Opinion

Making tax digital: Is there a hidden agenda to bring in earlier business tax payments?

7 min read

12 February 2016

There are too many inconsistencies in the government's digital tax proposal, and businesses need to be thinking about how each will meet rescheduled tax payments.

Two weeks ago, MPs debated the issue entitled “Small Business: Tax Reporting, or Making Tax Digital” after an e-petition against phasing out paper tax returns attracted 110,000 signatures. 

During the debate, MPs voiced constituents’ fears that quarterly reporting, or “updates” will lead to more professional fees for SMEs to comply with the new legislation. 

Another concern was that many small businesses do not operate financial records digitally, and the new legislation would introduce more red tape and yet another admin burden. 

Finally, MPs discussed tax payment time periods. David Gauke MP and financial secretary to the Treasury, said: “No decision has yet been made about changing payment dates.” 

My main concern, present before the debate, and stronger after it, was that the government, in making tax digital, seeks to shorten the gap between businesses filing returns and it collecting the tax.   

If this happens without supporting smaller businesses financially during the transition it could trigger a cash flow crisis among many SMEs, putting jobs and livelihoods at risk.
It’s a question we would like the government to answer unequivocally and soon. 

Smoke and mirrors?

Let’s look closely at the David Gauke’s comments to see why we are so concerned. Towards the end of the debate and sensing he was home and dry, Gauke let his guard down, exposing his true colours. 

He said: “….The taxpayer then pays their final tax bill on money made up to 21 months previously. It is a system designed for a world of paper and bookkeeping, in the literal sense, and it is not tenable in the 21st century.”

Sorry, we thought no decision has been made on payments. The 21 months – one would have to assume – would relate to an unincorporated body drawing up accounts to 30 April who would pay the balancing payment 21 months later in January. 

Perhaps Gauke, in the heat of the debate, forgot business owners would still need to make installment payments 12 months earlier for this period. 

Or perhaps he also forgot the extra tax they have already paid to get their basis period on the right track when they first started their business. 

More importantly, perhaps he had forgotten what he said five minutes earlier about no decision being made about the payment dates. 

If the system is “not tenable”, it seems highly unlikely that the government intend to leave it unchanged. 

The journey to the 21st century

It is abundantly clear that the government intends to make tax digital. But where the uncertainty lies is what sort of changes will be needed to bring it in. We are not questioning the destination, but we do question the journey.

On face value, the concept looks reasonable: a fairer system for all and businesses taxed more in line with the way employees are taxed under PAYE. The logic appears irrefutable.
But that’s until you consider that businesses don’t get paid in the same way as employees. It’s a fact that many businesses don’t get paid for many months after the invoices are raised. That of course is only half the story.

To get up to speed and pay taxes “live”, it is inevitable that businesses will need to catch up with payments. The result of these changes is an impending cash flow crisis for businesses – at worst payment of two years’ worth of tax within a twelve month period. Or to put it another way, a 70-80 per cent effective rate of tax in the year of transition!

Looking more depth at the situation, envisage this scenario: An unincorporated business is currently making payments on account of income tax three times a year under the old regime (two instalments and one balancing payment). The new regime kicks in and “live” tax is paid in relation to real time information but the tax payer still needs to finish paying last year’s tax! In harsh economic times, where is the money meant to come from? This is without even considering industry-specific cash flow issues.

Take farmers. With seasonal cash flows, they are already eligible for Farmers’ Averaging in respect of payment of tax (the good crop one year, bad crop the next year approach to meeting tax payments). But how will farmers that only generate cash for four or five months of the year meet quarterly tax payments in the 7-8 months where no cash is being generated?

And solicitors. Solicitors notoriously suffer from cash flow issues. In mid-2013 the Solicitors Regulation Authority (SRA) introduced a RAG (Red, Amber, Green) rating system to assess the financial stability of firms and indicated that as many as 20 per cent of the top 200 firms could be showing evidence of financial instability. 

If HMRC now says, “Please pay us two years’ worth of tax this year”, I can see many more red lights flashing.

In summary, there appear to be many inconsistencies in the government’s proposals with too many questions unasked let alone unanswered. 

But we believe SMEs’ main concern shouldn’t be additional compliance costs. The concern should be how each are going to meet rescheduled tax payments assuming the government has not thought about any transitional arrangements. In the face of a struggling economy and an impending base rate rise this year, this is far from being a paper exercise for thousands of smaller businesses.

Back in 2015, Real Business had a look at the good, the bad, and the ugly of tax changes.

Patrick King is head of tax at MHA MacIntyre Hudson.