HMRC defend approach to basis period reform and uncertain tax treatment

The claims were made during an oral evidence session of the House of Lords Finance Bill Sub-Committee inquiry on Draft Finance Bill 2021-22, held on 28 October, the day after the Budget.

The Government is proposing to change - for some businesses - the period over which their profits are taxed (the basis period). Under the new rules, unincorporated businesses will be taxed on the profits they generate within the relevant tax year, no matter what their accounting date is.

Making Tax Digital (MTD) is a key part of the Government’s plans to make it easier for individuals and businesses to get their tax right and keep on top of their affairs. Currently VAT-registered businesses with a taxable turnover above the VAT threshold (£85,000) are required to follow the MTD for VAT rules by keeping digital records and using software to submit their VAT returns. Remaining VAT-registered businesses will be required to follow MTD for VAT rules from April 2022. From April 2024 self-employed businesses and landlords with annual business or property income above £10,000 will need to follow the rules for MTD for Income Tax. The Government will provide businesses with an opportunity to take part in a pilot for MTD for Corporation Tax and will not mandate its usage before 2026.

In addition to basis period reform and MTD, the committee is focusing on the proposal in the Finance Bill to place new obligations on large businesses to notify HMRC where they have taken a tax position that is uncertain. Uncertain tax treatments are defined by two criteria: that a provision has been made in the accounts for the uncertainty, or that the position taken by the business is contrary to HMRC’s known interpretation (as stated in the public domain or in dealings with HMRC). A third criterion which was included in draft legislation published in the summer (that of where there is a substantial possibility that a tribunal or court would find the taxpayer’s position to be incorrect) will not be included in the Bill. This had been announced the day before the committee session.

Witnesses at the session were all from HMRC: Helen Page, Deputy Director, Tax Administration Policy and Strategy at HMRC; Bridget Micklem, Deputy Director, Business Profits at HMRC; Christopher Thomas, Deputy Director, Large Business at HMRC; and Thomas Brown, Senior Policy Adviser at HMRC.

Basis period reform and Making Tax Digital

A sceptical Lord Bridges of Headley, Committee Chair, asked the witnesses to explain the rationale for basis period reform.

Bridget Micklem said it is ‘simplification’ because it will remove the complex basis period rules, which make it very difficult for small businesses to understand how their income tax is calculated. That creates disproportionately high tax burdens for new businesses and leads to many thousands of errors a year. The new approach works for new businesses because they will no longer have to go through that complex set of rules about overlap profits and overlap relief at the beginning of their businesses. There are always trade-offs when you try to simplify, Micklem said. It is ‘critical’ that this reform happens before MTD for income tax self-assessment comes in, she said, adding: “If you have complexity in the tax code and then put technology over the top of it, the risk is still that the difficulty that creates complexity now makes things unclear going into the system and unclear going out again.”

Lord Butler of Brockwell, crossbencher, suggested an interval year between basis period reform and MTD. Micklem would not be drawn on Lord Butler’s suggestion but said there was a swift reaction that more time would be given for basis period reform and MTD, ‘so the Government have heard that and do understand the pressure’.

Baroness Noakes, Conservative, wondered why it took HMRC so long to realise basis period reform was integral to align with MTD. Micklem replied that through that period the Government have been ‘very responsive’ at all stages to the feedback that they have been getting. But Lord Bridges asked why HMRC have not been looking at this for a longer period and thinking through carefully the stages to make MTD work in simplification and implementation terms? Micklem explained that that is the nature of developing a complicated thing like MTD - you find that issues rise in importance as you go, but she said that basis period had been looked at before, including by the Office of Tax Simplification (OTS) in 2015.

Baroness Harding of Winscombe, Conservative, suggested that simply moving to an equivalence between the end of March and 5 April would give you the vast majority of the simplification benefits you are looking for without the huge complexity for the smaller number of businesses that will be caught by the complexities of basis period reform. Micklem said if you do not do basis period reform, you end up with a very odd misalignment of information going into MTD, which is not what it needs to deliver. The other thing is that you do not do anything to deal with the problems of overlap relief. Baroness Harding said that if you are a farmer, basis period reform will make your accounting more complex for ever.

