By Russell Gammon, Chief Innovation Officer, Tax Systems
MTD for VAT is now in “full swing”. Over 1.4 million businesses have signed up and filed over six million returns via the new HMRC API. From April 2021 we will see the roll out of “phase 2” (the requirement to implement digital links) and in 2022 the regime will be extended to encompass all VAT registered businesses. Keen to build upon this success and push ahead with further reform, HMRC announced back in July its intention to push ahead with an ambitious ten year plan that will see MTD extended to both Income and Corporation Tax.
The announcement stated that a consultation for the design of a new system for MTD for Corporation Tax would begin before the end of this year. We don’t yet know the precise details but we do know such as design will attempt to apply the lessons learnt from MTD for VAT. A recent evaluation of that service has been revealing.
The evaluation report found that businesses only experienced accuracy and efficiency benefits when they used “fully integrated software” as opposed to doing the minimum to comply, by using bridging software, for example. Bridging software was found to have “minimal impact on the capacity for error” and these businesses are having to rethink their compliance to meet the obligations for digital links. Other concerns flagged by businesses included the need for supplementary guidance to help with software selection, lack of support from HMRC and the potential for withdrawal of vendor support.
MTD for Corporation Tax has the potential to be far more complex, disruptive and demanding than MTD for VAT. There are a number of ways the regime is expected to change. By far the most widely anticipated is a move from annual to quarterly reporting, which is a material change to the reporting cycles of tax departments. This will allow for “better targeted policy” so that in the event we do see any future crises akin to the Coronavirus pandemic, the government can more readily respond given the increased amount of information available at their fingertips.
Yet while reform of Corporation Tax processes is to be welcomed, there are concerns over how businesses will adjust to quarterly reporting. The increase in frequency could see businesses required to generate as many as six returns a year (four quarterly, a true-up and an annual return), compared to the single return we have today. This could create a significant additional burden for finance and tax teams as it will effectively add to the usual “busy season” with more deadlines.
Such radical change could also see a transformation of the dominant tax models we have today. The ability of both in-house tax teams and advisory businesses (who complete outsourced computations) to access sufficient resource could be brought into question. As a result, we could see a movement away from these to a co-sourcing model, where different parts of the returns are completed by different teams (internal vs. external), for example.
The way in which reporting is carried out is also likely to change under a quarterly system. For parts of the calculation, each return would need to be a “best estimate” of the Corporation Tax position of the business, as it would be unreasonable for a full calculation of certain items to take place each quarter.
To provide businesses with an earlier view of their tax liability, a projected Corporation Tax position would therefore be required. Published accounts, as one of the normal starting points, would not be available with the period ongoing and so source data from accounting systems would have to be used. This would place significant importance on the ability to access reliable data, so the data collection part of the process is likely to need significant automation in order to pull this data from disparate sources and run diagnostics to ensure it is fit for use.
Many businesses are used to working with a “tax-based trial balance”, during the annual or semi-annual provisioning cycle. It will be interesting to see what similarities and differences there are between this process, and the process to provide an estimate to HMRC. Given the timescales, we would also expect some form of predictive analytics to come to the fore in the compliance software, to help estimate future positions.
In order to understand how MTD for Corporation Tax might work, it’s worth recapping the original remit. MTD was one of the “Four foundations” within the Government’s roadmap, within which the prospect of quarterly updates to HMRC were mooted. The roadmap did not distinguish between the taxes involved but said simply that businesses would be “required to use digital tools, such as software or apps, to keep records of their income and expenditure”. That software would then automatically produce tax calculations, scan for any errors or mistakes, and update tax return data on HMRC systems directly and in a “light-touch” manner.
MTD is now broadly understood to feature two key requirements: digital accounting records and functional compatible software to submit updates and the return to HMRC. This software must use HMRC’s API platform and so the commercial software currently used by large businesses to prepare and submit their Corporation Tax returns will require updating. Once the business signs up for MTD for VAT, they cease to be able to use the existing online tax return service hosted by HMRC so it’s safe to assume this will again be the case with MTD for Corporation Tax.
Under MTD for VAT, we’ve also seen the requirement to link from the digital records all the way through to the final calculation and the submission to create a digital end-to-end process. It’s not yet clear if this digital link requirement will be extended to Corporation Tax, although it’s sensible to assume the increased frequency of reporting will require compliance software to be far more tightly integrated with the systems used for record keeping.
Incorporating digital links into Corporation Tax would represent a material change in the way returns are prepared. That said, many aspects of the tax computation could be brought together by software with little in the way of manual intervention and so are prime candidates for automation. Software providers are already using machine reading techniques to apply basic income and expense analysis for tax purposes, and claims such as capital allowances and utilising losses could well be applied automatically.
Significant technological advances have been made in tax since the government outlined its plans under MTD. This means businesses will be able to take advantage of a number of processing techniques. With regards to data collection, Extract Transform and Load (ETL) tools can automatically pull data from one place to another, for example. This could significantly boost productivity as up to 75 percent of the time taken to complete Corporation Tax returns today is spent on manual or semi-automated data collection.
The type of software that will be needed for MTD for Corporation Tax does share some common ground with MTD for VAT. It’s likely to use data analytics to project future liabilities, for instance, which are also used in MTD for VAT for forecasting purposes. This could prove fortuitous for businesses as it means some will be able to leverage their existing MTD solution. Indeed, where firms choose a single MTD solution for multiple taxes, having a single “pane of glass” provided by a software product to view the affairs of the overall tax function could be a real benefit to many businesses.
There are, however, areas of the tax computation where either human-touch or a wider view will still be required and it remains to be seen how these challenges will be tackled. The intangible fixed assets regime, for example, is based upon following the accounting treatment, and the complexities of calculations such as the Corporate Interest Restriction (CIR) realistically could not be performed four further times per year. How the accruals principal is to be applied would also need consideration, for example in respect of retail businesses who experience seasonal sales and for whom quarterly reporting would give a misleading picture.
As with MTD for VAT, which had to make provisions for adjustments and amendments, and even exceptions in some cases, working out a way of digitalising Corporation Tax is going to take time. The initial consultation phase will aim to capture concerns. It will also seek to identify ways in which technology can be used to increase the frequency of reporting without increasing the risk of error or overburdening finance and tax teams. It remains to be seen how the reform will deal with the finer details but what we can be sure of is that MTD for Corporation Tax has the potential to fundamentally reshape the tax sector.