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VAT as a digital tax: HMRC needs a roadmap

Author: ICAEW Insights

Published: 28 Mar 2023

With aims to create real-time reporting for VAT, HMRC needs to fully articulate its plans to allow businesses time to adapt.

The past five years have seen the rapid advance of numerous different technologies simultaneously, which could possibly lead to them all maturing over the next five years. All these technologies, from big data to blockchain, have the potential to bring significant value to businesses and the government. 

Understanding how these technologies work, interact and add value can be daunting. While these technologies present a great opportunity, the overwhelming level of choice could be viewed as a crisis of change.

Tax is no exception to this. As it is fundamentally rules-based, it lends itself extremely well to automation. 

HMRC’s ambitions

HMRC has a vision to further digitise the tax system by 2030, driven by three elements:

  1. policy – the extension of HMRC‘s Making Tax Digital (MTD) initiative; 
  2. systems – appropriate timing and frequency for the payment of different taxes, and the investment in technology infrastructure needed to support; and 
  3. law and practice – reform of the tax administration framework itself. 

MTD VAT was the first phase of HMRC’s 10-year strategy to transform VAT into a digital tax. This strategy will culminate in introducing some sort of real-time reporting for VAT by 2030.  Since April 2022, MTD VAT has applied to all VAT registered businesses. It requires them to store digital records, submit returns through an application programming interface (API), and ensure that an electronic audit trail exists from digital records through to the submission of VAT returns. 

HMRC’s ambition – real-time reporting – requires businesses to send transaction-level information to HMRC in real time. Similar systems already exist in countries like in Spain, where transactions should be reported within four days, and Hungary, where transactions should be reported in real time. In Chile, 93.7% of businesses submit pre-filled VAT returns using real-time information sent to the authorities. 

If HMRC is to introduce a form of real-time reporting and utilise technologies maturing in the next five years, businesses need a clear roadmap. Little information has been published on how HMRC seeks to meet its 2030 ambition. Businesses need clarity to optimise their own decisions.

EY’s Future of VAT (EYFoV) campaign undertook a deep dive into the future of UK VAT as a digital tax. It explores whether businesses have a clear understanding of HMRC’s ambitions or clear views on how VAT should be transformed.

Benefits of real-time reporting 

According to HMRC, MTD has seen a reduction in the scope for error and improved accuracy in VAT reporting. There is a hope that real-time reporting could achieve similar success. It would allow HMRC to detect suspicious transactions early, enable better use of digital prompts to eliminate potential errors in real time, and help ensure businesses register the same invoices as counterparties. 

In Estonia, the mandatory reporting of business-to-business transactions in 2014 allowed a more strategic audit of transaction chains. This reduced the VAT gap from 14% to 5% in 2017. Chile and Hungary have combined real-time reporting with e-invoicing requirements, leading to similar success.

Real-time reporting opens the opportunity for ‘split payments’. This involves the real-time remittance of VAT to the tax authorities, which has a clear cash-flow benefit for tax authorities and helps prevent fraudulent activity such as missing trader fraud. 

Barriers to real-time reporting 

Respondents to the EYFoV survey saw enterprise resource planning (ERP) system changes as the biggest barrier to meeting potential real-time reporting requirements. These changes can be costly, and with a substantial proportion of costs being upfront, this could have an acute impact on SMEs. A number of respondents cited SMEs transforming systems as a specific barrier. 

While these changes are likely to be expensive, most viewed the time to implement them as the largest barrier. Many companies need bespoke software to bring all systems together to meet digital reporting requirements. According to 60% of EYFoV respondents, it would take more than two years to prepare for real-time reporting. 

Some respondents viewed complex areas of the VAT system as a barrier to the implementation of real-time reporting. In Singapore, financial services have been simplified by mandating that businesses in the industry are only entitled to credit a given proportion of input tax, instead of completing complex partial exemption calculations. With the UK no longer having to align with European Union VAT, it can make significant unilateral adaptations to the VAT system to support real-time reporting. 

The sooner HMRC sets out its roadmap, the better businesses will be able to make optimal investment decisions. A quick and clear articulation of a roadmap to 2030, incorporating multilateral agreement on software and data requirements, could support businesses and software providers to make investments and develop software solutions to realise HMRC’s vision of VAT as a digital tax. 

Joseph Eloi is Manager, Tax and Trade Strategy, EY

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