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Digital Tax for Small Business Growth

SummaryJan, 2019

This April sees the launch of the first phase of Making Tax Digital (MTD), a government initiative to get individuals and businesses to submit tax returns online. While media attention has largely painted MTD in a negative light, businesses of all sizes stand to benefit significantly from the increased efficiency brought by the digital accounting. While digitalising your accounting is a simple process that will ultimately bring huge rewards, an alarming number of small business owners still lack an in-depth knowledge of the initiative. The Digital Tax for Small Business Growth report covers how small businesses can prepare for April 2019, and explains how digital accounting, far more than being just a technological upgrade, can become a strategic lever to grow your business

In this report

The road to digital tax planning

Submitting tax returns online might be the norm for many companies, but thousands of small businesses have yet to get up to speed

More than 40 years after predictions about the “paperless office” became commonplace, one small corner of the working world is going digital.

This spring sees the start of a government initiative, Making Tax Digital (MTD), which aims to get individuals and businesses to submit tax returns online. The plan is that the scheme will be rolled out in phases over the next couple of years, starting with VAT this April; but there are plenty of voices calling for an extension in order to give more businesses the chance to comply.

“HMRC are not listening to small businesses,” according to Lord Forsyth of Drumlean, chairman of the House of Lords Economic Committee, which in November published a report recommending voluntary instead of mandatory compliance with the VAT changes in April. “Small businesses will not be ready for this significant change to their practices, especially with Brexit taking place three days earlier.”

Digital accounting can help small business owners keep better track of their income and outgoings, improving the ability to make accurate and timely decisions

Yet despite the predictions of doom, many businesses are already onboard with the change. If you use one of the popular branded software accounting packages such as Xero, you are probably already compliant (check HMRC’s website here for a list of compatible software).

So how do you know what your business needs to do? A first step is to understand the change, which requires businesses to maintain digital accounting records – that is, using MTD-compatible software to record and file your returns. Paper records will, ultimately, stop meeting the legal requirements for tax legislation.

Such a move will likely benefit your business by increasing efficiency, particularly if records are moved to the cloud. Digital accounting can help small business owners keep better track of their income and outgoings, improving the ability to make accurate and timely decisions.

Crucial is the use of digital record-keeping. You may already file your returns online via HMRC’s website, but this does not mean compliance; the data transfer must be between software programmes, rather than re-keyed or cut-and-pasted.

For HMRC, digital returns will not only increase efficiencies but save money; according to HMRC’s own estimates, avoidable mistakes – essentially, input errors – cost the Exchequer more than £9 billion a year.

The next step is to familiarise yourself with the MTD timetable, which phases in the digital requirement for different taxes over a period of several years. It starts this April with MTD for VAT; so most VAT-registered businesses will have to file VAT returns digitally this spring (there is a six-month deferral period for about 3.5 per cent of HMRC’s companies, including public sector entities and not-for-profit organisations). Some small businesses with complex needs will have to delay starting to file under MTD until October 2019.

If you are under the current turnover threshold of £85,000, you have until April 2020 to meet the digital requirements. Smaller business can continue to use HMRC’s online portal to file returns – though you can elect to submit your records digitally, a sensible move for any organisation already set up to do so.

The deadline for digital records for other taxes such as income or corporation tax has been pushed back to April 2020 at the earliest, giving most smaller businesses at least two years to adapt to the changes. It is a welcome breather, given the slow pace of change; according to a survey from the Institute of Chartered Accounts (ICAEW), carried out in July, only 38 per cent of businesses use accounting software. A quarter of businesses still use paper-based accounting systems.

It may seem annoying, but it could benefit your business in the long term

According to Anita Monteith, ICAEW Technical Tax Manager: “We support HMRC’s ambition to increase the use of digital technology, but we are concerned that many businesses are not going to be ready for implementation in April 2019. The lack of awareness among businesses about MTD is of concern and needs to be addressed: the communications on MTD do not appear to be getting through to VAT-registered businesses.”

ICAEW’s survey found that only half (51 per cent) of all UK VAT-registered businesses had heard of MTD for VAT, with 46 per cent not using accounting software.

“Given the need to review existing systems and potentially evaluate, purchase and test new software, this is a worry,” said Ms Monteith. “MTD for VAT is a major change in tax administration and it is important for the UK tax system that it is a success: this is too important to be rushed.”

