Making tax digital: how to comply with MTD

Making Tax Digital (MTD) is here: businesses are now required to keep all VAT records in a digital format. Here's how to keep your business compliant and up-to-date

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The Making Tax Digital (MTD) legislation came into effect on April 1 2019. Since that date, all VAT-registered businesses – including those that are voluntarily registered – are now required to store their VAT accounting records digitally, using HMRC-recognised accounting software.

MTD was a move from the UK government to make it easier for individuals and businesses to get their taxes digitalised, and help the environment by going paper-free.

Although the MTD deadline was first announced two years ago, SMEs have had a lot to contend with in that time. There’s been Brexit, multiple changes of prime minister, the cost of living crisis and the continuing impact of a global pandemic, to name but a few.

If you’re one of those small business owners who are still a little confused about the MTD changes – you’re in luck. Startups' expert financial team is here to help. In the below article, we’ll go through the new legislation and what it means, as well as take you through the two key steps to making your business meets all the new requirements.

What is Making Tax Digital (MTD)?

Making Tax Digital (MTD) was a bold plan by HMRC which aimed to get small businesses and the self-employed to complete their tax records and returns entirely online.

The first phase of the MTD legislation saw only businesses with a taxable turnover of over £85,000 affected, but now we are in the ‘second phase’, which means all VAT-registered businesses need to register for Making Tax Digital.

You also need to ensure you are now keeping your tax records digitally (for VAT purposes only) and submit your VAT return information to HMRC only through MTD-compatible software.

HMRC’s eventual aim is for all tax filing to go completely paperless. From April 2024, Self Assessment taxpayers will too need to comply with Making Tax Digital for income tax.

Why has MTD been introduced?

As every small business owner knows, filing tax returns is a tedious process that often results in errors.

Unfortunately, such mistakes can be both time-consuming and costly to fix – particularly if they have been submitted using paper filing.

It’s estimated that these issues cause not only delays for SMEs, but also a large bill for HMRC. In fact, a ‘tax gap’ of around £10bn is estimated to be lost each year as a result of the current process.

Making Tax Digital has been introduced to reduce the likelihood of SMEs making such errors.

Lee Murphy, managing director at The Accountancy Partnership, says: “In summary, the aim of the government’s Making Tax Digital initiative is to create a system that minimises mistakes and makes it easier for businesses to manage their tax responsibilities by making digital tax filing a legal requirement.”

What is the penalty if you’re not registered?

Currently, HMRC can levy a fine of up to £400 should your business fail to submit a return under the MTD requirements.

Earlier this year, HMRC also announced that two new penalty regimes will be introduced in January 2023 – one for late filing and the other for late payment.

In a similar system to speeding fines, businesses will receive a ‘point’ each time their submission deadline is missed. Once you have accrued a certain number of points, a £200 penalty will be applied.

However, until this new system comes into place, VAT returns are still subject to the current default surcharge of £400.

How to register for Making Tax Digital

If you haven’t already, you'll need to sign up to MTD on the gov.uk website.

This cannot be done less than five days before your accounts are due. If you haven’t registered already then the last day you’ll be able to sign up without a penalty is March 27th 2022.

You’ll need:

  • Your business email address
  • Government Gateway user ID and password – if you do not have a user ID, you can create one when you use the service
  • Your VAT registration number and latest 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 or registered society 
  • Your Unique Taxpayer Reference and the postcode where you’re registered for Self Assessment if you’re a general partnership 
  • Your Unique Taxpayer Reference, the postcode where you’re registered for Self Assessment and your company’s registration number if you’re a limited partnership

You will need to have chosen the software you intend to use to file your returns before signing up for MTD for VAT. See our section below for our top picks.

This is a legal requirement. It is therefore imperative that you do your research properly,  and check you are subscribing to an MTD-compatible software package for VAT before purchasing.

Murphy continues: “Although some businesses may have already made the switch to digital tax records, this doesn’t mean that they are ready for MTD. Using a compatible software package is mandatory, and businesses should be aware of the potential consequences if they don’t make this switch in time for the deadline.”

