Will Making Tax Digital bridge the tax gap?

29th Jun 2018

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Following the release of the latest tax gap analysis, Wendy Bradley explores whether the mandation of MTD for VAT from next April is really justified by the figures.

HMRC has published its latest estimate of the tax gap and the methodology it used to arrive at the figures. I have argued before that Making Tax Digital (MTD) is a customer service initiative reframed as a revenue-raising intervention and I wondered if the latest figures changed anything. Is the mandation of MTD from next April for traders over the VAT threshold really justified by the tax gap figures?

How is the tax gap calculated?

The tax gap is calculated, to put it crudely, in two different ways: one for direct and one for indirect taxes. A direct tax is "a tax imposed on a person or business" such as SA or CT, and an indirect tax is "a tax imposed on a transaction" such as VAT or Excise duty. For direct taxes, the tax gap is calculated "bottom up" and for indirect taxes, it is "top down".

There seems to me to be a false equivalence here. VAT and other indirect tax gaps are worked out by taking the total transactions – derived largely from externally visible Office of National Statistics data sources – and then calculating what the total tax on these transactions could have been, making allowances for exceptions (small businesses below the VAT threshold, schemes, allowances etc) and then subtracting the actual VAT received from the theoretical maximum.

In contrast, for direct taxes there is a large degree of estimation based on information known only to HMRC. The calculation starts from an extremely small number of random enquiries – see table H1 in the Methodology document where we learn that there were 2,763 SA random enquiries, 925 random employer compliance audits and 362 random enquiries into corporation taxpayers.

We are told that the results are statistically valid and we must, of course, trust HMRC to mark its own homework in this regard. However, the results are then "adjusted", firstly by assuming that the random selections which aren't worked would give the same results as the ones which are.

Figures ‘not the end of the story’

It is a long time since I worked an HMRC enquiry personally, but I seem to recall that when random enquiry cases were allocated to you that was not the end of the story.

You could convince your manager that a particular random case should not be worked as a full enquiry because, for example, the taxpayer was too old, ill or otherwise vulnerable for it to be reasonable to put them through the stress of an enquiry without prima facie evidence. If this is still the case, we might wonder if it is reasonable for this kind of taxpayer to be assumed to be as likely to understate their profits as the rest of the population?

There's more, though. Even after "adjusting" for cases selected but not worked, the numbers are then subject to a "multiplier", on the assumption that even though the cases have been fully worked by an HMRC investigator the investigator won't have found everything.

Apparently, they do this in the States, so the UK has adopted and adapted their methodology (page 64 of Measuring the Tax Gaps: "these multipliers are generated through supplementary studies on particular tax return entries, together with econometric analysis of non-detection rates across IRS examiners".)

Will MTD narrow the gap?

The tax gaps for direct taxes are subject to a larger degree of secrecy and of adjustment than the "top-down" figures for VAT, and it was largely by arguing the speculative nature of the estimated tax yield from making direct taxes subject to Making Tax Digital that enabled the industry to argue its way out of mandation for the smallest taxpayers, at least for now.

Is the requirement for traders over the VAT limit to keep their records electronically and update HMRC with their results four times a year likely to close the tax gap for indirect taxes?

The VAT gap has gone down over the medium term: in 2005-6 it was 12.5% and in 2016-17 it was 8.9%. But it has gone up in the short term: in 2015-6 it was 8.4%. Figure 2.4 on page 31 of Measuring the Tax Gaps shows us that perhaps the figure is best thought of, like the administrative burden figure, as a score.

Just as the administrative burden figure doesn't really tell you whether your business will save £x or £y as a result of a particular change to administration but will tell you whether the overall trend is up or down, so the top-down tax gap figures seem to be capable of multiple revisions year-on-year as fresher or better data become available, but the overall shape remains the same.

The real question is, will imposing the huge administrative burden of Making Tax Digital have a real impact on the Tax Gaps figures? I can see nothing in the new calculations that makes me revise my opinion, that MTD is a customer service initiative that should be funded and carried out. But that making it compulsory in the mistaken belief it will, at a stroke, reduce the tax gaps is a delusion.

