Chapter 7: Revisiting the case for Making Tax Digital
135.HMRC’s case for MTD is that it will reduce the ‘tax gap’—the difference between the amount of tax that should, in theory, be collected by HMRC, and what is actually collected. In particular, HMRC argue that MTD will reduce the amount of tax not collected due to taxpayer errors and carelessness. HMRC recognised that taxpayers would incur costs in the transition to digital but initially expected that administrative savings realised would outweigh those costs.
136.The Committee’s 2017 report identified widespread scepticism of the tax gap assertions. Most witnesses other than HMRC were unconvinced that MTD would reduce errors and so increase tax yield, and we concluded that the case for this was “not yet proven”. We also concluded that costs for taxpayers were understated and benefits overstated.83
137.As noted in chapter 2, policy changes at the time of the 2017 Budget meant HMRC revised its estimates of by how much MTD would reduce the tax gap. This chapter revisits the case for MTD for VAT and the costs and benefits for businesses in the light of experience and new evidence.
HMRC’s estimates of tax gap reduction
138.HMRC expects MTD for VAT to deliver just over £1 billion from implementation to 2022–23. Theresa Middleton, Director of Making Tax Digital for Business at HMRC, told us this would come from a reduction in manual steps where error could arise—“arithmetic” and “transposition” errors—and reduced risk of lost paperwork due to more timely record-keeping.84
139.The methodology originally used by HMRC to calculate the impact on the tax gap assumed digital data capture, software that would use ‘nudges’ and ‘prompts’, and spreadsheets being replaced by integrated bookkeeping and reporting packages. Evidence from software providers suggests that HMRC’s analysis had not adequately considered the fact that none of these benefits are required by MTD for VAT. IRIS Accountancy Solutions said: “HMRC’s plan for MTD to reduce the tax gap caused by errors seems unlikely while spreadsheets are still being used”.85 Sage noted, in respect of the revised proposals, that “HMRC could have introduced more measures to reduce errors in the tax system from the start”.86 Reducing errors could reduce tax revenue as well as increase it.
140.Nothing has changed in HMRC’s assumptions since our last report, nor is there evidence of further research to evaluate its figures. In its announcement of 1 December 2017 HMRC committed to “review and further test this analysis and our assumptions through ongoing extensive engagement and consultation with businesses, and through further research and analysis”.87
141.HMRC is now designing a study to measure the impact on the error rate.88 By the time it is published it will be past the implementation it was intended to inform.
142.HMRC told us that the Office for Budget Responsibility has validated its tax gap estimates. Witnesses were however sceptical of the likely tax gap yield. CIOT noted: “We do not believe that MTD will deliver the ‘pot of gold’ HMRC expect it to”.89 In our private roundtable with practitioners, it was suggested that taxpayers may simply make “different errors”90 when dealing with an unfamiliar new system, as discussed in chapter 4. We do not consider discussions with the OBR, who have no apparatus for contacting businesses or their advisers, provide an adequate substitute for testing directly with taxpayers.
143.We support the Government’s attempts to modernise HMRC systems and seek efficiencies for taxpayers, but we remain unconvinced that MTD will reduce error and thereby the tax gap. If Making Tax Digital does not deliver the additional tax yield HMRC expects, the argument for mandating Making Tax Digital for VAT in April 2019 is much diminished.
Taxpayer costs and benefits
144.Costs will arise for taxpayers in transitioning to MTD for VAT—the one-off purchases of hardware, software, familiarisation, advice and training—and on an ongoing basis for software or any additional agent support.
145.HMRC estimate that the average one-off ‘transition’ cost for businesses moving to MTD for VAT will be £109, and that businesses will pay an additional £43 in ongoing costs on average.91 This estimate was calculated by segmenting businesses along two dimensions. The first dimension divided small, medium and large businesses. The second dimension divided businesses into the following categories:92
- Paper-based moving to MTD software
- Spreadsheet-based moving to ‘bridging software’
- Spreadsheet-based moving to MTD software
- Businesses already using accounting software
- Businesses outsourcing all VAT work to agents
146. Many witnesses expressed scepticism at HMRC’s average cost assessments.93 The National Farmers’ Union described them as “extremely low”,94. Several practitioners challenged the estimates based on the experiences of their clients.95 For those transitioning from paper records, one suggested costs as high as £2,600 and three days of client time.96
147.HMRC expects agents to advise their clients on what software to use and which changes to make. Thirty-four per cent of businesses expect their agents to handle MTD for them,97 resulting in increased agents’ fees.98 Businesses moving to software for the first time will also incur the costs of training and time spent on the transition.
148.HMRC included in its estimates the cost to businesses of software, hardware and agent fees. For ongoing costs, it assumed there would be only software costs. HMRC’s March 2017 impact assessment explained its omission of ongoing agents’ fees:
“we assumed that, in steady state from 2021–2022, accountants and businesses would be familiar with the necessary [MTD for Business] requirements and processes, and that competition in the agents’ market should mean that there would be no overall increase in agents or accountancy fees after the transitional period”.99
The December 2017 revised impact assessment retained this assumption. However, some agents thought that clients who struggle with digitalisation would need additional ongoing support. One predicted their clients would see a threefold increase in ongoing agent fees, as would take longer for agents to process accounts using software compared to “mixtures of manual lists and spreadsheets”.100
149.In a letter on 9 November, HMRC provided further detail on costs.101 This detail was provided late, having originally been promised when HMRC gave oral evidence on 22 October.102 We consider the analysis lacking in several respects.
