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With the roll-out of HM Revenue & Customs’ (HMRC) Making Tax Digital plan, thousands of small UK businesses are facing the realities of digital transformation as they are forced to sign up for the online tax collection system.
Making Tax Digital (MTD) is an umbrella term for a major digitisation of the UK tax system, which was introduced 1 April 2019 for VAT returns, with scope of automation ultimately expanding into main duties such as corporation and income tax.
HMRC describes MTD as a way to help businesses and individuals reduce errors leading to tax overpayment or underpayment. Once reports go fully digital, the new approach is intended to reduce tax evasion. Mistakes reportedly accounted for a £33bn “tax gap” in 2016-17, which is the difference between what the exchequer expected to receive and what was actually paid.
In this first stage, submitting returns through approved software is mandatory for VAT for all businesses with a taxable turnover of more than £85,000, while businesses will not be asked to keep digital records for other taxes until at least 2020.
The initial launch follows hordes of criticism around the project and the publication of a report by the Lords Economic Affairs Committee in November, which urged HMRC to delay the go-live date of the programme for at least a year as small businesses were unlikely to be ready by April 2019.
Under MTD, companies are no longer be able to complete paper-based VAT returns or submit returns online at the HMRC VAT portal, and will need to handle their record keeping and submissions using fully featured cloud-compliant systems.
As an alternative, Bridging Software is available for small businesses as a way to securely link HMRC systems with non-compliant systems such as Excel, while free software is also available for businesses with more straightforward tax affairs.
According to the tax authority, 1.2 million UK businesses will be mandated to join MTD. As the new rules went live, the tax authority announced that nearly 100,000 organisations – including agents and independent businesses – have already signed up.
At the current rate of 4,000 switching over a day, as reported by HMRC, less than half a million companies will have made the switch by August, when most quarterly VAT returns will be due.
Non-compliant businesses can be charged penalties of up to £500, but HMRC has expressed plans to adopt a light-touch approach in the first year of mandation by not issuing filing or record-keeping fines as firms try to comply with MTD.
Resistance to change
The changeover to digital tax has been particularly tough for smaller businesses. Research from software firm Xero found that 32% of small and medium-sized enterprises (SME) owners rely on pen and paper accounting, leading to antiquated filing mistakes.
Many SMEs also view MTD as a nuisance and report significant new administrative burdens as well as a lack of clear guidance from HMRC, according to the British Chambers of Commerce (BCC).
A third of 1,000 UK firms surveyed by the BCC reported having to upgrade or source accounting software to prepare for the new rules, and incurred “significant costs” to upgrade, including training.
According to Sean Farnell, partner at accountancy firm Burgis & Bullock, the main reason for the slow uptake is reluctance by a majority of SMEs to digitise their record keeping.
“A lot of companies have used simple spreadsheet software, kept records manually and developed their own system for ensuring they are submitting the correct tax details to HMRC for a long time,” he said.
Many businesses are already using the right software but aren’t aware of the registration process, according to Farnell. He added that communication by HMRC hasn’t been particularly strong.
The tax authority also fails to understand that businesses need time to adjust to such a big change, he said, because book keeping and record keeping for tax submissions is not a top priority for SMEs.
“Record keeping is often something that is done as a Sunday afternoon job, when there is a bit of time available, especially when the size of the company indicates they can’t really afford to bring in admin support,” he said.
Smaller firms face challenges beyond culture when switching to digital accounting. According to Paul McCooey, director at accountancy firm Duncan & Toplis, broadband access has played a significant role in the preparations for the changeover, particularly when it comes to business located outside large urban centres.
“Poor connectivity has been cited as one of the main reasons why businesses are reluctant and concerned about the move from paper to digital in rural areas like Lincolnshire, where we have most of our offices,” McCooey said.
“[Slow broadband connections] is a source of frustration for many people and rural businesses just don’t benefit from the same level of connectivity that businesses in cities enjoy,” he said, adding that his company has worked with agricultural sector accountancy software providers Farmplan and Landmark as well as Xero to help clients become MTD compliant.
The potential upside
An alternative view of MTD is that it can help address the drain on business efficiencies caused by admin tasks. UK businesses in the UK are spending an average of 120 working days per year on administrative tasks, according to a Sage study, amounting to more than £9.5bn wasted collectively so far this year.
Small businesses and sole traders who tend to spend not as much time as they should do on their IT will be the most affected by the changes, but technology advances are catching up with them and MTD will force an adaptation, according to Nikki Adams, chief executive at Ad Valorem Accountants.
“The worlds of finance and IT are coming together with software that is much more user-friendly, and there is a lot of information available online to help businesses get familiar with MTD. While there has been some resistance [to the shift to digital], a key benefit from it is getting companies a more engaged in their finances than they were before,” said Adams.
While the timing for MTD is seen by some as unfortunate given the Brexit-related uncertainty, Adams pointed out that the tax digitisation plan has been known since 2015. Pilot trials have been carried out by HMRC to allow companies to test the new tax submission methods, and only businesses with “their heads in the sand” will be resisting the shift.
MTD is good news for accountants, Adams said, as it allows them to offer more services as they get more visibility into the finances of their customers.
Her firm has been working with businesses over the past three years to increase digital tax awareness and has often argued that investment in compliant software ends up paying for itself because of the money and time savings that it can generate to businesses.
“Businesses have been doing a lot on the internet already, with online banking and many have embraced cloud software to simplify their financial affairs, so MTD is concerning to them only if they left it until now,” she said.
“It’s something that only traditional firms found hard to get their heads around and reap the associated benefits, as it is a different way of working.”
It’s still early days to assess the real impact of MTD as a catalyst for business transformation, but tax digitisation will be ultimately positive, according to Demien De Souza, a tax partner at Deloitte.
“MTD, and the VAT aspect especially, will be beneficial to HMRC as they progress with their goal of better understanding and collecting tax from UK businesses, as well as businesses themselves, with the introduction of more efficient processes supported by better data between the taxpayer and the tax authority,” said De Souza.
“This can only be a good thing in respect of improving the quality of the compliance reporting processes.”
Read more about Making Tax Digital
- The National Audit Office called on HM Revenue & Customs to increase transparency and assess how moving to a digital tax system will impact businesses and individuals.
- HM Revenue & Customs published an IT strategy outlining how it plans to transform its IT estate by taking a platform approach, moving to virtual infrastructure and cloud-based services.
- MPs urged HMRC to push back the go-live date of its Making Tax Digital project amid concerns over costs, software and readiness.