The UK tax gap figure for 2019/20 of £34.8bn equates to 5.2% of theoretical tax liabilities. The estimated gap has reduced over time in percentage terms. However, in real terms it remains stubbornly around the same £30-35bn level.

The latest set of figures, published in September 2021, showed a 0.2 percentage point increase in the gap, largely attributable to an estimated increase in the VAT gap. The VAT gap increased quite sharply from its lowest-ever point of £10bn in 2018/19 to £12.3bn in 2019/20, or from 7% to 8.4% of theoretical VAT liabilities.

Tax avoidance is estimated to make up £0.1bn of the VAT gap. However, the other behaviours attributed to causing the tax gap (failure to take reasonable care, legal interpretation, evasion, criminal attacks, non-payment, error and the hidden economy), are not broken down by tax.

Digital record keeping and error reduction

The amount of the total tax gap attributed to failure to take reasonable care was £5.5bn or 18% in 2018/19 and £3.1bn or 10% of the gap was attributed to error. It is these elements of the gap that HMRC hopes to reduce through Making Tax Digital (MTD). 

In its stakeholder communications pack, HMRC states: “The move to digital integration will eliminate many of the existing paper-based processes, reducing errors and allowing businesses and their agents to devote more time to running their business… We know that the majority of customers want to get their tax right but recent tax gap figures (2018 to 2019) show too many find this hard, with avoidable mistakes costing the Exchequer almost £8.5bn a year. The improved accuracy that digital records provide, along with the help built into many software products and the fact that information is sent directly to HMRC from the digital records avoiding transposition errors, reduces the amount of tax lost to these avoidable errors.”

On 10 March 2022, HMRC published a research paper, Evaluating additional tax revenue from Making Tax Digital for VAT. The paper separately calculates the additional VAT generated from those required to join MTD VAT from April or October 2019 and those with turnover below the £85,000 VAT registration threshold who voluntarily joined MTD VAT before being required to do so from April 2022.

For the population below the £85,000 VAT registration threshold, the paper estimates that the average additional tax revenue from MTD is £19 per business per quarter. This represents a 2.2% increase from the average liability estimated had the businesses not signed up to MTD.

For the population above the threshold, the estimated average additional tax revenue from MTD is £57 per business per quarter. This represents a 0.9% increase from the average amount estimated had the businesses not signed up to MTD.

Extrapolating these results, the paper concludes that the estimated total additional tax revenue from MTD VAT in 2019/20 is around £185m or £195m depending on the method chosen. This compares with a previously published estimate of £115m.

This all sounds very positive. But in the context of a VAT gap that grew by an estimated £2.3bn in the same period, has MTD really made a difference? Also, if the tax gap attributable to failure to take reasonable care or making errors is assumed to be similar across all taxes, then that element of the VAT gap would be around £3.7bn in 2019/20, so whether it is £185m or £195m, these figures are just a drop in the ocean. 

The report is, however, at an early point in MTD. With digital links only mandated from April 2021 and with more businesses joining MTD VAT from April 2022, it will be interesting to see how this picture evolves.

Deregistration?

Also on 10 March 2022, HMRC highlighted an error in its Value Added Tax (VAT) annual statistics that has caused an under-reporting of deregistrations since April 2019. As a result, the published overall VAT-registered population at the end of the 2020/21 financial year is approximately 5% too high.

It is not known what impact this may have on either the VAT gap figures or the estimated additional revenue from MTD VAT. 

More than 52% of all VAT-registered traders are estimated to have turnover below the VAT registration threshold. About a third of those are understood to have signed up early to MTD VAT. It is not yet known whether the extension of MTD VAT to those that are voluntarily registered will have triggered an increase in VAT deregistration.

Many of those registered voluntarily for VAT are repayment traders. Unless the value of repayments is minimal, they are likely to want to remain registered. Even if a business does deregister from VAT to avoid MTD VAT requirements, they may then find that they are subject to the MTD income tax self assessment (MTD ITSA) requirement from April 2024 if their total gross income from self-employment and property exceeds £10,000 in a tax year.

Looking overseas

The European Commission is also considering how to reduce the tax gap. The EU VAT gap was estimated at €137bn in 2017. Its current consultation, VAT in the digital age, is considering:

• VAT reporting obligations and e-invoicing;
• the VAT treatment of the platform economy; and
• the use of a single EU VAT registration.

So what is e-invoicing? It is not an invoice attached as a pdf or jpg file to an e-mail. An e-invoice moves away from the visual representation of data that we expect on a paper invoice such as amounts, values, descriptions and quantities. The data is in a structured form to allow it to be automatically imported into a customer’s accounts payable system. Automation becomes the primary objective with a visual, human-readable format becoming secondary.

Should the European Commission adopt e-invoicing, this will not only affect EU businesses, but also potentially businesses operating with and within the EU.

Does MTD need a reset?

The world has moved on since we first started consulting on MTD in 2016. The pandemic and the contrast in the data available to deliver the support schemes for the employed and the self-employed are being used as the driver for MTD ITSA and, in particular, quarterly reporting.

As accountants, we all understand the value of good record keeping and timely management information. Many businesses, particularly those with simple affairs, are able to get their tax right without the need for software.

Even if MTD VAT has delivered additional VAT revenue, how does this compare with the cost to business and HMRC where this has necessitated system investment? Yes, technology moves on and it is undeniable that HMRC’s systems need investment, streamlining and development.

However, any digital record-keeping solution should be based first and foremost on the needs of the business and improving efficiency. Ensuring profitability, generating wealth and employment should be the primary concern. Imposing additional reporting obligations runs counter to an enterprise culture. 

Given the European Commission’s focus on VAT, and in particular e-invoicing, has MTD ITSA become a distraction from further developing MTD VAT beyond digital record keeping? VAT has led the way for MTD. Should it continue to do so?

About the author

Lindsey Wicks, Technical Editor, Tax Faculty