It is tempting to ask if we are being massively naïve if we think that the tax gap—the difference between the total amount of tax actually collected and the theoretical amount that should have been paid—will ever be closed. In the real world, it feels as if the answer must surely be “no.”
HM Revenue & Customs recently published its Measuring Tax Gaps statistics for 2020/21, and the hypothetical nature of much of the data and the assumptions made in the calculations, taken with the unavoidable fact that there will always be a minority who do not pay what they owe, underline that it is unlikely in the extreme that the tax gap will ever disappear altogether.
However, given the ongoing pressure on public finances, HMRC is very clearly focused on improving compliance and increasing tax yield—and uses the tax gap both to illustrate the scale of the issue and, in looking to close it, as a measure of their performance.
According to the data, a large amount of the tax gap in 2020/21 comes down to two main sources: small businesses, and those taxpayers who, according to HMRC, have not taken reasonable care with their tax obligations. Many of these latter will have completed a tax return—with those in the self-assessment system contributing 7.4 billion pounds ($8.9 billion) to the gap overall.
This is a telling point, and indicates why HMRC is putting so much emphasis on streamlining personal tax reporting through Making Tax Digital.
Overall, it has to be said that there continues to be a lack of general understanding of and engagement with the UK tax system—no one would deny that it is enormously complicated—and honest errors are common, particularly among those with business interests. Many of these people will have struggled to keep afloat during Covid-19, and now at a time of increasingly high operating costs. Another group who may struggle despite their best efforts are those with multiple sources of income and gains.
In looking to close the tax gap, MTD for income tax is the key weapon in HMRC’s armory aimed squarely at addressing these issues—improving compliance and helping bridge the tax literacy gap through digitizing and, ostensibly, simplifying the process for filing returns. All of this should, the Treasury hopes, also begin to improve tax collection and close the gap.
MTD for Income Tax: the Basics
MTD has already started in some areas, including value-added tax registered businesses. Following a delay to wider implementation during the height of the pandemic, HMRC confirmed back in September 2021 that MTD for income tax will be rolled out from April 2024 to individual taxpayers with business and/or property income over 10,000 pounds, including sole traders, landlords and partnerships, although large parts of the detail are as yet unknown.
For these taxpayers, the new regime will replace the existing reporting system for income tax through the annual self-assessment return, with quarterly summary updates of income and expenditure based on the taxpayers’ digital records, with a “catch up” at the end of the year. It is hoped reporting closer to “real time” will improve efficiency and cost-effectiveness, and prove less time consuming than traditional annual reporting and—key for the Exchequer—improve tax receipts.
In seeking to road-test MTD for income tax ahead of implementation, HMRC launched a pilot as far back as 2017, with a select group of invited sole traders, landlords and their agents participating. In January 2022, HMRC revealed that there were just nine taxpayers in the pilot.
Although efforts to ramp up the numbers are ongoing, nine taxpayers is a vanishingly small proportion of the estimated 4.2 million who will be eligible for the transition to MTD in just two years’ time.
MTD is a major change to the current set-up for tax reporting, and naturally there will be a lot to get to grips with and bugs to work out. There remain unanswered questions, not least in relation to aligning multiple sources of income into a single digital record.
The comparative lack of testing and scrutiny, given the small sample size in the pilot thus far, risks potential teething problems, as HMRC can hardly hope to have tested the huge variety of circumstances that MTD will be required to accommodate in practice when it goes live.
Nor does this seem to be a particularly strong vote of confidence in the system on behalf of taxpayers and their agents—perhaps driven by concerns about the business changes, and investments, needed to transition towards digital record keeping.
The Digital Road Ahead
In the meantime, with its eye firmly on the tax gap, HMRC continues to use its various powers to track and crack down on suspected non-compliance, though there remain question marks over its capacity to deal with the growing volume of work involved. We have seen cases where offers to pay a tax bill following, say, a query or challenge, have been declined by HMRC due to capacity to deal with the required correspondence, and one example of HMRC saying it will process a repayment claim submitted to it, but will not look at the claim until January 2023.
This may be symptomatic of HMRC’s mid- to long-term drive to digitalization and streamlining of its workforce—which is the certain direction of travel—coming into conflict operationally with the near-term needs of taxpayers and, dare we say it, the fact that so many HMRC staff are still working remotely.
If current experience is anything to go by, it feels as if the transition to digital is going to come with a trade off in terms of taxpayer experience, and potentially the tax take, in the interim. This would be ironic give the aim to close the gap.
But the transition to MTD is coming and should improve the tax gap picture in the medium term. Or at least that is the hope.
With this change on the horizon, now is a good time for those who are likely to be affected, including landlords and entrepreneurs, to implement digital record keeping and make sure the right tools and practices are in place so as to not end up as a part of the tax gap in future years.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Mike Hodges is tax partner and head of the Private Wealth Practice Group at Saffery Champness.
The author may be contacted at: firstname.lastname@example.org