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Replies (21)

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By djtax

29th Jun 2018 12:55

Presumably HMRC accept (and our professional bodies will no doubt concur) that the vast majority of qualified professional advisers ensure that their clients are submitting reliable figures on the current systems for all taxes. If so does that then lead to a conclusion that the tax gap is predominantly down to unrepresented taxpayers? Yet all the furore over MTD for VAT is being debated by advisers only and HMRC have done NOTHING WHATSOEVER yet to publicise the imminent arrival of MTD VAT to the wider business public. But that then does not make any sense...

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Replying to djtax:

By Wendy Bradley

29th Jun 2018 15:27

I don’t think I would make any assumptions about HMRC’s confidence (or lack of it) in the industry - look at the figures for errors in the £1-500 band in the methodology document & you’ll see what kind of error HMRC thinks it’s seeing...

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Replying to djtax:

By Open all hours

01st Jul 2018 12:09

According to HMRC at the seminar we attended in November (?) 2016, they see the same level of ‘errors’ right across the board from qualified, other agent and unrepresented tax payers. We didn’t believe them either.

If ‘customers’ are going to be more up to date with their records they will be more inclined to record expenses. Cash jobs will still be cash jobs and the tax gap with expand.

The lack of information from HMRC to the unrepresented tax payers about MTD is a disgrace indeed it is a scandal.

The fact that MTD is an international (OECD) inspired initiative fills me with dread. We are being led into true Orwellian territory. It just feels wrong and we are powerless to do anything about it.

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By GW

29th Jun 2018 17:10

As the tax gap is the difference between estimated amounts due and actual amounts received and considering the result of prepopulating tax returns - less tax collected; is MTD going to lower the tax gap, not by increasing the tax take but by showing how inaccurate the estimates are?

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By Tornado

29th Jun 2018 17:26

The word 'estimate' appears about 400 times in the Methodology publication.

I didn't have any enthusiasm to check the 'estimate of tax gap" publication.

Thank you Wendy for wading through these publications for us.

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By Tornado

01st Jul 2018 14:25

It is interesting to note that in the Methodological Annex, page 47 paragraph H.73, HMRC estimate that out of £680 millions of tax lost from 'Moonlighters' an astonishing £590 million is lost solely from under declared lettings.

I don't see how MTD will help with this as these 'Moonlighters' are probably already in the PAYE system and are already obliged to declare such income.

I can think much easier and effective ways to deal with this problem than the MTD solution.

If anything, this estimate just proves how bad HMRC are at the moment in collecting relatively straightforward taxes.

This morning on TV I heard someone pointing out that whilst AI, super computer system, and other technological wonders are promised for the NHS as a cure for its problems, the solutions are much simpler than that. Simply making it easier to get Doctors Appointments and easier access to the service is all that is required.

As with MTD, forget the technology and stick to the basics and the tax gap will then naturally decrease.

Thanks (1)

By gracegariff

02nd Jul 2018 10:22

Although I acknowledge that we are moving towards digitalisation in many areas of life, I honestly can not see how MTD will close the (estimated) tax gap. If a trader's figures are incorrect on paper, will it not be just as easy for the trader to have them incorrect on a cloud book keeping system? Am I missing something?

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By leon0001

02nd Jul 2018 10:36

No.
Next question please.

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Replying to leon0001:

By Tornado

02nd Jul 2018 10:49

leon0001 wrote:

No.
Next question please.

The next question is predictable -

Why do you say No?

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Replying to Tornado:

By leon0001

02nd Jul 2018 11:10

You are welcome to refer to to any or all of my previous comments on MTD.
The current plans for MTD, which have already been kicked into the long grass in respect of direct taxation, won't happen.
The VAT plans will be implemented but after the usual initial problems, the rules will be eased to allow keyed input of return data.
I won't be wasting any more time on this subject.

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By cfield

02nd Jul 2018 11:39

The trouble with MTD and indeed most other Government initiatives is that the decision-makers are not close enough to the coal face to see how things work in practice. They just cannot see the wood for the trees.

Of necessity, they rely on rough estimates and statistics collected in all sorts of ways, some quite dubious, and then treat them as robust data. Policy then takes over and all objections/reservations based on practicalities get steamrollered in the drive to implement the policy in the shortest possible time-frame.

