Spare a thought for Mrs McClafferty & Co. Like thousands of small business owners, she has spent years managing things the old-fashioned way: jotting down figures in a Silvine cash book, stuffing receipts into a shoebox and sorting it all out when the tax return comes around.
But according to HMRC, taxpayers like her are partly responsible for a £24 billion black hole in UK tax receipts. Which means the taxman is coming for them.
If you are self-employed and had an income of more than £50,000 last year, get ready for Making Tax Digital (MTD). From 6 April, you will have to file an income and expenses update four times a year, then an adjustment, then the annual return. You must use HMRC-approved software to do it all.
For anyone earning above the VAT threshold of £90,000, that means up to nine filings a year. Add rental income and you could be making 13. Those with more modest earnings will not escape either. Sole traders and landlords earning more than £30,000 join the regime in April 2027, followed by those earning over £20,000 a year later.
From next month, the self-employed may have to file an income and expenses update four times a year
MTD was first announced by then chancellor George Osborne in 2015 and has already been delayed several times. In that period, HMRC’s reputation for competence and customer service has fallen off a cliff.
Its accounts have been qualified every year since Gordon Brown introduced tax credits in 2004. HMRC estimates the tax gap at £46 billion with more than £20 billion from taxpayer error.
A parliamentary committee report in January last year was scathing about HMRC’s customer service, noting that a third of calls went unanswered and describing the department as ‘a tax authority excavating its way to new lows in service levels every year’.
HMRC insists digitalisation is the solution. Last summer it unveiled a ‘transformation road map’, promising to become a ‘digital-first organisation focused on closing the tax gap and improving the experience of customers’.
That experience could also become more expensive. Basic software exists, but many users will have to pay for additional features. Tools that can digitise spreadsheet records cost up to £15 a month, while cloud accounting systems can reach £35. HMRC estimates businesses will face initial setup costs of £280 to £350, with ongoing annual costs of about £110. Small business owners expect the bill to rise. A survey by insurer Simply Business found almost three-quarters of firms and accountants believe MTD will increase their costs.
Since digital filing was introduced for VAT-registered businesses in 2022, some accounting platforms have quietly increased subscription fees. Meanwhile surveys suggest freelancers’ day rates have barely moved in recent years; many self-employed workers report falling real incomes once inflation is considered.
The software market that MTD will help create is already flourishing. HMRC has approved roughly 50 products, dominated by Intuit, which owns QuickBooks, New Zealand-based Xero and the UK’s Sage.
In the US, the Direct File trial programme enabling taxpayers in 12 states to file directly to the IRS with no intermediary worked well. But this was axed by Elon Musk’s Doge unit last November after lobbying by Intuit and other players.
Banks are also getting involved. Several offer free accounting software to business customers as a way of deepening relationships and attracting new clients. Now might be a good time to shop around.
HMRC says the quarterly updates will be simple. In its telling, the process will be little more than a ‘check and send’ submission, while mandatory software will ‘improve the customer journey’ by giving businesses real-time insight into their finances.
But Fiona Fernie, partner at Blick Rothenberg, says the benefits are overstated. ‘This is a weak attempt to justify the introduction of MTD… Data entry is just as likely to be done incorrectly on an MTD platform.’
The Institute of Chartered Accountants in England and Wales has also warned the administrative burden could be disproportionate, particularly for smaller businesses. Accountants themselves, however, will not be grumbling too loudly. Surveys suggest around two-thirds expect MTD to generate new work, while trade magazine Tax Adviser notes firms may be able to upsell advisory services or partner with software providers.
There may also be financial incentives for HMRC. In the year to October 2023, the department collected £346 million in interest on late tax payments. That figure is expected to rise above half a billion pounds. More than one million of the UK’s roughly 12 million self-assessment returns are filed late each year, triggering an automatic £100 penalty.
Penalties for late filing will be waived during the first year of MTD. Just as well. Reports indicate only around 80,000 people who need to register have done so. That leaves as many as 800,000 sole traders and landlords facing a steep learning curve before the first compulsory returns in August.
From year two, filing more than 15 days late could trigger fines worth 3 to 10 per cent of the tax due, plus interest, up to £3,000. A new points system similar to driving licence penalties should allow for honest mistakes. But with up to 13 filings a year, errors could soon mount up.
The freelancers’ body IPSE says anxiety around MTD is being fuelled by misunderstandings. Tax will not be paid quarterly and genuine mistakes will not automatically trigger fines. But this does not answer a bigger question: how much difference will MTD actually make to the public finances?
When the policy was first costed, the government expected it to raise about £400 million this tax year by reducing mistakes and improving compliance. By last year that estimate had shrunk to just £25 million.
The long-term forecast is more optimistic. By 2028/29 HMRC expects MTD to raise about £780 million a year. Even that needs context. A parliamentary report noted that HMRC wrote off £5 billion in ‘uncollectable’ tax debts in 2023/24, more than 50 per cent higher than the year before.
For those affected, the sensible move is simply to get ahead of the change. Check whether your bookkeeping software is MTD-compatible, see if your bank offers free accounting tools and make sure your records are digital before the first quarterly update is due in August.
In other words, Mrs McClafferty, it may be time to retire the shoebox.
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