According to the House of Lords report, some 400,000 companies (around a third of those affected) are still not aware they will have to file digitally from this April. Adrian Rudd, chair of the CIOT/ATT Digitalisation and Agent Strategy Working Group (DASWG), said: “These knowledge gaps could mean normally compliant firms fail to fulfil their new obligations.”

There will be penalties for companies that fail to meet the new requirements, which will be treated as a late submission and fined accordingly. However, HMRC has confirmed there will be a grace period, with no financial penalties for record-keeping failures till March 2020.

Finally, if you are not already registered with HMRC, make sure you leave enough time to do so; it can take up to three weeks to complete the registration process.

MTD may sound scary, but many businesses do not need to worry, as their existing software will already be compliant. If you find it is not, use this deadline as an opportunity to improve and upgrade your record-keeping. It may seem annoying, but it could benefit your business in the long term.

Digitalising for business growth

Digitalising your accounts system is far more than a technological upgrade, it’s quickly proving the best way to grow your business

“I seriously hope nobody is using Excel to do their accounts. Yikes! Makes me cringe.” Daniele Poggio runs a Harley Street digestive health clinic called Aqualibria, and whilst today he’s proud of his operation, he soon admits to a dark secret. He used to do his company accounts on an old-fashioned accounts package, and it crippled his productivity.

“It was antiquated,” he admits. “Our bookkeeper needed to physically come into our office. I would hand over receipts and he would sit at the PC doing our accounts. And when he used the office computer, it meant I couldn’t use it.”

When you know precisely what cash you have, and what tax you owe, you can budget and make forecasts. You run your business better. It’s a no-brainer

When Poggio upgraded to a cloud-based accounts system, the impact was a revelation. “It’s faster. We now scan receipts in. Our bookkeeper, Gina, can log on when she needs, from anywhere. Tasks are so quick they take five minutes. And when you can do something in five minutes you do them. When they take an hour, you need to schedule time. You don’t, so an hour becomes, two, three, four hours, a day.”

The growth of Aqualibria has improved as a result of its more efficient accounting practices. “When you know precisely what cash you have, and what tax you owe, you can budget and make forecasts. You run your business better. It’s a no-brainer.”

Mr Poggio’s experience is typical. Switching to a cloud-based accounts system is more than a technical issue. It’s a gateway to a new way of doing business.

“You don’t need to rely on hunches any more,” says Will Farnell, an accountant with Farnell Clarke, and author of The Digital Firm, a book about how to improve company accounts. “A cloud accounting system gives you live data. This means the business owner can investigate issues such as how exchange rates are affecting the business, or compare current performance to the previous year. With old-fashioned accounting, your numbers could be six weeks old, making it impossible. You’d be guessing.”

Furthermore, the top accounting platforms have add-ons to help run the enterprise. “Xero has a huge ecosystem of 700 apps,” says Mr Farnell. “For example, we use an app called Deputy with our clients. It lets companies clock staff in and out each day. If someone calls in sick, Deputy lets you post a message telling staff a shift is available, so you don’t have to ring around. Then at the end you export time-sheets into Xero and do payroll.”

Xero’s app marketplace is teeming with productivity enhancers. Soldo is one of the newest. It offers pre-paid Mastercards for field agents. They buy lunch, coffee and stationery on the card. Spending is registered and itemised online, and feeds directly into an accounts package like Xero. “It gives the accounting team instant visibility over spending,” says Mr Farnell.

It is possible to get paid faster, with an add-on like Stripe. This enables a Pay Now button to be added to emails and invoices, making it simpler for customers to settle bills. Cash-flow is improved as a result.

The overall impact can be tremendous. For a company like Selesti, a fast-growing digital agency for brands with clients such as Zoopla, Barclays, and Soho House, cloud-based accounting is essential to ensure expansion is kept on track. “We rely on it,” says Kate Wood, the office manager. “We have senior management meetings every month, and need to know costs. We also use it to manage projects. It’s vital there is are no delays with our financial information. The fact that the MD and I can look at the accounts at any given time is so important. Of course, we have accountants, but our system means we don’t have to ask them.”