150.First, the segmentation set out left many smaller businesses insufficiently represented. The small business segment covered too wide a range of turnovers (from £85,000 to £10 million), and included 1.15 million of the total 1.2 million business population. There is a significant difference, particularly in this context, between businesses with turnovers of £85,000 and £10 million. This segment is not representative of those smaller businesses that will struggle most with the costs of Making Tax Digital for VAT.
151.Second, HMRC repeated their assessment that software costs would be the only ongoing cost for businesses after 2021–22. In justifying their judgement that there will be no ongoing increase to agent fees, they used the same wording as in their March 2017 impact assessment. We can only infer that this assumption has not been revisited in the intervening period.
152.Third, HMRC assume there will be no additional agents’ costs for transition either. This conflicts with the evidence presented above. Elsewhere in its transition costs, HMRC assumes a segment of the small business population will employ an agent to assist with transition. HMRC therefore appears to be expecting agents to provide small businesses with additional support without charging for it. HMRC justifies this assumption by noting that almost all businesses with taxable turnover over £10 million use an agent, who, “due to [the business’s] size and agent loyalty” would not charge additional fees. But this represents only 32,500 businesses out of the 1.2 million MTD for VAT population.
153.One accountant submitted an estimate of the one-off transition costs of MTD for VAT for their clients:
Table 1: One practitioner’s estimate of transition costs of MTD for VAT for their clients
Cost type |
Cloud software users |
Desktop software users |
Paper records users |
|
Software costs |
£0–300 |
£300–£600 |
£300–£600 |
|
Accounting support |
£200 |
£500–£1,000 |
£1,000–£2,000 |
|
Client time |
1–2 hours |
2 days |
3 days |
|
Total |
£100–£500, and 1–2 hours |
£800–£1,600, and 2 days |
£1,300–£2,600, and 3 days |
Source: Written evidence from James Smith, Chartered Accountant (DFC0039)
Several other practitioners provided similar estimates, which represent a significant departure from HMRC’s figures.103 This may be because many of those giving evidence to our inquiry represented businesses with smaller turnovers, who were not adequately represented in HMRC’s segmentation exercise.
154.The benefits to taxpayers adopting digital means for the first time should be balanced against these costs. Witnesses generally supported increased digitalisation and modernisation of the tax system.104 The AAT observed: “for many in business, any increase in the cost of compliance attributable to MTD is likely to eventually be outweighed by the availability of added value built in as standard to much of the MTD-compliant software”.105
155.The most generous view of the benefits to businesses of moving to digital was presented by Sage, who put the average efficiency savings for the whole MTD programme at £17,000 per annum.106
156.Our evidence suggests the costs to businesses of MTD for VAT, both for initial setup and for subsequent operation, will significantly exceed those used in the Government’s impact assessment.
157.We recommend that the Government updates the impact assessment to reflect evidence gathered in recent months, including from the pilot. A revised impact assessment should be published alongside the Government’s long-term plan for mandating MTD for other taxes.
83 Economic Affairs Finance Bill Sub-Committee, Draft Finance Bill 2017: Making Tax Digital for Business (3rd Report, Session 2016–17, HL Paper 137)
87 HM Revenue & Customs, Making Tax Digital for Business (1 December 2017): https://www.gov.uk/government/publications/making-tax-digital-changing-the-scope-and-pace-technical-note/making-tax-digital-for-business [accessed 12 November 2018]
90 Private oral evidence taken on 22 October 2018 (Session 2017–19)
92 Letter from Ruth Stanier OBE to The Rt Hon Lord Forsyth of Drumlean, 31 October 2018: https://www.parliament.uk/documents/lords-committees/economic-affairs-finance-bill/draft-finance-bill-2018/8%2031%20Oct%20Stanier%20to%20Chairman%20letter%20.pdf
93 Written evidence from Association of Convenience Stores (DFC0087), Chartered Institute of Taxation (DFC0071)
95 Written evidence from James Smith (Accountants) Ltd (DFC0039), Kevin Ringer (DFC0064), Hodgsons Chartered Accountants (DFC0001) and P McKelvey & Co. (DFC0003)
98 Written evidence from Javes Co. Chartered Certified Accountants (DFC0033), Kevin Ringer (DFC0064), National Farmers’ Union (DFC0084), Association of Convenience Stores (DFC0087)
99 HM Revenue & Customs, Updated Impact Assessment on Making Tax Digital for Business, (21 March 2017): https://www.parliament.uk/documents/commons-committees/treasury/Correspondence/HMRC-updated-impact-assessment-MTFfB.pdf [accessed 12 November 2018]
101 Letter from Ruth Stanier OBE to The Rt Hon Lord Forsyth of Drumlean, 9 November 2018: https://www.parliament.uk/documents/lords-committees/economic-affairs-finance-bill/draft-finance-bill-2018/8%2031%20Oct%20Stanier%20to%20Chairman%20letter%20.pdf