Making Tax Digital and the digitisation of tax in the UK

Written by the experts at Sage

If you are a self-employed individual, someone with property rental income, or registered for VAT, chances are that you have already heard about Making Tax Digital or, how it’s commonly referred to, MTD, at least once. Whether it was during a conversation with your accountant, with a fellow entrepreneur, or by stumbling across articles on news outlets, Making Tax Digital has been a hot topic for a while now. But in case you are still struggling to understand why, how, and when changes are being implemented, here is an overview of it.

Overview

Making Tax Digital is the biggest legislation change to the UK tax system in a generation. It was created with the objective of making it easier for individuals and businesses to get their tax right and keep on top of their affairs. HMRC’s aim is to become one of the most digitally advanced tax administrations in the world. Making Tax Digital is making important changes to the way the tax system works – transforming tax administration so that it is more effective, more efficient, and easier for taxpayers to get their tax right.

By mandating regular digital record keeping and reporting to HMRC, MTD will help provide a better view of cashflow and tax owed, saving small businesses time and money to invest back into their business and reduce tax inaccuracies. Additionally, MTD is also expected to help close HMRC’s tax gap. The UK government estimates that £12.3bn of VAT was not paid in 2019/20 when it should have been.

Back in 2015 when it was originally announced, the intention was to digitise all kinds of tax submissions by 2020. However, the initial timeline was revised, and the programme really started with the first mandate back in April 2019 for VAT-registered businesses with taxable turnover over £85,000.

MTD for VAT

This year, on 1 April 2022, the remaining VAT-registered businesses were required to comply with MTD as well. This effectively impacted those businesses who are voluntarily registered, making less than £85,000 of taxable turnover annually.

To be compliant with MTD for VAT, businesses must keep records in digital form and file their VAT Returns using MTD compatible software.

Whilst remaining VAT registered businesses were mandated to comply with MTD from April this year, MTD have continued to allow businesses to file through their HMRC online tax accounts which is not permitted under MTD, it is important to note that from 1 November 2022, businesses will no longer be able to use their existing VAT online account to file their quarterly or monthly VAT returns. This effectively means that all VAT-registered businesses must now sign up for Making Tax Digital (MTD) and use MTD-compatible software to keep their VAT records and file their VAT returns. Failing to do so might result in Filing Through the Incorrect Channel penalties. Moreover, it’s also worth noting that a new penalty system will be introduced for VAT periods beginning on or after 1 January 2023. This will be on a point-based system that varies depending on your submission frequency. Once a penalty threshold is reached, you will receive a £200 penalty and a further £200 penalty for each subsequent late submission.

It seems like a lot to process but it’s easy to remember what needs to be done in four steps:

Step 1. Choose MTD-compatible software like Sage Accounting.

Step 2. Check the VAT configurations in software ahead of authentication with HMRC.

Step 3. Keep digital records for current and future VAT returns.

Step 4. Sign up for MTD, allow software to work with MTD, and file future VAT returns directly to HMRC.

You can apply for an exemption if it’s not reasonable or practical for you to use computers, software, or the internet to follow Making Tax Digital for VAT rules. HMRC will assess each application on a case-by-case basis.

MTD for ITSA

The next Making Tax Digital event will be for Income Tax Self Assessment, impacting individuals with annual income from self-employment and/or property of over £10,000 from April 2024. This is the mandate that’ll impact the highest number of individuals, whether they submit their self-assessment tax returns by themselves or by an agent like an accountant. This will be expanded to also cover general partnerships from April 2025.

The premise is still the same as Making Tax Digital for VAT: the taxpayer will need to keep digital records and submit their returns digitally direct to HMRC’s systems. However, whilst the frequency of VAT Returns was not impacted by the digitisation of the process, we can’t say the same about the changes for Income Tax. This is because the taxpayer will be required to:

  • Keep digital records of all business income and expenses, categorised in line with tax reporting.
  • Periodic updates: update HMRC at least quarterly with a summary of business income & expenses for each business. This is very much a new requirement of taxpayers.
  • End-of-Period Statement: at the end of the tax year, finalise the taxable profit or loss for the business, adjustments for allowances & reliefs via an End of Period Statement.
  • Final Declaration: bring together all data, including business & non-business, needed to finalise their tax position & reach the final tax liability.

Although it seems like it’s a long time until the mandate, there are benefits to adopting digital accounting now, which includes:

  1. Reducing space for inaccuracies – fully compatible software powers a lot of automated processes which decreases the chance for human error and helps automatically identify inconsistencies within records.
  2. Saving time – embedding fully compatible software into their day-to-day operations found that they were able to complete tasks such as invoicing and expenses ‘on the go’, rather than as a single big task at the end of the month.
  3. Greater insight and financial control – software can offer clear, real-time financial clarity which isn’t always possible from a bespoke spreadsheet. This has helped some businesses to plan more effectively and anticipate challenges.

A full list of currently approved software vendors like Sage can be found on gov.uk.

MTD for Corporation Tax

All the details of Making Tax Digital for Corporation Tax are yet to be announced but the parameters of the consultation with the public considered that MTD for Corporation Tax rules will require that mandated businesses must:

  • maintain their records (e.g. records of income and expenditure) digitally
  • use MTD compatible software to provide regular (quarterly) summary updates of their income and expenditure to HMRC
  • provide an annual CT return using their MTD compatible software.

We don’t yet know when MTD for Corporation Tax will come into effect, but HMRC have said that it will be from April 2026 at the earliest and it’s expected that most businesses impacted by it will also have been impacted by the VAT mandate, therefore they will be more acquainted with the use of software to keep digital records and to submit information digitally direct to HMRC.

Conclusion

Creating a tax system fit for a 21st-century Digital Economy lays the foundations for further digitisation of small businesses. The Confederation of British Industry estimates that £100bn could be unlocked by the UK economy by increasing business adoption of key technologies and management practices, which benefits both businesses and the tax system. Using MTD-compatible accounting software is a key part of this, whether you decide to do it all by yourself or in collaboration with the services of an accountant.