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MTD: The costs and the reality

30th Jan 2017
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Wendy Bradley seeks out the truth behind the figures quoted by HMRC for the costs and savings from making tax digital (MTD) for small businesses.

Expenses ignored?

From my conversations with self-employed friends (I am not an accountant), I conclude they generally record takings carefully, because they know they could get into trouble if they fail to record any money coming in. But the business owner may be a bit less careful about recording every penny going out. At tax return time, instead of searching for every last receipt, they include an estimate for say, printer paper and hit "send".

If you have enough money in hand to pay the tax figure the computer spits out, then who cares if you could have paid a bit less tax so long as the thing is done?

What if there are other small traders who are careful with income but less so with expenditure? Will the government really get an extra £625m in tax after 2020-21 from introducing the MTD digital record keeping requirements? Are small business accounts really inaccurate by hundreds of millions a year?

MTD savings

The MTD impact assessment suggests there will be a £400m benefit to businesses in administrative burden savings, but how does this interact with the tax figure?

If there are savings in time spent by the business owner by using digital record keeping, that time can be ascribed a cost which results in a notional saving. A balanced assessment of costs and savings should also consider hard costs like the purchase or license of software and increased expenditure on book-keeping.

These costs, as well as contributing to the admin burden methodology, also contribute in accounting terms to the reduction of taxable profits.  If the savings from the £400m MTD admin burden aren't captured in taxable profits but the costs are, then won't the overall taxable profit figure, and thus the overall tax figure, in fact go down?

Calculating the figures

In the main MTD consultation document the tax figure is found on page 67 under “Exchequer Impact”.  It says there will be an extra revenue of £10m in 2018-19, £310m in 2019-20 and £625m in 2020-21 and "each year thereafter".

The impact assessment chapter of the same document says the figures have been certified by the OBR and are also published in the Budget (table 2.2 of Budget 2016).  Downloading table 2.2 simply gives you an excel spreadsheet which includes the same figures as the draft TIIN chapter.

Looking further at the rubric under the exchequer impact figures in the TIIN, however, we see this statement: "Revenue lost to HMRC due to errors and failure to take reasonable care was estimated at £6.5bn in 2013/14. The methodology behind this estimate was published in Measuring Tax Gaps 2015."

Source of tax gap figures

Measuring Tax Gaps 2015 is archived but still available and it is an interesting read. Figure A.2 in the introduction shows which of the five methods of measuring the tax gap applies to which tax and taxpayer grouping. 

The five methods are data matching, top down methods, management information, random enquiries, and illustrative (they are explained further in the document). The MTD population of "SA business taxpayers" is coloured brown to indicate the tax gap has been calculated using "random enquiries".

What are random enquires?

As part of their enquiry programme, as well as the usual "risk based" tax enquiries, HMRC carries out a certain number of "random" enquiries each year. 

The exact number is not disclosed, and the taxpayer under enquiry is not told that this is the reason for the enquiry, although all taxpayers subject to enquiries are supposed to be made aware that this is a possibility.  It is generally felt that the number of random enquiries is small, perhaps 100-200 per year, although HMRC has assurance from the National Statistics Office that their methodology is robust.

However, at paragraph B15 from the methodological annex it says: “For direct tax estimates based on random enquiries, an adjustment is made to account for under-declarations that are not detected. HMRC continues to undertake analyses to define suitable ranges for other systematic biases in the direct tax estimates. “

In other words, after they have looked at a random enquiry, HMRC add on an "adjustment" to account for anything else they might not have discovered.  (The number they first thought of, perhaps?)

Digging further

MTD will be one of the biggest changes the tax system has ever seen, and it is therefore important that the reasons for making the change are robust and evidence based. I have contacted HMRC on behalf of AccountingWEB, and made a request under the Freedom of Information Act for details of the computation, and the underlying data resulting in the exchequer impact figures in the MTD impact assessment.

Watch this space: The Freedom of Information Act gives HMRC just 20 working days to respond.

Replies (9)

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By RobertD
30th Jan 2017 17:51

So, the tax gap for SA has been based on 100 to 200 random enquiry partly estimated undiscovered tax adjustments. The basis for MTD is as flawed as the plan itself. Mucho egg coming your way Harra, Ellison and Gauke.

Thanks (3)
Replying to RobertD:
By Wendy Bradley
31st Jan 2017 14:18

Well it *may* have been - but there may be more and better information we haven't seen yet. Hence the Freedom of Information request.

Thanks (1)
By ireallyshouldknowthisbut
31st Jan 2017 09:07

My assumption would be that sole trader clients who do their bookkeeping at least quarterly claim a lot more expenses than those than do it annually.

Simply due to remembering more stuff they have spent.