Selesti is discovering that a cloud-based system can do so much more than basic accounting. “We use it for purchase orders, so we know what is going out. There are no hidden nasty surprises.” Receipts are handled with an app add-on. “We use Receipt Bank,” says Ms Wood. “We scan receipts into Receipt Bank. It’s really efficient.” In the future, she says, Selesti will be doing more and more with the accounts platform to administer the business.

Don’t think of an accounting system as technology for technology’s sake. It’s technology to deliver a better way of delivering services to customers

A further bonus awaits. A company with up-to-date accounts is more valuable. Sean Mallon, MD at Bizdaq, an online marketplace for buying and selling businesses, says, “Having been involved in literally thousands of business sales, from one-person operations through to corporates, there is a consistent theme in which businesses sell for the best price and in the shortest time – those with well-prepared and clean financial details. Making Tax Digital should ensure that most businesses are forced into maintaining their bookkeeping, which in turn will make due diligence much easier and quicker for buyers.”

Mr Mallon points out that a buyer will be able to arrange finance more easily when the target company has clean financials. “The biggest reason for a deal breakdown is the lack of funding available. This isn’t always because a lender doesn’t want to lend, more often it’s down to the lack of quality financial information being available at a particular point in time. Making Tax Digital will ensure that most businesses have better-kept financials, which are up to date and should ultimately make funding of these ventures far easier.”

Ultimately, moving to a modern, efficient cloud-based accounts package is about giving a company a foundation for sustained, long-term growth. “If your business is over a certain size, you need the right tools to manage effectively,” says Will Farnell. “Don’t think of an accounting system as technology for technology’s sake. It’s technology to deliver a better way of delivering services to customers.”

As Kate Wood of Selesti puts it: “I simply can’t imagine what it would be like to go back.”

Five misconceptions about Making Tax Digital and small businesses

Making Tax Digital should make for a smoother-run business yet many are not prepared for the change. Here are five common misunderstandings small businesses are making about going digital

1. Paper records are adequate so long as the totals are recorded in MTD-compliant software

Making Tax Digital means that each and every transaction must be recorded electronically. Part of the intention behind MTD is that manual entry increases the risk of errors, and all data transfer, not just totals, has to be done digitally.

That is not to say you can’t keep paper records; but you will have to duplicate the work by entering every item into an MTD-compliant software package, which rather defeats the object of the exercise.

There may be some very limited exceptions on VAT, such as petty cash recording.

2. I already file my returns using the HMRC Gateway – I don’t need to do anything

The current web portal is not the same as the new MTD system. From April 2019, it will close for VAT return submissions for businesses with a turnover of more than the threshold of £85,000; from April 2020 it will close to those filing corporation and income tax returns as well.

You will need to file using MTD-compliant software – you can find a list of suitable packages on the HMRC website. The HMRC itself is not providing the software.

3. I don’t have to think about it till 2020

It depends on the size of your business and how efficient your current systems are. Even if you are voluntarily registered for VAT, so under the £85,000 turnover threshold, you will need to be aware of your monthly turnover, as if it tips over you will have to comply – even if it subsequently drops again.

Remember that changes can take time to bed down. If you do have to change to using an MTD-compliant software package, you need to give yourself time to research the package you want to buy, learn the system and transfer your records across. Don’t leave it till March 2020.

4. My accountant deals with it all

It’s true that your accountant, if registered as your tax agent, will be able to use their own MTD-compliant software to file your VAT returns (and other tax returns from 2020).

But you will need a digital link (that is, one that does not need manual intervention) from your data to theirs. So if you do your own bookkeeping, you may need new software – micro-businesses recording income and expenditure on a spreadsheet will no longer be compliant.

MTD isn’t just about a digital return. It’s about keeping all your records digitally.

5. Businesses will have to keep electronic copies of all documents and provide more information to HMRC

The taxman is not asking you to scan paper documents or keep digital copies of all documents, though it may be more efficient for you to do so. Retention periods for documentation remain the same as before – in general, for six years after the end of the last financial year (though there are some exceptions). You will have to keep digital records for the same period.

There is no increase in the information you are required to file; it is just a different way of filing it.

Accounting stress melts away on the cloud

Paul Bulpitt, head of accounting at Xero, explains the advantages of upgrading to a cloud-based digital accounting package in preparation from HMRC’s digital tax regime

Paul, what’s so great about a cloud-based accounts package?

