Lee Sharpe looks at taxpayers’ record-keeping obligations in light of HMRC’s inexorable march to digital everything (almost).
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Historically, HMRC has been quite relaxed about whether original records must be maintained or digital facsimiles (scans, etc.). For instance, the 2013 ‘General Guide to Keeping Records for Your Tax Return’ states:
‘You can keep most records on a computer or use any storage device such as CD-ROM, USB memory stick or a network drive. You may not need to keep the original paper records as long as the method you use captures all the information (front and back) on the document and allows you to present the information to us in a readable format, if requested.’
NB You can tell this guidance is now more than a decade old, because it makes no mention of storing records ‘in the cloud’.
In terms of records required to be kept for the purposes of tax returns, the primary legislation states that the duty to preserve records may be discharged by preserving the records ‘in any form and by any means’, or by merely ‘preserving the information contained in them in any form and by any means’ (emphasis added).
So, according to my understanding, the first part of the legislation permits facsimile copies such as scans, microfiche or photocopies, while the second part permits recording all relevant details in a database or ledger, with exceptions including the following (TMA 1970 s 12B; FA 1998 Sch 18 Para 21,22; see also HMRC’s Compliance Handbook Manual as below):
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certain company distribution statements (broadly, dividend vouchers);
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certificates of income and tax deducted from banks, building societies and trusts; and
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certificates or vouchers of income and tax deducted, as given to sub-contractors in the construction industry scheme (CIS).
To summarise, the law for direct taxes starts with the assumption that records are initially on paper, and states that, for the most part, they may be converted into digital format so long as all relevant information is preserved for possible future scrutiny by HMRC.
Making tax digital
It could be said that making tax digital (MTD) has broadly turned this on its head by stipulating that specified business records must be kept in ‘electronic form’. The legislation (in F(No 2)A 2017, s 60) grants HMRC wide powers to introduce regulations to require how business records must be kept for the purposes of making returns to HMRC.
Strictly speaking, however, this is an additional requirement, meaning that it does not override or replace any other record-keeping requirements. To my reading, the legislation does not state that the records must be kept only as specified, which would seem eminently sensible, given how wide and varied a particular business’s own peculiar financial reporting requirements might be.
In other words, businesses may broadly carry on as before, except that they now also must incorporate these new electronic record-keeping requirements into their systems, which in turn must drive the quarterly ‘updates’ and annual tax returns to HMRC. Of course, in many cases, and perhaps for older businesses with more traditional ledger-based systems, this will require major changes to their core bookkeeping systems and routines. But larger businesses, that may conceivably place a greater priority on internal management accounting, may yet find the MTD requirements to be more peripheral in effect.
MTD regulations: Income tax
For income tax purposes, the main regulations were issued in late 2021 (although they are still being tweaked and refined as we are dragged towards implementation of MTD for income tax self-assessment at the time of writing).
Drilling down into those regulations, we find that the ‘digital records’ requirement includes only that there be a record of each transaction made in the course of the business, including:
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the amount of the transaction;
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the date of the transaction; and
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the categorisation of the transaction (e.g., sales, employment costs, etc., as may be specified in an update notice issued by HMRC).
Draft update notices were published in December 2023. The business expense categories are broadly as one might expect from many years of filling in the standard accounts information charts in the self-employed pages of a self-assessment return, except that:
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advertising expenditure has been split from business entertainment costs; and
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depreciation and irrecoverable debts written off have been ignored.
Presumably, this is because HMRC wants to isolate entertaining expenditure, a high proportion of which is typically disallowable, and intends that depreciation and bad debts should be relegated now that HMRC is championing the cash basis by default.
Fuller picture
Taxpayers will focus on the regulations that apply directly to them, see that the definition of ‘digital records’ is actually very straightforward, and perhaps conclude that MTD has minimal effect. But that is to overlook that the legislation also requires ‘functional compatible software’ to be used to keep digital records. In practice, there is a quite separate conversation that HMRC is having with software providers about HMRC’s aspirations for MTD software functionality, and all those software companies are keen to achieve accreditation by HMRC.
Digital exclusion or exemption from MTD and implications
The legislation allows certain taxpayers to forego the rigours of digital record-keeping and online quarterly or annual updates under MTD, including:
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trustees (NB the primary legislation excluded certain trust categories, but this was extended to all trustees in 2021 (SI 2021/1076, reg 25));
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Lloyds underwriters (but only in relation to their underwriting business);
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where annual gross income across all a taxpayer’s businesses aggregates to £10,000 pa* or less; or
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if the taxpayer satisfies HMRC that they cannot comply with the digital requirements due to (for example) age, disability, location or religion.
* The legislation for the income exemption currently states £10,000 pa but the threshold may be increased to £30,000 pa – although keep in mind that this limit applies to the grand total of a taxpayer’s gross business incomes across all returnable sources (SI 2021/1076, reg 21).
If a person is claiming exception from the MTD digital requirements, then depending on the rationale behind the exception, HMRC may expect to see records kept in non-digital (paper) form. If the taxpayer’s location means that Internet connectivity is unreliable, they may still be able to use a scanner to convert paperwork to digital format by choice, but HMRC may wonder at a taxpayer who says they are too old to use MTD software but chooses to scan paperwork, prepare and submit their annual tax return online, etc.
So what must be retained in its original form?
Having said that HMRC is generally permissive as to record-keeping, its Compliance Handbook Manual at CH13300 states that certain documents must be retained in their original form, and taxpayers must retain any written statement showing:
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company distributions or dividend vouchers that detail a tax credit;
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interest certificates showing tax deducted therefrom;
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receipts of income paid under a construction contract (CIS, as noted above); and
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paperwork in relation to overseas-sourced income and tax paid, etc.
Separately, VAT Notice 700/21 states that Import VAT Certificates C79 must also be kept in their original form.
Conclusion
The list of records that HMRC insists be kept on paper is ever smaller. Readers may recall that VAT ‘DIY Housebuilder’ claims used to have to include original invoices alongside the VAT431NB; since December 2023, original invoices no longer need be sent; in fact, the updated claim guidance states: ‘do not send original documents as we will not be able to return them to you’. However, the new guidance also states: ‘you must keep…the original shipping or transit document showing…goods imported from abroad’.
However, even if HMRC will accept digital records, it may not always be sensible to rely on them for the very long term. Would you be confident in retrieving an option to tax (VAT) property from the cloud up to 20 years hence?