Thomas Brown tried to ‘unpack’ the two burdens in the reform: the apportionment burden and the estimated or provisional figures burden. People think that apportionment is quite a simple process that is done by a simple mathematical sum or done entirely in software, so it is not that great an issue, he suggested. For provisional figures or estimation, there is a slightly larger issue and one that we are taking ‘quite seriously’. More taxpayers (around 278,000) will have to start using provisional figures under the basis period reform. But provisional figures are nothing new, he claimed.

Lib Dem Baroness Kramer remarked that rather than taking an approach that says, “Let’s drive the timetable by looking at the best way to introduce basis period reform, given that it will have complexity and raise some real issues for a significant number of small businesses, particularly in some sectors”, HMRC seemed to be saying that we have to “squash it into the timetable and the track that MTD is already following.” Micklem said that the Government had listened to the call for more time in September.

Lord Monks, Labour, asked what HMRC are doing, if anything, to raise awareness of the reform and the rules that will be altered. Brown said there are two very practical areas that HMRC can support the change, which are overlap relief and general communications. HMRC are exploring the best way to communicate the data that HMRC currently holds on overlap relief to taxpayers. He suggested the use of touchpoints like tax returns to make sure that affected businesses are aware of the change, and a ‘special focus on unrepresented taxpayers, those who do not have the help and support of an agent or an accountant, even though the vast majority of affected businesses are represented by an agent’.

Micklem explained that the Government has been influenced by pressure from ‘represented bodies and tax professionals’ to do something about basis period reform before MTD.

Kramer was worried that, with 18 months to go before we hit the transitional year, there are “something like 13 or so technical issues that are quite fundamental in both apportionment and the estimation of profits” and, she claims, there is no timetable for getting these issues resolved.

Micklem replied that the UK Budget has confirmed that the reform is going ahead and when, and the documentation has also confirmed that the Government will be publishing revised legislation and that this legislation will respond to suggestions from the consultation. The Government response to the consultation is coming with the Finance Bill legislation, she added. But Kramer remarked that ‘some of us are probably at the point of bashing our heads against the wall’, because we get almost to the end of a piece of legislation and suddenly there is a raft of corrections.

Thomas Brown told Baroness Noakes that the delay to basis period reform means that if a business wishes it could take a specific course of action to change its accounting date to align with the tax year in advance of the transition.

Brown said 20 per cent of the affected population of taxpayers (those who do not have tax year basis periods already) are unrepresented. Of those, around 75,000 are sole traders, he said.

Bridget Micklem said the Government is very clear that this is a simplification measure and that it is broadly revenue neutral in the long term. The profits brought forward are just reversing what would happen anyway in future events.

Lord Butler spoke about concerns that taxpayers may miss out on overlap relief in the transitional year because they do not have the necessary figures. Brown said they are working on the process to get taxpayers the information that HMRC currently hold on overlap relief, but he warned that ‘taxpayers do not always put it in their returns, they do not always carry it forward, so we can only tell taxpayers what we know from the figures that we hold’. Publicity and communications are key on this issue, especially for unrepresented taxpayers and working with representative bodies to get the message out there. Where HMRC do not have the figures, but the taxpayers do not have the figures either, it may be possible to look back through previous tax returns, previous records, and make a calculation of the overlap period – the period where basis periods have overlapped and the amount of profit that fell in that period, said Brown.

Baroness Harding of Winscombe said the committee has heard from the professional tax bodies that they are concerned that their members will not have the capacity to provide the support their clients will need to cope with basis period reform and MTD at the same time – and they even queried whether HMRC are sufficiently resourced for them. Micklem said the £13 million set aside to deliver them is ‘not an insignificant budget’. She added that HMRC have seen improvements in the customer service levels in the first quarter of 2021 to 2022, and saw strong customer satisfaction in August, where 84 per cent were satisfied with the service provided.

