we may have been further along the line with this. I think it is time that this particular nettle was grasped once and for all. We are so used to the way the system works that it is hard to appreciate just how odd it is that somebody with a 30 April year-end could pay tax on transactions during that year more than two years after they took place. While the cash flow benefit is undoubtedly highly valuable to some taxpayers, this delay creates real problems to many others. Taxpayers simply do not understand (and given the complexities I don’t blame them) the basis on which they are taxed: there seems to be a complete disconnect between payments of tax and the earning of income. This is certainly one of the major contributors to tax debt in this sector of the population.

What’s in it for me?

So I am open to a proper discussion about bringing together more regular tax reporting and tax payments. It is difficult to argue against this in principle. But, and this is vitally important, there has to be an advantage for the taxpayer as well as for the government.

A lack of clarity as to what it will bring for taxpayers has been very noticeable during the whole saga of MTD. The early emphasis on reducing the administrative burden and red tape was increasingly drowned out by the role of MTD in reducing the tax gap. Whether MTD will, in the form proposed, have an impact in that respect is open to question – the latest tax gap figures for VAT certainly do not suggest that it has had a significant impact there. But putting this point to one side for the moment it is surely unarguable that a proper digital system has to bring benefits to all parties. What might it offer to taxpayers?

Let’s look first at payments. In any system of real-time payments there would have to be a system under which repayments were also made in real time. So in a hypothetical quarterly system in which a taxpayer had a good first quarter and paid tax but had a bad second quarter so that the net result for the first six months was nil, the first quarter’s tax would need to be repaid automatically on receipt of the second quarter’s information. No delays: no claims. Just an automatic and instant process. Tax deducted at source under the construction industry scheme would have to be subject to the same rules.

Secondly, there would have to be a quid pro quo regarding HMRC’s ability to enquire and assess. One of the features of the MTD system as currently proposed which really concerns me is that it is all one way. The taxpayer is subject to earlier reporting requirements, but essentially HMRC’s enquiry and assessing powers are not similarly restricted. That cannot be right. If taxpayers have to act more quickly then so should HMRC.

Clearly HMRC must have the right to enquire and to raise assessments, but how long should that period be? If the enquiry period is to remain a year should it be a year from the date of the quarterly return (if we retain quarterly reporting) rather than the end of the tax year? Indeed, given how much HMRC now extolls the virtues of its Connect system and the vast range of information available to it at the touch of a button, is a year too long? That is something which should at least be discussed, though clearly in cases of evasion different rules would have to apply.

Death of the tax return?

Will there still be a need for a form of tax return or some sort of annual reconciliation? It may be that the answer is yes, but I would at least like to explore the issue rather than automatically assuming that this is the case.

There are two different areas of annual adjustments which sole traders would normally have to deal with: accounts adjustments and tax return reconciliations. I think that in the vast majority of cases the accounting adjustments, including disallowables and capital allowances, could be dealt with in real time in the way I have suggested.

What about tax return adjustments, by which I mean things like allocation of personal allowances, claims and elections and items of sundry income? Instinctively, it is natural to suppose that there would be a need for an annual tidying up, but I am not even sure that even this would be necessary in a well-designed system. Remember I am talking here about self-employed taxpayers with the simplest tax affairs – more complex cases would obviously need a different treatment.

Technology has a part to play here. Let’s take the simple example of capital allowances being wasted because they reduce taxable profits to below the personal allowance. Surely the technology should be able to flag automatically that a claim should be reduced (or not made at all) and automatically carry a balance forward to give a deduction next year. All taxpayers, rather than those who are well advised or who take the trouble to learn how the system works, should be able to benefit from this. A system designed with the needs of taxpayers as much as the needs of HMRC in mind would certainly do this.

Indeed if we really wanted to be radical we could ask why capital allowances should be any different from any other relief. Take traders with profits after normal expenditure of £12,000. If they incur expenditure on new equipment of £2,000 they can disclaim allowances and carry forward the cost to obtain relief in the following years. But if instead they spend £2,000 on repairs their profit is reduced to £10,000 but they derive no benefit because profits are covered by the personal allowance, so in tax terms the expenditure is wasted. Is there any sound policy reason why one type of expenditure can be retained for future benefit and not the other? It is hard to see why there should be. But I am now moving too far from my brief and starting to reform the entire tax system – that might have to wait for another week or two!

Going forward

The more I have thought about this and especially since I started to draft this piece, the more convinced I am that we need to think through some of the fundamental issues here. A digital tax administration system must be the way forward (accepting that there will be a group of people who will always be digitally excluded) but I think things have rather lost their way. After all, the broad outline of the current system was proposed in 2015 and the digital landscape has changed dramatically since then. Had someone told me then that I would be asking Alexa to turn on my lights or tell me the latest news I would have been amazed. If we assume that there was some planning time before the 2015 announcement it would mean that there would be something like a decade between the initial design of MTD and its implementation. That’s a lifetime in IT terms.

Finally, what is the role of agents in all this? I know that there is a view that MTD was a deliberate ploy from HMRC to take agents out of the equation. I never subscribed to that view, but I think that the role of agents has not properly been considered. There are two fundamental issues here. First, I believe that it is right for the system to be designed in such a way that a taxpayer with straightforward affairs can, if they want, do everything for themselves. It would be totally wrong to design a system which depended on having an agent. But it is equally important that somebody who wishes to use an agent to assist with their obligations should be free to do so and that the agent can have the same access to the same systems and the same information screens as the taxpayer. We are a long way from that at the moment.

Final plea

This has been a long article. There is much more that can be said and I hope that others will continue the discussion, including looking at larger businesses. But I come back to my initial point. Let’s use the delay constructively – just rolling forward a year should not be an option. 

Issue: 4811 / Categories: Comment & Analysis