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Tax payments are not ready for algorithms

Michael Quinlan Retired tax adviser, member of LSCA Tax Committee, elected member of Council 2017-2021 discusses HMRC’s plans for earlier interim tax payments.

August 2021

Michael Quinlan

Last month I examined current HMRC plans to update their administration systems. I now consider their plan for earlier tax payments for companies and other traders – ‘Timely Payment’.

They propose quarterly or more frequent MTD tax reporting with linked interim payments based on those results. They helpfully suggest this will assist taxpayers in managing their affairs. Most taxpayers would say tax would be collected sooner and compliance costs raised. It is also important to understand this would be only a one-off cashflow benefit to the Exchequer; once earlier payment had been fully implemented, future payments would be received at the same intervals as previously.

HMRC say earlier payment better supports taxpayers during a crisis. This seems perverse. Government’s response to COVID has not been to ask taxpayers for earlier payment; it has been to offer later payment, in some cases more than a year later. Or to reduce the amount of tax permanently, as for business rates on hospitality and entertainment.

The Great Idea

The idea is to create a computer derived algorithm that can anticipate future profits or losses from past results (don’t laugh). Interim payments will be made accurate by the ability to predict results for the remainder of the period. HMRC claims this can be accurate enough to minimise over- and under-payments and not require year-end adjustments. It is very hard to see how this could work. Companies and investment managers cannot do it – they are made to say that future results may not reflect past results; and frequently they don’t. Business profits fluctuate, sometimes wildly and unpredictably. The obvious current example is COVID that hit heavily within a couple of months, but the banking crash isn’t so long ago, previously the deepest recession since the 1930s.

The paper appears a serious over-estimation of what IT can achieve, currently or in the near future. Simple examples: a costly machine breaks down irrecoverably in month 12 and a new one has to be purchased? Flooding or extreme heat hits a farmer. How can a computer predict that? Tax has been overpaid and there will be a big year-end repayment.

It speaks of tax in ‘real time’. But most traders prepare accounts on the accruals basis. It is usually a number of months before payment is received for sales, sometimes longer. Some traders negotiate sales on the basis of allowing longer time for payment. Real time is the time cash is received in respect of sales, not the time sales are booked. This must be fully acknowledged in any changes made. It would be unreasonable to expect businesses to pay tax on unrealised profits. If that were to come about, accounts would have to treat invoiced sales as bad debts until payment is received. Tax reporting would reflect cashflow and not GAAP.

Practical issues

Highly seasonal profitability is interesting in this context. Take a company earning most profits before Christmas. If it prepares accounts to December, it will likely make losses in the first three quarters. HMRC will have to repay tax on those losses. Similarly a summer profits company might account to September and obtain the same advantage from government. Sauce for the goose, as they say.

If such a system were implemented there would be a big temptation for it to overstate tax due on interim reports. Government would have to demonstrate it was fair. But in the actual out-turn, it is inevitable that some payments would be larger than the ‘correct’ figure and some smaller.

Where an interim report shows a cumulative loss, it is important tax is repaid immediately. Otherwise government would be borrowing free of charge from taxpayers – there is no place for this in a real-time system. Currently HMRC averages two months to process a repayment even though all business reporting has been computerised for a good few years now.

A better solution

HMRC has an unwarranted obsession with ‘real-time’ records and tax payments. The paper admits these are annual taxes. Interim profits cannot be taxed accurately. If government wants earlier tax payments, it doesn’t need to introduce complex and costly profit predicting algorithms that probably won’t work well. It is absurdly simple to have a payment on account say 9 months into the accounting period based on prior year or a lower profit claim with the balance paid say 3 or 6 months after the year-end. Just like self-assessment. Advantages:

  • No accounting, reporting or compliance difficulty for taxpayers
  • Business interests could not reasonably say it would be unfair
  • No new costly, delayed and risky computer systems
  • Can advance tax receipts as much as the government wants
  • Can be enacted in three or four lines of legislation
  • Can be implemented immediately or whenever government wishes.

I commend it to government and to HMRC.

London Accountant

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