Indeed this time of year I often berate clients for the paucity of their claims, and spend ages playing the "what have you missed?" game to save them some tax.

Thanks (1)
By Tornado
31st Jan 2017 12:01

In this run up to the filing deadline, it always becomes apparent where the tax gap is likely to originate. Many of my clients interpret taxable income their way and if it were not for the fact that I assist them with the completion of their Tax Returns, then I am sure that a lot of income and gains would be missed from their Returns if they did it themselves.

There is no intention to evade or avoid tax, it is just ignorance of the tax system and they do the right thing by getting a professional to assist them with their Returns.

It is undeniable that Accountants are key in 'policing' the Tax Administration system and the Government's plans to sideline Accountants is at their own risk.

In my mind, the tax gap is predominately created by the increasing encouragement by the Government for people to complete their Tax Returns themselves. It takes a lot of skill and experience to complete a Tax Return properly and although the average person can deal with basic tax, anything a little more complex defeats them.

I see this particularly with Capital Gains which is almost a voluntary tax. Unless the gains on some transactions are reported on the Return, the chances of the lost tax being discovered are slim.

I happen to believe that the Self-Assessment system is an excellent way to capture tax data, and some improvements to this system would make it perfect in my view. If the Government realised that their belief that everyone is a tax expert is just a delusion which is simply fuelling the tax gap and did something about that, then the situation would improve dramatically.

I think I can confidently say that those people who seek the assistance of professionals to complete their Tax Returns contribute very little to the Tax Gap.

Making Tax Digital will not solve the problem of people doing it themselves. As with the assumption that everyone is capable of filling in their own Tax Return, the assumption that everyone is capable of learning how to use accounting software is equally absurd. As with do-it-yourself tax, there is a tendency for people to completely ignore something if they do not understand it and just forget it. This will be the same with the accounting software that people will be forced to use. And who is going to police this? HMRC will not cope and Accountants and Software developers will not be interested unless there is a fee for the time involved.

The bottom line is that we already have a very good system of tax data collection through Self-Assessment and this has the potential to be enhanced with complimentary digital services. We can move towards digital tax services confidently and successfully by building on what we already have.

What madness is it that the tax administration system has to be completely renewed at enormous financial, business and social cost when this is completely unnecessary.

Thanks (8)
By Wendy Bradley
31st Jan 2017 15:12

Note the consultation responses, published today (31/1) include an updated impact assessment (here: https://www.gov.uk/government/publications/digital-reporting-and-record-...) and the figures for exchequer impact remain the same: £945million by 2021 including £625m in 20-21 and (presumably) each year thereafter. Interesting times!

Thanks (1)
Replying to wendybradley:
By RobertD
31st Jan 2017 16:24

wendybradley wrote:

Note the consultation responses, published today (31/1) include an updated impact assessment (here: https://www.gov.uk/government/publications/digital-reporting-and-record-...) and the figures for exchequer impact remain the same: £945million by 2021 including £625m in 20-21 and (presumably) each year thereafter. Interesting times!

Although less interesting when you completed 138 tax returns and 50 companies on your own last year. Daunting, yes, worrying, yes, selling up, distinct possibity.

Thanks (0)
By Ah Choo
01st Feb 2017 11:26

Be very interested to hear the response to your freedom of information request Wendy and to understand the substance behind these figures.

As well as reducing the tax gap, the impact assessment you mention goes on to suggest that MTD will actually save business money rather than cost it money in the long run for complying? I would dearly like to see the workings behind this nonsense too as all we have is a pretty little graph. The treasury select committee certainly don't agree.

How can moving from doing something once a year to five times a year possibly take less time and save business money however simple the process may be (which I'm not convinced it will be)? It will either cost business more accountancy fees or more of their own time both of which have a cost associated to them.

Thanks (4)
By North East Accountant
02nd Feb 2017 09:13

Interesting to see if they send it. They will have to type something up from the back of a fag packet calculation they have done.

Let's say the home office decide that to catch all criminals they are introducing a self submission process whereby the criminal has to submit a quarterly report of all the crimes they have committed. Just a 3 line summary nothing too complicated. Reports received=Nil.

You catch criminals by having detectives working cases to a conclusion.

Same for tax. You catch cheats, fraudsters and fiddlers by having inspectors investigate them.

Unfortunately the entire tax system is set up to pick on the easy targets who at least try to comply and ignore the people who don't bother. A lot of people will look at MTD , think why bother and drop out of the system.

Thanks (1)
By cfield
03rd Feb 2017 00:54

We all know that tax gap figure is pie in the sky, but it is revealing to hear how it actually came about. Just 5 minutes basic arithmetic on the back of an envelope would have made it blindingly obvious that it can't possibly be true. The FOI response will make interesting reading indeed.

Thanks (0)