Digital innovation is everywhere we look and there is no sign of the pace of change slowing. It wasn’t that long ago that chip and pin technology was introduced and now even contactless payment is starting to feel dated due to payment apps on our phones and watches.

Whether we recognise it or not we have all undergone a fundamental digital transformation over the last decade or more. The phrase ‘digital transformation’ feels slightly odd when applied to us, but it is now part of everyday language in HMRC.

HMRC’s Digital Transformation programme is one of the most ambitious across Government in the UK, and will see fundamental changes to how HMRC is structured, the offices it works from and how it interacts with its customers. Making Tax Digital is just one part of this digital transformation.

According to HMRC Chief Executive Jon Thompson this transformation will make HMRC ‘a world class, digital-first tax authority’. The aspiration is commendable; we can all imagine how a more efficient, more accessible, more responsive tax authority would help in our work and personal lives. There are many opportunities here and there are also a significant number of challenges, some of which are explored below.

Why make tax digital?

In very simple terms, from HMRC’s perspective, Making Tax Digital should bring in more tax and reduce its resource costs, while meeting customer service targets.

1. HMRC highlights that the annual tax gap figure for error and failure to take reasonable care is £9.4bn. According to HMRC, Making Tax Digital will help businesses get their tax right meaning this portion of the tax gap should reduce.
2. HMRC also highlights the associated benefit of reducing the cost, uncertainty and worry that businesses face when HMRC is forced to intervene to put things right. Implied in this benefit is the corresponding resource saving for HMRC gained from a reduced number of compliance interventions.

History of Making Tax Digital

In December 2015 the Government published the Making Tax Digital roadmap. If you have followed the development of Making Tax Digital you will be aware that the timeframe for Making Tax Digital has since changed.

Following representations about the scope and pace of reforms, the Government announced by Written Ministerial Statement, on 13 July 2017, that businesses would not be mandated to use the Making Tax Digital system until April 2019 and then only for VAT, if your turnover is above the VAT registration threshold which is currently £85,000.

The Government has committed not to widen the scope of Making Tax Digital beyond VAT before the system has been shown to work, and not before April 2020 at the earliest.

Shortly after the revised timeframe was announced, EY discussed this with HMRC, highlighting the fact that the implementation date of April 2019 coincides with Brexit. However, HMRC was clear that the timings are coincidental, the Making Tax Digital timeline has been known for some time and there is no need for a change. This remains HMRC’s position.

Making Tax Digital for VAT

In December 2017 HMRC published draft regulations, together with a draft explanatory memorandum and draft VAT Notice for public comment. The outcome of this consultation was that the final Regulations were laid on 28 February 2018 with some minor changes made.

The core requirements remain as follows:

1. Digital records – HMRC will require businesses to keep and preserve digital records
2. Electronic filing of returns – to submit a VAT Return, businesses will be required to use information stored in their digital (electronic) records and use functional compatible software to submit VAT returns directly to (and receive responses) from HMRC

Functional compatible software is software which will maintain the mandatory digital records, calculate the return and submit it to HMRC via an Application Programme Interface (API).

For a small business the idea of a single software package that interfaces with HMRC’s system to provide tax information in real time is realistic and the development of Making Tax Digital for Business started with small businesses and with this idea. When this relatively simple approach was scaled up to accommodate larger and more complex businesses the challenges became clear.

HMRC now recognises that it is not realistic for every business to put in place a single piece of Making Tax Digital compatible software. Following representations, changes to the requirements have been introduced to accommodate existing VAT return systems, including the use of spreadsheets.

There are now a number of options to meet the ‘functional compatible software’ requirement, including bridging software and API enabled spreadsheets.

It is important to note the idea of a ‘digital journey’ becomes very relevant here: if spreadsheets are to be used in the VAT return process the information must move onto the spreadsheet digitally and also move off the spreadsheet digitally. The documents published by HMRC outline its expectations in some detail in the form of customer journeys.

What does this mean for me?

If you are a VAT-registered business with a turnover exceeding the current VAT registration threshold of £85,000 you will need to ensure that you are ready to comply with the two core requirements – digital record keeping and digital submission of returns – from April 2019.

To get ready for this you will need to (i) do some preparatory work on your software to ensure you can submit your VAT returns and, (ii) review and update your systems and processes to ensure that all steps meet the requirements under the ‘digital journey’.

Software

While I expect most businesses will implement a software solution to meet the requirements, it is possible for an agent, with the appropriate software, to submit VAT returns on behalf of a client. We, at EY, are developing a number of solutions in this area for businesses.

If you chose to update your software to submit returns yourself, you have two main options:

1. Purchasing new software or updating existing software so that your accounting software is Making Tax Digital compatible, i.e. the functionality exists in the software to digitally submit a VAT return directly to HMRC.
2. Purchasing or developing bridging software which will interface with both your existing system and HMRC’s system to make the necessary digital connection, i.e. bridge the gap between the systems.

