Non-compliance risk for “laggards” as MTD for VAT lands

The initial phases of the Making Tax Digital for VAT (MTD for VAT) rollout could be fraught with challenges due to a reluctance among smaller businesses to change, market participants have said.

As of today, UK businesses with a taxable, annual turnover below £85,000 are subject to the government’s new electronic filing requirements. Mandatory compliance has been in place for businesses above the threshold since April 1, 2021.

According to HMRC, around a third of VAT-registered businesses with taxable turnover below the threshold have voluntarily signed up to MTD for VAT ahead of the deadline.

“It’s those that are reluctant that are probably going to be impacted the most by this,” says Becki Roberts, senior manager and UK lead of cloud accounting at UHY Hacker Young.

“Whilst there’s been an awareness around this now for three years, people have maybe had their heads in the sand with it because they’ve never needed to submit in this way before and they’ve always been compliant.”

Such sentiments are echoed by Russell Gammon, chief solutions officer at Tax Systems, who identifies sole traders as a particularly challenging group to advise on this matter.

“In a lot of instances, sole traders are clearly not people who are necessarily tech-savvy,” he says.

“They’re people that will typically use a high street accountant or someone that they know to do their books. Just generally speaking, there’s always going to be a batch of laggards that you need to push.”

Under the new regime, businesses must file returns using one of two solutions. The first, and more simplistic option, is a bridging tool. It works by using an API to connect non-compatible software such as Excel spreadsheets to HMRC’s systems.

Alternatively, businesses can adopt one of several HMRC-recognised and fully compatible MTD software solutions. Depending on the price point, these more sophisticated solutions come with a range of forecasting and record-keeping functionalities.

“Bridging software is fine – it’s compliant, but it’s not going to add any value to your process,” says Gammon.

“[Fully compatible solutions] are that gold standard that we’re seeing now where you’re effectively buying technology that will do the calculation for you.”

But the wealth of options is likely to present advisers with a dilemma, according to Roberts, with many smaller businesses unable to see the immediate benefits of adopting such solutions.

“The biggest shift is going to be those businesses that are below a certain level of complexity and, therefore, don’t use technology in this way,” she says.

“Someone who already knows their numbers might not see any benefits from making their records digital.”

According to Emma Rawson, technical officer at the Association for Taxation Technicians, this range of options and potential push-back from clients is likely to make it a challenge for businesses and advisers under pressure as the compliance deadline looms.

“It’s a case of that next step being a bit of a shock to some people,” she says.

“I think the main challenge for them will be finding the software that’s right for them and then getting up to speed with that in time to file their first return.”

MTD for VAT: No one-size-fits-all solution

Rawson suggests that a number of businesses will fall into an awkward middle ground between the two MTD compliant software options.

“At that point, it falls to the adviser to have a conversation and talk about the different benefits,” she says.

“It’s a case of looking at the clients and their needs and circumstances and how tech-savvy they are, what their budgets are, and then finding something that works for them. I don’t think there’s a one-size-fits-all solution.”

Advisers have a critical role to play in getting the more sceptical businesses over the line, adds Roberts, who argues that a key aspect of this is helping them to fully understand and visualise the benefits.

“From our stance, the important thing is that what clients are paying is right. So that will prevent them from potentially overpaying and will reduce the risk of HMRC investigation and any penalties that may go along with that.”

According to an HMRC report released in March 2022, the estimated additional tax revenue raised from MTD for VAT during the 2019-20 financial year was between £185m to £195m.

“This research provides strong evidence that [MTD] is achieving its objective of reducing the tax gap,” the report said.

Additionally, in a recent HMRC study of more than 2,000 businesses, 69 percent reported experiencing at least one benefit from MTD, while more than two-thirds (67 percent) said MTD had reduced the potential for mistakes in at least one aspect of the record-keeping, preparation and returns process.

“Tax function budgets are either staying the same or getting cut, but what’s also happening is that they’re being asked to do a lot more, and you’re seeing lots of different agendas around ESG and other things,” says Gammon.

“The only way to do that, realistically, is through technology. There’s definitely a big time-saving driver here.”

But for Rawson, the key selling point for businesses is the prospect of future readiness. Even if businesses feel as though it won’t add significant value now, the upgrade is necessitated by future tax system changes, she argues.

“If you were going to go in for a software package and you were a sole trader, you’re going to want to know that in two years’ time, it’ll work for income tax as well. You’re not going to want to change again.”

Having been pushed back by two years, the UK government will introduce MTD for Income Tax Self-Assessment (MTD for ITSA) from April 2024. MTD for Corporation Tax will be rolled out in April 2026 at the earliest.

Gammon goes on to argue that businesses coming into the scope of MTD for VAT this April will benefit from “playing the long game”.

“The way we think of it is, do you want to put the sticky plaster over it and do the Excel process, or do you want to properly sort it out for good?

“It’s a simple ROI calculation. The software will cost X, but that might save me 10 days of Excel work, and it might recover me X number of pounds per quarter.”

Impact on the wider tax system

The value of MTD for VAT for the economy at large is great, adds Gammon, pointing out the UK’s growing tax gap, which HMRC estimates to be 5.2 percent of total theoretical tax liabilities (around £35bn).

“You’d think the biggest offenders are underground and fraudulent traders, but they’re not.”

The deficit predominantly comes down to what HMRC terms “not taking reasonable care”, says Gammon. This can be as simple as mistakenly typing the number 1,000 instead of 10,000, he says.

“It’s the kind of thing that should be very simple to drum out in theory. So, what MTD is really aiming at is getting access to that data sooner so they can make more informed decisions.”

HMRC also states that the three primary risks of failing to take reasonable care when filing returns are: an understatement of a person’s liability to tax; a false or inflated statement of a loss; and a false or inflated claim to repayment of tax.

“This isn’t just one thing that needs doing and then it’s gone,” says Rawson. “It’s the start of a longer journey towards fewer errors, more digitalisation and greater use of software.”