Making Tax Digital accounting software guide

MTD-compatible software is any accounting system that directly connects to HMRC and maintains all digital records mandated by the new regulations.

That means your software must also calculate:

  • The amount of VAT you pay on your products and services (both supplied and received)
  • The source of your VAT transactions
  • Any adjustments made to your VAT tax returns

Two options we recommend are QuickBooks, our top-rated accounting software choice for SMEs, and FreshBooks, the easiest to get set up with quickly.

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Lee Murphy advises: “Some software includes particular features that may enable businesses to maximise their processes. Payroll features, bank reconciliation and project tracking facilities have the potential to save time and money in the future.

“Free options are available, but owners should consider whether those features are sufficient to create the best possible outcome for their business.”

If you use a third-party accountant, they can also sign up to MTD on your behalf but remember: you’ll still need to store your VAT records digitally, and you will still need to use software for your VAT accounting.

Your accountant may therefore ask you to link your software to theirs to ensure it’s all HMRC-compliant.

What is the best MTD-compliant accounting software for SMEs?

The right accounting software can help to make your VAT and other tax returns simple and easy – as well as managing other tasks like tracking cash flow, revenue and expenses.

Read our comprehensive guide to the best accounting software solutions for small businesses, and get started today.

Making Tax Digital exemptions

Despite the large number of business owners that are currently underprepared or even unaware of the upcoming MTD deadline, there is virtually zero chance of it being postponed.

Clare Bowen, director for MHA Monahans, explains that it would not be beneficial to postpone the deadline: “The first round of MTD was a success and businesses embraced the new systems, not only gaining the ability to file VAT returns digitally but also other benefits from these systems.”

This means that, if you are a VAT-registered company, the only way you will not have to register for Making Tax Digital is if you successfully apply for an exemption.

Exemptions are not commonly given. You will need to have a very good reason to not be able to file taxes digitally to qualify for one. They tend to be awarded on the grounds of age, disability, location or religious reasons.

If your business has already been granted an exemption to MTD, you don’t need to apply again. This will still apply beyond 1 April 2022.

Conclusion

Registering for MTD might feel like a chore, but it’s one that will definitely pay for itself. Businesses which fully embrace digital cloud accounting systems will be able to streamline their accounting tasks and save both money and time down the line.

Essentially, the Making Tax Digital registration process boils down to two key steps: you need to sign up to MTD on the Gov.uk website, and find MTD-compliant accounting software.

Once you have completed these two steps then you should be able to easily file your VAT returns online – with greater efficiency and fewer mistakes than under the previous system.

Pauline Green, head of product compliances and programs at QuickBooks, leaves us with some helpful advice to business owners that might be feeling concerned by the new MTD compliance expectations.

“Going digital may seem like a daunting prospect, but it doesn’t need to be – and there is plenty of help and support available for those who are yet to embark on the process, even as deadline day approaches.”

FAQs

Frequently Asked Questions
  • What is the threshold for Making Tax Digital?
    It has been mandated that all VAT-registered businesses must file digitally through Making Tax Digital, regardless of turnover.
  • What happens if I don't register for MTD?
    Currently, HMRC can levy a fine of up to £400 should your business fail to submit a return under the MTD requirements - as well as additional charges for late filings and late payments.
  • Can I use Excel for Making Tax Digital?
    Unfortunately not, the software you use needs to be able to connect to HMRC directly, so we recommend HMRC-compatible accounting software.
  • Can I opt out of Making Tax Digital?
    No, Making Tax Digital is a legal requirement for all UK VAT-registered businesses.

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Written by:
Stephanie Lennox is the resident funding & finance expert at Startups: A successful startup founder in her own right, 2x bestselling author and business strategist, she covers everything from business grants and loans to venture capital and angel investing. With over 14 years of hands-on experience in the startup industry, Stephanie is passionate about how business owners can not only survive but thrive in the face of turbulent financial times and economic crises. With a background in media, publishing, finance and sales psychology, and an education at Oxford University, Stephanie has been featured on all things 'entrepreneur' in such prominent media outlets as The Bookseller, The Guardian, TimeOut, The Southbank Centre and ITV News, as well as several other national publications.

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