Budget legislation will allow the Inland Revenue (IR) and Customs and Excise (CE) to start moving away from paper documents, the current legal requirement, and towards electronic files.

In the US, a similar system placing tax return data straight into the Internal Revenue Service's computer has halved the time taken to send out rebates to three weeks.

UK tax agents can currently register to use the Electronic Lodgement Service (ELS) to send in their clients' Self Assessment Returns entirely over the Internet.

The first returns done this way were for 1996-7 when 43,000 were accepted. Over 198,000 were received the next year and now 3,000 accountants are registered.

The new legislation will lead to individual taxpayers being able to submit returns on the Internet themselves. It is expected that IR and CE will start accepting tax returns over the Internet during 2000-2001.

The announcement comes soon after a Department of Trade and Industry consultation on e-commerce abandoned government proposals to regulate encryption.

This was a victory for civil liberty and business groups but a let down for crime-fighters who wanted ready access to locked data.

Encryption can secure data

The IR and CE say: "Until recently, the Internet was not regarded as sufficiently private and secure for the communication of tax information, partly because the information is transmitted over an open network and partly because of the need to validate the identity of both the recipient and sender.

"This is no longer the case as encryption is available to secure the information being transmitted, and encrypted digital signatures can authenticate that information."

But personal tax consultant, John Wilderspoon, from Hardwick, Cambridgeshire, says: "I have a certain amount of trepidation and am waiting for the dust to settle. Over the last 12 months, I have found the IR has had a lot of trouble with its computer system."

"Larger accountancy firms have taken it up, but there are an awful lot like me who haven't and quite how it will work with individual tax payers, I don't know - the software costs £300.

"But I think ELS is definitely the way to go in the future. The deadlines are very strict and time is money. With ELS that wouldn't happen, you'd click a button and off it would go, at least you hope it would."

The cost of the software might encourage "bucket shops" to set up and send in tax returns for a small fee, thinks Mr Wilderspoon.

Electronic signatures

This has happened in the US, where IRS already accepts electronic federal tax returns. Last year about 24.6m people used the system. They did have to sign and return a paper document, sent out after their electronic submission, but the IRS are currently piloting an electronic signature scheme.

The UK CE is preparing for a live pilot of electronic VAT returns during 1999-2000. Other taxes targeted for early electronic collection are Insurance Premium Tax, Landfill Tax, employers' PAYE returns and VAT registration applications.

CE says: "The main benefit for businesses is that they will have an additional 7 days after the normal due date in order to pay VAT and Insurance Premium Tax.

"The main benefit to the Exchequer is the added security of receiving guaranteed cleared funds, which are processed automatically through the banking system."