The old basis period system had an administrative burden, an administrative cost, of recording and of calculating overlap relief, and a real direct tax cost in businesses having to pay the overlap tax and then having to wait 10 to 20 years, for example, in the case of farmers, to be able to claim that relief back, said Brown.

Uncertain tax treatment

HMRC’s Helen Page said the aim with uncertain tax treatment is to tackle the very large ‘legal interpretation’ tax gap. This measure breaks new ground because it will enable HMRC to find out more legal interpretation issues and to find out about them sooner. It will help HMRC to identify potential high-risk legal interpretation disputes sooner and more consistently. It is a ‘levelling the playing field measure’ because some customers already do this with HMRC.

Baroness Noakes said previous witnesses in this inquiry said they do not see the rules as having that effect. They see the rules as having the effect of putting more burdens on compliant organisations. Page’s colleague Christopher Thomas said the measure is not aimed only at a minority of non-compliant businesses. We encourage them to raise issues of uncertainty with us and talk to us and engage with us early before filing. HMRC will apply its business risk review process to look at the way a business is applying the uncertain tax treatment.

Lord Monks spoke of previous witnesses’ concerns that HMRC may not have the resources to keep its guidance up to date that is relevant to uncertain tax treatment. Page said the test is ‘whether the tax position taken conflicts with HMRC’s known position’. That means that the taxpayer has to know what HMRC’s known position is, but it is a clearer objective and manageable test, she said, adding the definition of the test was welcomed by consultees. It is right that the legislative definition is quite broad, she argued. We will state our known view in guidance. We will not require businesses to trawl through decades of different statements or back through years of documents. HMRC will not expect businesses to know the content of HMRC forum minutes that are published or submissions that are made in litigation. She added: “We will interpret that test in a sensible and proportionate way.”

Committee chair Lord Bridges cited the Law Society as saying ‘this subtly erodes the central position of the law as the foundation for the tax system by making it more difficult in practice to diverge from an HMRC interpretation, even when the law itself is clear’. Page countered that that is ultimately for the courts to decide, but HMRC think it is reasonable for the UK’s largest businesses to know what HMRC’s position is.

Page told Baroness Kramer that HMRC are proceeding with the first two triggers only in the forthcoming Finance Bill. They will ‘keep looking’ at the third trigger because it would identify a category of uncertain tax treatment that is not caught by the other two triggers. It would have to be part of primary legislation and a new Finance Bill.

Thomas believed that ‘we are not starting from a position where any company has to put a whole new system in place’.

The legal interpretation tax gap is £4.9 billion. Last year, the costings were that this measure would save around £45 million (now downscaled to £35 million in 2023 and diminishing to £20 million in 2026-27). The cost for business across the board may be £3 million, and HMRC said that the cost to them is £15 million. “Putting all those figures together, it does not sound like very good value for money,” said Lord Butler of Brockwell. Thomas said he expects a more significant impact on the legal interpretation tax gap because of the combination of this measure with other activities in HMRC’s compliance strategy.

Baroness Noakes asked how this will work for the average compliant taxpayer, who is trying to have a relationship with their customer compliance manager (CCM). Thomas said HMRC have the right model and the right resourcing for this policy. HMRC’s survey of large business shows satisfaction over 90 per cent, he added, which shows large businesses think CCMs are doing a good job despite the extra demands on CCMs because of the pandemic. Thomas explained businesses dealt with by HMRC’s mid-size business teams are generally smaller and less complex and may present less tax compliance risk than those dealt with by the large business directorate.

This committee recommended last year that the Government went back to the drawing board and started again with a stage 1 consultation to develop a more proportionate measure. Why was that not done? asked Baroness Harding. Helen Page said: “The first consultation we think now was perhaps too narrow and focused on a certain proposal. We heard that message loud and clear from the responses we had. We listened and responded by deferring implementation for a year to allow reshaping of the policy design and further consultation.”

Will this measure simplify and bring certainty to the tax system? asked Lord Bridges. Page said she cannot claim that it will simplify the tax code ‘but I do believe that it can drive simplification by levelling the playing field and providing a better understanding of the tax gap’.

The transcript is here.

By Hamant Verma, CIOT Senior External Relations Officer