Only years later when the project is seen irrefutably to have failed will any sort of enquiry take place into what happened. People will then ask why all the obvious bad signs were ignored.

The only way to overcome this is for all major changes in the way things are done in the public sector to undergo a proper degree of independent scrutiny first before policy decisions are made. I know we have Impact Assessments but these tend to be conducted by the very people who wish to push through the proposed changes and I suspect that in most cases they make sure the revealed impacts are not severe enough to derail the initiative.

Maybe we should have some sort of independent public enquiry first rather than afterwards once things have gone belly-up.

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By ohgoodgodno

02nd Jul 2018 12:03

I also went on the HMRC consultations on MTD

they just didn't get the message that most tax payers, especially those represented by professional firms are actually responsible tax payers trying to do things right, for the vast majority if errors are made they are genuine

they also failed to grasp that someone who currently doesnt comply with the regulations as they are now, will still not comply under a new set of rules

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Replying to ohgoodgodno:

By kevinringer

02nd Jul 2018 13:25

I also went to a HRMC MTD meeting. I pointed out that SA already has a mechanism for dealing with these errors: enquiries. I pointed out that if my clients were typical, the loss of tax from client base would be several thousand a year (I no loner have the figures) but I had not had an enquiry for years. Other agents also said they hadn't had enquiries for a long time. This all suggests HMRC are happy with the tax take from our clients in which case the gap must be mainly attributable to a small number of offenders. If these were all in SA the tax gap per offending taxpayer would be huge and unrealistic so the gap must be with people who are not known to HMRC. These people aren't going to think 'oh no, MTD, I must register with HMRC'. No, these people are going to remain off-radar. How will MTD bring these people to HMRC's notice?

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Replying to ohgoodgodno:

By DAS

06th Jul 2018 13:43

My understanding is that errors tend to be random: eliminating errors that close the tax gap will be offset by eliminating errors that widen the tax gap.
If we're actually talking about VAT-fraud, then individuals who have been intent on committing VAT- fraud in the past, are unlikely to be deterred by digitisation.

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Replying to DAS:

By kevinringer

09th Jul 2018 09:54

A point that I have made to HMRC many times during the MTD consultations and subsquently

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By Ajtms

02nd Jul 2018 12:33

I agree with "Open all hours" if taxpayers and their agents are going to be forced into MTD where income = £10,000 then everyone will be more vigilant in keeping track of their receipts, and expenditure claims will rise and the tax gap will widen. In my 40+ years in the profession I have never seen anybody under-declare their income, but when I query with them where are their expenses for stationery and postage, so many have said they don't bother claiming as "I get these in the supermarket with my groceries and don't bother checking through the 1/2 meter long till receipt for everything business related". If MTD for income tax comes in then there will not be so much as a paperclip unclaimed for with a resultant legal loss to the exchequer. As "Tornado" points out there will be Moonlighters, but MTD is not the solution to that problem. Instead the government should force us all to only pay small traders via their bank account and not by cash thus leaving an audit trail.

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By JD

02nd Jul 2018 22:50

Perhaps somebody can enlighten me on why HMRC seem to think cash is digital?

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By JD

02nd Jul 2018 22:52

Edited as duplicate of above

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By EnglishRose

13th Jul 2018 16:49

I see today they are delaying the VAT pilot
I wonder which of these approved suppliers will have a product as close as possible to my current paper records and which does not require use of a mobile telephone.

https://www.gov.uk/government/publications/making-tax-digital-for-busine...

ttps://www.gov.uk/government/publications/software-suppliers-supporting-making-...

Accu-Man
Ajaacts
BTC Software
Bx
Clear Books plc
DataTracks Global Private Limited
eFileReady
Farmplan
Go Simple Software
Intuit
IRIS
Liquid Accounts
PwC
Quickfile Accounting Software
Sage (UK) Limited
Simplifi-HQ Limited
Tax Optimiser
Xero

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Replying to EnglishRose:

By kevinringer

13th Jul 2018 16:53

EnglishRose wrote:

I see today they are delaying the VAT pilot

Where does it say that?

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Replying to EnglishRose:

By kevinringer

13th Jul 2018 16:54

Does the list include linking software? I ask because https://www.neilsonjamestech.co.uk/ is not included.

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Will Making Tax Digital bridge the tax gap?