You should seek advice in relation to the best option for your business. Software changes or upgrades can be both expensive and time consuming. The timeframe for these options will be a vital component of the Making Tax Digital readiness timeline I recommend below.

While there will undoubtedly be a cost in updating or purchasing software you may be able to avail yourself of additional functionality in the software, for example, enhanced management information in relation to tax, and this should form part of your consideration of the best option.

Systems review

To ensure you are Making Tax Digital compliant you will need to conduct a review of your systems to ensure you meet the core requirements of digital record keeping and digital submission of returns. Depending on your business this review could be a brief, confirmatory exercise or it could be a significant root and branch review.

You may be asking what benefit there is for your business from Making Tax Digital: one benefit is the review of your VAT systems and processes. From my experience, there is scope for improvement in most systems. Identifying improvements may lead to efficiency savings, VAT reclaim opportunities or other benefits.

These changes will also bring a number of opportunities for advisers, including expanding your service offering, e.g. to provide a bookkeeping service, or assisting with the systems review, transition or implementation. We are working with businesses in each of these areas.

What about other taxes?

The statement that “the Government will not widen the scope of Making Tax Digital beyond VAT before the system has been shown to work, and not before April 2020 at the earliest”, will be of interest to everyone responsible for taxes beyond VAT. The idea that the system has been shown to work is an interesting one. Presumably this will be HMRC’s assessment of the system and I think it is reasonable to assume that the system, limited in scope as it is, will be shown to work.

On this basis the best approach for businesses will likely be to work towards using Making Tax Digital for income tax and corporation tax from 2020. On one hand this should not be a big step, because the accounting records for the business will already be digital (where the business is in Making Tax Digital for VAT). However, the software position will need to be considered as the functionality for income tax or corporation tax may not yet have been developed by your chosen software provider.

You should take some time to think about what impact Making Tax Digital will have on your workflow and resourcing. It would be helpful to sketch out a Making Tax Digital readiness timeline for your business. Taking income tax services provided by an accountant as an example, when you move from Self-Assessment, with a deadline of 10 months after the year end for submission of the tax return, to Making Tax Digital, with quarterly reporting, there will be an overlap during the 10 month period where you will be preparing the Self-Assessment return and also completing quarterly reports. This may have a significant resource impact on your business and you should consider how to manage this as far in advance as possible.

What might the future look like?

Based on my experience of working in HMRC as Making Tax Digital was being developed, and from consideration of the public statements from HMRC, I think much can be read into the functionality which is being offered on a voluntary basis. This includes provision of voluntary updates containing supplementary information, e.g. transaction data. Once these functions are normalised within Making Tax Digital, with the functionality shown to work, it will be a natural step for HMRC to mandate them.

Focusing on VAT, if businesses are required to provide supporting information for their VAT returns HMRC will be in possession of much more information than they currently have (just the 9 box VAT return) and this information will be in a digital format, perhaps with the format being prescribed by HMRC at a point in the future.

This information could quite easily be analysed digitally, with the application of risk rules to identify risks where HMRC will intervene. This approach is currently used in many parts of HMRC, but not Large Business, where ‘risking’ is generally carried out by a tax specialist. I expect the shift from a specialist assessing information for risks to information being digitally analysed across all businesses will take place reasonably soon.

It remains to be seen how effective this approach will be in practice, but it may be that this results in a change in role for tax specialists in HMRC. Will this mean that direct contact with a specialist individual in HMRC will be less common?

This digital approach could work very well for binary issues but what about areas of legal interpretation? Some elements of the tax system are not able to be dealt with neatly by risk rules, parameters and systems exceptions.

Practical actions and conclusion

I hope I have given you some food for thought. To finish I would offer the following suggestions:

• The next 12–18 months will bring a range of new challenges for businesses, including not only Making Tax Digital but the ongoing Brexit negotiations. To prepare your business for these challenges as best you can, you should be considering action now.
• You should prepare a Making Tax Digital readiness timeline for your business, anticipating when future changes will happen and the steps you need to take to be ready.
• A review of your tax processes and systems will be essential. This could be a brief review or a root and branch review and the depth of review required will determine the time and resource required. You should commence work to assess your systems now.
• In preparation for April 2019 HMRC has committed to having a period of 12 months to pilot Making Tax Digital for VAT. There are benefits to using as much of this period as possible so you are ready for Making Tax Digital well in advance of April 2019. (HMRC’s APIs should be in place for VAT from April 2018).
• Once you are on course for the VAT implementation in 2019 you should consider voluntary adoption for other taxes. If you prepare an indicative timeframe for your business you can act now to mitigate the resource and deadline pressures which will arise.
• If you are an adviser you should also consider the impact of Making Tax Digital on your practice, e.g. how will you submit each of the returns you currently submit when Making Tax Digital is mandatory.

David Reaney is Director and Head of VAT for EY in Belfast

Email: DReaney@uk.ey.com