What challenges does HMRC's digital approach create for SMEs?

tabletIs this the beginning of the end for the tax return? Mike Smith explains what’s changing, and why.

By now, most business owners will have probably heard about the HM Revenue & Customs (HMRC) drive to ‘make tax digital’. But what exactly does that mean, what new obligations will it bring, and what potential challenges could business owners face when adopting the scheme?

Towards the end of last year, HMRC announced its ambitious plans to digitise the tax system. The new rules will mean that businesses need to keep digital records and send quarterly updates to HMRC by digital means.

The motivation behind the changes is to help reduce the number of errors that businesses and the self-employed make on their tax returns, which is currently costing the UK taxpayer around £8bn a year. It’s also argued that going digital will benefit taxpayers by giving them a clearer view of their business as they progress through the tax year.

What does making tax digital really mean?

The move towards making tax digital has been hailed as the end of the tax return, and eventually, that’s exactly what it will mean. The government wants to streamline the way in which taxes are reported in the UK, with the overall aim of simplifying and improving the accuracy of declaring taxable income.  

Instead of filing a tax return at the end of the year, business taxpayers will instead use third-party ‘functional compatible software’ to report their taxable income and gains in real-time.

However, for the time being, HMRC has accepted a key demand from small businesses that spreadsheets can continue to be used to record business information, although users may have to change the type of spreadsheets they use to link with HMRC’s approved quarterly reporting software.

The first tax to be impacted by the changes will be VAT, and it will only be businesses that meet the VAT threshold of £85,000 in the previous 12 months that will be affected. This means that sole traders, partnerships, charities, schools, public bodies and corporate bodies will need to submit their VAT returns digitally by April 2019.  

What will the key challenges for businesses be?

Some of the common concerns of UK businesses include:

  • Initial costs: the requirement to use ‘functional compatible software’, such as cloud accounting platforms, will bring extra costs for millions of businesses that do not already have this technology in place. The costs are expected to average £280 for businesses, landlords and the self-employed, although HMRC suggests that these businesses will save money on compliance costs from 2021.
  • Additional reporting requirements: at present, businesses only need to keep a record of their total sales for their VAT return. Under the making tax digital changes, businesses will also need to keep digital records of their sales, broken down by VAT liability (ie which sales attract zero-rated, standard-rated and are exempt from VAT). They will also have to summarise purchases broken down by VAT and retain information such as the adjustments made for car leasing, business entertainment and reverse charges on imported services.
  • Increased reliance on accountants: there are also concerns that there will be an additional requirement to seek professional assistance on multiple occasions throughout the year, which will inevitably cost more. Businesses will still be required to submit a year-end declaration, as well as provide information throughout the year.
  • The digitally excluded: another concern is how some business owners will meet the new requirements if they are unable to access digital technology, or do not have the skills to use it. Currently, around 19 percent of the UK’s self-employed are ‘digitally excluded’. However, HMRC has sought to put provisions in place that allow people to supply information over the phone, or nominate others to submit their tax returns on their behalf.   

The potential benefits of the tax changes

Although many businesses will have concerns about complying with the changes, there could also be much to gain from a digitised tax system. Some of the potential benefits for business owners and the self-employed include:

  • More efficient businesses: instead of relying on paper ledgers and clumsy spreadsheets, it makes a lot of sense to simplify a business’s tax obligations by switching to digital. Relying on antiquated systems leads to mistakes that impact everyone. The result can be financial penalties for businesses and errors that take time to correct. Using cloud technology and accounting software also allows businesses to detect and rectify mistakes as soon as they occur, and makes it easier to claim expenses back as they happen, instead of having to dig through a box of receipts at the end of the year.
  • Reducing the reliance on professional assistance over time: although in the short-term, the digitisation of the tax system is likely to increase the reliance on accountants, in the long run, as businesses get used to their new obligations, accounting software will take much of the strain. This could reduce the requirement and cost of professional assistance.  

Time to embrace making tax digital

Like it or not, your tax obligations are going to change with the introduction of cloud technology and accounting software. However, rather than panicking about the perceived negative effects, it’s time to focus on the positives.

Over the longer-term, digitising the tax system will make businesses more efficient, which will benefit society. And this is, after all, is what taxation is all about.

About the author

Mike Smith is a senior director of Company Debt. A business insolvency expert, Mike has four decades of experience in helping small businesses deal with tax issues and debt problems.

See also

HMRC: Making tax digital for business