We did a survey of business owners to find out. One comment really stood out. A director told us, “It’s about stress. My new accounting system has made me less anxious.” Old-fashioned legacy accounts systems are laborious to provide financial snapshots that are six weeks out of date. He didn’t know where he was. With cloud accounting software a lot of the work is automated, and the information is available in real-time. Now this director could log in to his new system at any time of day, from any location, and see his financial position. He found it a great relief. This can be true for businesses of all sizes.

Can companies save time?

Absolutely. It’s so much faster. In our own analysis we found that accountants expect online services to save them at least 117.5 hours – or 15 days – per year. If you’re the sort of person who winds up doing accounting in your spare time, you’ll appreciate the hours it gives you back. But the benefits are more than just time. The biggest gain is the change to your business by having accurate live information at your fingertips. Now you can answer big commercial questions with confidence. Can you afford to expand to a new territory? Is your cash-flow strong enough to hire new staff? When you have the right numbers, you can make better business decisions.

Xero is more than an accounts package. It’s a platform for running your business in the most efficient way possible

What about putting numbers in the cloud. How does that help?

It’s a huge plus. Not only is the data automatically backed up, cloud systems change the way you work. Data is opened up to other team members. Gone are the days when the finance team kept the data on an Excel sheet on their PC. Anyone with a log in can participate in planning. The director I just mentioned also said he’d improved engagement levels with his top team, as they all had access to the finance. They could all be consulted and included. It made a huge difference to his company.

Data analytics is a growing part of business. How can advanced accounting software help?

It transforms your capabilities. With an old system you would get static numbers. Now you can drill down and get the story behind the data. You can understand how revenue is generated, break down costs over time, and see what activities are contributing to the top line. Your understanding of your enterprise soars. Second, you have dashboards displaying vital metrics such as cash flow and revenue. Xero reports make this easy. And you can export the data easily into reporting products like Futrli or Fluidly. If you have a retail business, you can match revenue with footfall. If you are an online business, you can introduce Google Analytics.

Why are some businesses reticent to move to a cloud accounting system?

I wouldn’t say they are “reticent”. During our research we asked why companies still use old-fashioned legacy systems. The most common response was that they didn’t know anything better was out there. If you’ve spent the last ten years building your business, you are unlikely to be up-to-date with accounting software. You’ve got better things to focus on, like growing your business. It’s a lack of time and knowledge that keeps people trapped using a legacy system.

Is it hard to migrate to Xero?

My advice is that it will go smoothly, so long as you plan carefully. But the feedback we get from CFOs is that it’s as easy as it could be. Xero offers a free data conversion service from existing platforms and accounting packages. So getting the data across is straightforward. Then there is training and configuration. Xero’s support is second to none. And there is an awful lot of education online, including videos and webinars. There is ten years of accumulated support. I have yet to find a question not yet answered online. Furthermore, Xero can co-exist with your old system, if you want. You make the transition slowly, over the year. There’s no sudden switch from one to the other.

Accountants expect online services to save them at least 117.5 hours – or 15 days – per year

What is the Xero App Marketplace?

Xero offers users the ability to download and use more than 700 business apps which all integrate with our platform. It’s like with an iPhone. The product comes alive when you download apps, and no two users have exactly the same needs. It’s the same with Xero. You can automate expenses with Receipt Bank, collect direct debits from customers with GoCardless, or run your online business with Shopify. The apps dovetail brilliantly with Xero, making it incredibly easy to run and grow your business.

Why should businesses choose Xero over rivals?

Born in the cloud, Xero is a beautiful, easy-to-use platform for small businesses and their advisors. The company has over 1.6 million subscribers in over 180 countries, with more than 355,000 of those in the UK. Our mission is to rewire the global economy, connecting millions of businesses to their advisors, banks and each other. We are a global platform, so we can help you grow overseas. Frankly, there aren’t many rivals who can offer that. Our system is the most intuitive. The App Marketplace sets Xero apart, helping companies automate and streamline many business functions. If you run a farm, there are dedicated tools to help you. Electronic point of sale systems integrate easily. Xero is more than an accounts package. It’s a platform for running your business in the most efficient way possible. Switching to a new accounts system to prepare for HMRC’s digital tax regime is just the catalyst to something so much bigger and more exciting.

Mind the gap!

