Will MTD reduce the tax gap?
HMRC says MTD will make it easier for taxpayers to get things right and, as a result, will reduce the tax gap. Rebecca Cave interviews CIOT tax policy director John Cullinane on the evidence for this assertion.
Q. How much of the tax gap is due to taxpayer error and mistake?
The tax gap estimate for 2018/19 attributes £8.6bn to taxpayer error and mistake, which amounts to 28% of a total gap of £31bn. Although, around £3.1bn of the tax lost was due to mistakes made when the taxpayer took all reasonable care.
Q. Can this figure be broken down between different taxes or different types of taxpayer?
The CIOT understand that as much as 80% of the ‘error’ and ‘failure to take reasonable care’ categories in the tax gap could be down to businesses with less than £85,000 turnover. These businesses are mainly within the target for MTD for income tax and are not required to comply with MTD for VAT at present.
Q. Why has MTD for VAT not reduced taxpayer errors as HMRC claimed it would?
The latest tax gap figures are for 2018/19 before MTD for VAT came in, so it’s too early to say.
However, a CIOT survey found that over 70% of respondents considered MTD for VAT had little impact on the errors made by their clients. The majority of the remaining responses reported an increase in taxpayer errors rather than a reduction.
MTD for VAT doesn’t affect the taxpayer population held mostly responsible for errors, and it wasn’t intended to in the first wave.
Q. Will the error reduction rate improve for MTD for income tax?
MTD for income tax will apply to the smaller businesses that HMRC believes make most of the mistakes. But there is a great deal of evidence that basic business records are not particularly deficient. HMRC’s decision in October 2015 to abandon business record checks could be taken as a tacit acknowledgement of this.
More errors tend to arise in the judgmental areas for tax, such as private use adjustments and the capital/revenue distinction. But software doesn’t deal with these areas very well.
Q. Is HMRC relying on prompts and directions within MTD compatible software to reduce the taxpayer’s errors?
Generally speaking, the software on offer to businesses to comply with MTD for VAT doesn’t nudge or prompt people in the right direction, beyond applying some very basic rules. Sometimes there is no particular default option on difficult issues and, in other cases, the default option is bound to be wrong. For example, a built-in assumption that cash outgoings have standard rate VAT component.
The CIOT is fearful that this may happen again with MTD for income tax. This is partly about the reliance on third-party software. Do software providers want the costs of incorporating nudges, or the potential liabilities if people are nudged in the wrong direction? All this could improve over time, but it could be a long while before we get beyond the most basic nudges.
Q. Is this confidence in MTD software well placed?
It is easier in principle to incorporate the right nudges and error-blocks into tax software than it is to write lots of nudge letters. But currently, there seems more of an accent in getting tax software providers to build an MTD software market than in some of these error-reduction benefits.
Q. What examples have you seen of tax software permitting or creating errors in tax records?
Claiming back a supposed VAT component of cash outgoings that didn’t suffer VAT is one theme. Perhaps the market will get wise to this, but other more complex errors may take longer to root out.
Typically, when the CIOT hear of a problem, it means tax agents (our members) have spotted and corrected it. But members report that it can be harder and more time-consuming to work out what has gone wrong in software than it used to be with spreadsheets or even on paper. Not all the software has a great audit trail, and this will concern HMRC at some stage.
It would be fair to say that the software has generally ‘permitted’ the error than ‘created’ it. I am not sure how well errant taxpayers will fare in citing the software as an excuse.
Q. Does HMRC check that the MTD software it promotes as approved to taxpayers performs tasks correctly and produces an accurate tax calculation?
We know that HMRC checks the compatibility of software with its own systems before it goes on the ‘approved’ list. There is probably an inherent ‘technical correctness’ component of this type of checking, but we suspect more needs to be done.
However, tax law is so complex, and so full of judgmental, specific-fact-dependent distinctions, that the software can’t guarantee the right answer, although some adverts almost suggest that it can.
Q. If HMRC does not check that the tax software performs calculations according to the tax law, who does?
HMRC would say that is the taxpayer’s responsibility to check the tax calculations are correct. Generally speaking, that is probably the correct legal position. In time, this could create a rich seam of controversy when errors are discovered by HMRC, and the taxpayer blames the ‘approved’ software.
Q. Should there be a body that audits tax software to check it performs the tasks it claims it does, correctly and in line with tax law?
When the CIOT responded to HMRC’s call for evidence on raising standards in the tax services market on this point it said: “tax advice that is ‘hidden’, by being embedded in broader advice or in technology platforms, needs to be brought in scope… of Government intervention to address the problems identified.”
Q. Is it reasonable to ask tax software producers to develop products that will reduce taxpayer errors to a significant extent without simplifying the tax system?
Not entirely, no. After nearly 50 years of VAT, software still doesn’t address partial exemption well, although admittedly this can be a very complex issue.
I think HMRC and Treasury believe that tax software offers a way of living with the complexities of the tax system. This may be true for number-crunching requirements but actually, most of the complexities reflect judgmental issues and fact-specific points that aren’t so easy to address in that way.