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Everything you need to know about Making Tax Digital

If you’re a small business owner or freelancer, you might have heard of Making Tax Digital (MTD). But what is it, exactly? What do you need to know? And what impact will it have on you and your business?

Don’t worry if you’re asking yourself all of these questions (and more). We’re here to guide you through MTD and make the switch to digital easier.
Graphic showing pile of forms

What is Making Tax Digital?

MTD is part of the government’s plans to make tax easier for businesses and individuals.

Making Tax Digital makes it a legal requirement to keep digital records and use compatible, HMRC-recognised MTD software to keep digital records and file VAT returns.

It was first introduced in 2019 for businesses over the VAT threshold (£85,000). Now, though, it’s being extended to all VAT-registered businesses, no matter what their turnover is. As of April 2022, all VAT-registered businesses must comply with the MTD for VAT rules. The first mandatory MTD VAT period started on 1st of April 2022, but your business’ MTD VAT period depends on your own VAT start and end dates.

Even if you’re not a VAT-registered business, MTD should be on your radar, as sole traders and landlords with business or property income above £10,000 will need to sign up for MTD for ITSA when it’s introduced in 2024. The next phase of the MTD roll-out is MTD for Income Tax Self Assessment, which will be mandatory from April 2024.

For sole traders and landlords with business or property income above £10,000, MTD for ITSA is due to be introduced in the tax year beginning April 2024. General partnerships with income above £10,000 will follow in the tax year beginning April 2025.

followed by MTD for Corporation Tax, which is due to be rolled out from April 2026 (at the earliest).

So if you’re a VAT-registered business, keep reading because – as of April 2022 – you need to comply with MTD rules.

What are the benefits of MTD?

According to the government, MTD is designed to make tax:

  • Simplify record-keeping
  • Reduce costly admin errors
  • Simplify payment

It might seem a little confusing at first, but because MTD requires businesses to use compatible software (such as Xero, QuickBooks or FreeAgent) to keep records and submit their tax return, there are a host of potential benefits for your company.

Reduce the paperwork

You’ll need to use digital software to record your tax throughout the year – more on that later – so it should be quicker and easier to file your tax returns. That means you can say goodbye to piles of paperwork to sift through and manual data entry, and say hello to everything you need, all in one place.

Improved visibility

It’ll be easier for you to stay in control of your tax with real-time data, and reduce anxiety about submitting your tax return. Both you and HMRC will be able to see your VAT return figures, ensuring any issues are picked up in advance. HMRC will not be able to see individual transactions or other sensitive data.

Save time and effort

HMRC reports that the Lloyds Bank Digital Index found that the most digitally engaged businesses could save a day a week in administration by making their tax digital. That means you can channel that extra time into activities that will really help to drive your business forward.

Requirements you need to meet

The main requirements of Making Tax Digital are that you:

  • Keep and maintain digital records
  • Submit your tax returns using MTD-compatible software

Compatible accounting software includes Xero, and you can find a full list of suitable software on the government’s website.

There are some specific VAT scheme requirements you’ll need to be aware of. For example, retail scheme users will need to record total daily gross takings. If you’ve previously entered your sales on a weekly or monthly basis, you’ll now need to enter them as daily totals – although they don’t need to be recorded on a daily basis. You can enter your totals whenever you usually do your bookkeeping, but you’ll need to work out the totals for each day rather than for the week or month.

It’s currently not a requirement for non-VAT registered businesses to register or comply with Making Tax Digital. If you are currently registered for VAT but your turnover is below the registration threshold of £85,000, as of April 2022, you need to register for MTD for VAT.

What do sole traders need to know about MTD?

If you’re a VAT-registered sole trader earning over £85,000, you’ll already be aware of Making Tax Digital rules, as it’s been a requirement to use MTD since April 2019. But if you’re VAT registered and earn under £85,000, you’ll also now be required to keep digital records and submit your VAT returns using MTD-compatible software.

If you have an unincorporated business, or you’re a landlord, and you have an income of £10,000 or more, then you’ll need to be ready for Making Tax Digital as of 6th April 2024, when MTD for Income Tax Self Assessment comes into play. You can always sign up early for MTD ITSA if you want to get used to how it all works ahead of mandatory registration.

If you’re a sole trader earning below the £10,000 threshold, then you can continue to use the old HMRC system for filing their returns.

How to sign up for MTD

All VAT-registered businesses, regardless of turnover, should have signed up for MTD before April 2022. If you’re not VAT registered but are looking to get ahead of the new regulations coming in for unincorporated businesses and landlords in 2024, then you can sign up using your Government Gateway ID and password. You’ll need:

  • Your VAT number
  • The date your business became VAT registered
  • The postcode of your main place of business
  • The month your most recent VAT return was submitted
  • The amount paid/received from your last VAT return
  • Your national insurance number (if you’re a sole trader)
  • Your company registration number and Unique Taxpayer Reference (if you’re a limited company)

Are there any exemptions?

All eligible businesses must register for MTD. There are some VAT-registered businesses that can apply for an exemption from MTD, if you’re unable to reasonably or practically use computers. Reasons for exemption include:

  • Your age
  • Disability
  • You’re running your business from a remote geographical location
  • You object to using computers on religious grounds
  • Any other reason why it might not be reasonable or practical for your business

If you believe you’re digitally exempt, you must apply directly to HMRC, as each application is considered on an individual basis.
Penalties to be aware of
The new MTD penalty system is points-based and will replace the current system in January 2023.

If you miss a submission deadline, you’ll get one point, and your points will turn into fines if you reach a certain points threshold. If you submit annually, then when you accrue two points, you’ll receive a penalty; four points equal a penalty for quarterly submissions, and those who make monthly submissions will receive a penalty if you get five points.

If you reach the submission penalty threshold you’ll be fined £200, and you could also be fined if you don’t comply with the new rules, such as not having a digital record or links.

Those who are consistently compliant, but occasionally make errors won’t be heavily penalised. The new system is designed to target businesses that aren’t compliant with Making Tax Digital rules and miss deadlines.

You can avoid penalties by using MTD-compliant software and ensuring you always meet the submission deadlines.

Resources to help you with MTD

Are you ready to start Making Tax Digital? We’re here to help make it easier to stay on top of your VAT. We know that it’s a pain point for many of our customers when it comes to cash flow forecasting, so we’re working on a way to make VAT planning easier for you.

In the meantime, our partners over at Xero have some excellent information on Making Tax Digital, and you can also find plenty of research into the impact of MTD on the government website.

Meghan Flannery

I'm a marketer and restaurant connoisseur with a love for all things Edinburgh