The divide between large companies and SMEs may widen as HMRC’s Making Tax Digital initiative comes into force, but what can be done to get tax right?

Small businesses have always been a headache for the taxman. In 2016–17, HMRC held them responsible for an estimated £14.1 billion of unpaid tax, more than any other customer group including large businesses at £7 billion. This was largely due to reporting errors, but also avoidance and evasion.

Naturally the revenue has been cracking down, but some warn it’s putting too much pressure on small firms. Others say the tax system unfairly favours bigger businesses and needs a revamp – so what can be done to make it fairer and more efficient?

The reasons small businesses are more likely to get their tax wrong are self-evident, says Andy Lymer, Professor of Accounting and Taxation at the University of Birmingham.

“Smaller businesses are more likely to be cash-based which makes them susceptible to errors in their tax reporting, and makes it easier to bend the rules, by omitting income on returns or simply not filing a return at all. This needs to change,” says Professor Lymer.

HMRC says it is working with small businesses to help them get their tax right “first time around”. Core to this is its Making Tax Digital (MTD) initiative, which aims to fully digitise the VAT tax returns system.

There are 5.7 million businesses in the UK and most still use spreadsheets to record their VAT transactions

Damon Anderson, who heads up product development at accounting software provider Xero, thinks it is a step in the right direction. “There are 5.7 million businesses in the UK and most still use spreadsheets to record their VAT transactions before transferring the numbers into the government’s Gateway.

“Often, numbers have to be re-entered multiple times and every time there is a manual entry there is the chance of an error,” he says.

Eventually the government will turn off the Gateway, bringing the UK into line with such countries as Estonia and Australia who the lead the way in this area. But not everyone is pleased with the rollout of MTD.

Xero’s own research shows that a quarter of businesses are still unaware of the initiative, despite the fact the first phase kicks off in early 2019. Richard Murphy, a tax campaigner and professor at City University, also believes MTD reflects a tendency for HMRC to pass the burden of compliance onto the taxpayer as a means of cutting costs, rather than improving the way it enforces the law.

“When it comes to corporation tax, a fifth of tax returns are not even filed, which is really unfair on the people who do submit,” he says. “There are numerous loopholes that people can take advantage of and I have raised this with HMRC, but they are only just about able to deal with the returns they do receive, not the ones they don’t.”

In January 2018, the House of Commons Public Accounts stated that “HMRC is unclear how far it can close the tax gap with existing resources”.

Critics also point out that MTD also comes as small firms face a host of other challenges, including a slowdown in consumer spending on the High Street, rising business rates and disruption from the internet to bricks-and-mortar-based business models.

In his most recent budget, Chancellor Philip Hammond promised to address these concerns by offering £900 million of relief from business rates and to look at ways of taxing purely online operators more fairly; however, for many this was nowhere near enough. It was also overshadowed by another proposal to crack down on people falsely claiming self-employed status as contractors to minimise their tax bills.

In Sweden, you can look up the tax returns of any individual you want to, they are all public

The government said the changes to the IR35 rules were simply aimed at levelling the playing field and that the move would generate an extra £2.9 billion of tax by 2024. But the Association of Independent Professionals and the Self-Employed (IPSE) said the plan would “punish the overwhelming majority of genuinely self-employed people, heap a massive administrative burden onto businesses at a time of Brexit uncertainty, and also undermine one of the UK’s most dynamic and productive sectors”.

For Professor Lymer, it points to an unhelpfully punitive approach towards business taxation in the UK that is doing little to fundamentally improve the system. “I think there are two ways of getting people to be more compliant – the stick and carrot. You can name and shame and punish, but we need more carrots.”

He’d like to see more education and debate about tax in the UK, arguing that many people know little about it or the implications of being an avoider. He’d also like to see more transparency in terms who is paying what.

“In Sweden, you can look up the tax returns of any individual you want to, they are all public. That changes the debate and makes people think twice about cheating on their tax returns. It also gives you more insight into who is paying what, particularly how much the wealthy are paying and whether it is morally fair.”

Mr Murphy believes nothing less than wholesale reform of the agency will do.

“The government favours bigger businesses. It’s obvious, just look at the board of HMRC. Big companies are members but the Federation of Small Businesses is nowhere to be seen.

“We need total transformation of HMRC to remove this bias, nothing else will create a level playing field,” he says.