Making Tax Digital (“MTD”) has recently been introduced in the UK. The new regime is effective from the first VAT period commencing on or after 1 April 2019, with a six month deferral in place for a small cohort of taxpayers. The aim of MTD is to transform and modernise how tax is reported and managed and the first stage of MTD is to bring VAT into the digital domain.
The UK is one of many jurisdictions taking measures to modernise the tax reporting process. Tax authorities are increasingly leveraging new technologies that can quickly analyse millions of records to accurately identify issues, thereby reducing the resources and time required to conduct audits. The tax return itself is no longer the sole focal point of an audit. Instead, taxpayers are increasingly requested to share the underlying data behind those numbers and a tax authority can compare the tax return to the underlying workings that support it.
MTD is unique in its design and, unlike measures taken in mainland Europe, doesn’t require additional data to be provided to the tax authorities. However, from April 2020 when the initial ‘soft landing’ period ceases, it will be necessary for an electronic audit trail to be in place. HMRC expects that MTD will eliminate many of the manual errors that may occur in the VAT return preparation process, which are believed to contribute significantly to the tax gap in the UK.
While no additional data is to be provided to HMRC, the need to maintain quality data to support the tax reporting process is critical for businesses in order to build the robust electronic audit trail that is now required.
For VAT periods commencing on or after 1 April 2019, all VAT registered businesses with a turnover in excess of the VAT registration threshold (taxable supplies of £85,000 per annum) will have to maintain digital records for VAT and submit their VAT returns digitally. There will be some limited exceptions which are in line with the current exceptions for businesses that are unable to submit returns electronically (e.g. due to lack of internet access, insolvency, religious beliefs). Once a business is covered by MTD it will remain within the regime even if its turnover later goes below the threshold. Businesses for whom it is not mandatory can opt into MTD if they wish.
There are three principal requirements in relation to MTD for VAT:
1. Digital Records (effective from 1 April 2019)
Details of the business transactions, that directly lead to the creation of the summarised
VAT return figures due for periodic submission to HMRC, must be maintained in digital form within Functional Compatible Software. HMRC have clarified that Functional Compatible Software includes Microsoft Excel and it is permitted to maintain records in multiple systems.
For all accounts payable / purchases transactions, the following must be recorded digitally:
For accounts receivable / sales transactions, it is necessary to record:
Where multiple VAT rates appear on an invoice, it is not necessary under the MTD regulations to split out the details and separately record the line item detail. However, where such detail is not captured it can lead to manual input being required and present major challenges in maintaining the digital audit trail for a business.
The digital record keeping requirement is likely to be straightforward for larger businesses who already record granular data in ERP systems. However, while standard Accounts Payable or Accounts Receivable transactions will contain the required data, exceptional items being recorded by journal entry or manual workarounds are presenting challenges to businesses in meeting their MTD obligations.
It should be noted that where improvements can be made to the raw data and system tax logic supporting VAT compliance, this will help to streamline the tax compliance process and help businesses to meet the other requirements around MTD, particularly the need to build ‘digital links’.
2. Digital Links (soft landing up to 1 April 2020)
It will be necessary to demonstrate that ‘digital links’ are used throughout the end to end VAT return preparation process to transmit data between systems used to produce data relevant to the VAT return. Re-keying data and the use of ‘cut and paste’ are specifically prohibited, which will require information flows between systems to be automated. This essentially requires there to be an electronic audit trail between the source invoice data and the 9 boxes in the UK VAT return.
It should be noted that links between various Excel documents are permitted. However, the challenge that lies ahead for businesses is with regard to the manual adjustments and various journal entries which can form part of the VAT reporting process.
While this requirement has the force of law from 1 April 2019, HMRC have confirmed that a ‘soft landing’ period will apply, whereby penalties will not be imposed for non-compliance prior to 1 April 2020 (or 1 October 2020 where the deferral applies). It should be noted that the soft landing only applies in respect of the Digital Links requirement.
3. Digital Submission of VAT returns (effective from 1 April 2019)
For VAT periods commencing on or after 1 April 2019, VAT return information can only be submitted to HMRC via an Application Programme Interface (API). It will no longer be permitted to manually complete the 9 box UK VAT return via HMRC’s portal. HMRC have issued a list of compatible software packages that will support this requirement.
For some of the larger businesses who already keep digital records and have automated VAT compliance processes that comply with the first two requirements mentioned above, MTD may only require investment in some bridging software to allow the business’s software package(s) to ‘talk’ to the HMRC systems and enable them to comply with the third requirement. For others, rather more action may be needed, depending on how they arrive at their VAT return figures at present and the extent to which records are currently maintained digitally.
Some larger businesses may look to build a solution to meet the MTD requirements. It should be noted however that this would require HMRC approval and may need significant updates as the MTD requirements evolve.
A six month deferral is available for certain categories of taxpayers including public bodies, members of VAT groups and foreign non-established businesses with a UK VAT registration.
The MTD regulations stipulate that it is necessary to have received a ‘specific direction’ from HMRC in order for the deferral to apply. We understand that HMRC have now written to all taxpayers that they believe to be in this category. Where the deferral applies, the requirements in respect of digital records and the digital submission will apply from 1 October 2019, while the requirement to maintain ‘digital links’ will not apply until October 2020. Businesses who believe that they should be entitled to the deferral, but have not received a notice from HMRC, should contact their HMRC case manager as a priority.
HMRC will not automatically enrol VAT registered businesses for MTD. Businesses must therefore sign up for MTD via the HMRC website, or have an agent sign them up on their behalf. This should not be done until the last VAT return prior to entering the MTD regime has been filed. Businesses that currently pay VAT by direct debit cannot sign up in the 7 working days leading up to, or the 5 working days after their VAT return is due. Therefore it is important that care is taken when signing up to ensure that it is done at the appropriate time.
Businesses should assess the impact of MTD on their UK VAT reporting process to ensure that they are compliant from 1 April 2019. This should include:
MTD is expected to be extended to income tax and corporation tax in the future. An exact timeline for implementation has not yet been confirmed, however HMRC have confirmed that they will not be mandating MTD for any new taxes or businesses in 2020. It is expected that MTD for income tax and corporation tax will require periodic disclosure of income, expenditure and profit data, which would not currently be disclosed until annual tax returns are filed. This is seen by many commentators to signal the beginning of the end of the tax return as we know it.
This also raises the question as to when such measures are likely to be introduced in Ireland. Revenue’s first step into the world of real time reporting, PAYE Modernisation, is now up and running. Changes to the administration of VAT and other operational taxes may be a logical next step as Revenue continue to modernise Ireland’s tax system.
As tax authorities become more sophisticated with their analytics capabilities, without a change in the way compliance is managed, businesses will need to deploy significant resources reacting to tax authority changes. While the exact requirements may vary across jurisdictions, the principle of ‘garbage in garbage out’ holds true across the board. Many businesses, especially those with operations in multiple jurisdictions, are using MTD as the opportunity to revamp outdated compliance processes and seek out opportunities to automate time consuming processes before the compliance burden gets even larger. As businesses seek to future proof their tax reporting process, the starting point for tax and finance teams is typically a data cleansing exercise and a review of tax functionality in finance systems and supporting business processes to eliminate the root cause of existing inefficiencies and workarounds.
If you would like to discuss this further, please contact Jennifer Upton, Director in KPMG’s Belfast VAT team, Senan Kavanagh, Associate Director in KPMG’s Tax Technology team, or any member of the KPMG’s VAT team.
This article appeared in the Irish Tax Review Magazine, and is reproduced here with their kind permission.