What is Making Tax Digital?

Making Tax Digital (MTD) is a government initiative introduced by Her Majesty’s Revenue and Customs (HMRC) in the UK to modernize the tax system by transitioning to a digital and more efficient approach. The aim of MTD is to simplify tax processes, reduce errors, and make it easier for individuals and businesses to manage their tax affairs through digital platforms.

MTD was launched in 2019 and has gradually been rolled out to various sectors, with a strong focus on VAT, income tax, and corporation tax. This article provides an in-depth guide on what Making Tax Digital is, its purpose, how it works, and what businesses and individuals need to do to comply.

Purpose of Making Tax Digital

The primary goals of MTD are:

1. To improve the accuracy of tax reporting: By moving to digital systems, HMRC aims to reduce errors that often arise from manual processes, ensuring that businesses and individuals report their taxes more accurately.

2. To simplify the tax process: MTD aims to make it easier for businesses and individuals to submit their tax information, providing a more user-friendly experience through digital tools.

3. To improve efficiency and reduce the tax gap: HMRC believes that MTD will help close the tax gap by reducing mistakes that lead to underpayment or overpayment of taxes.

4. To encourage the use of digital records: The shift to digital tax returns encourages businesses to keep accurate, up-to-date financial records, which are essential for compliance and reducing the risk of errors.

How Does Making Tax Digital Work?

Making Tax Digital requires businesses and individuals to maintain digital records of their income and expenses using HMRC-compliant software. These records are then used to submit tax returns digitally to HMRC. The process ensures that all transactions are accurately captured and that tax is calculated correctly.

Here’s how MTD generally works:

1. Keeping digital records: Businesses and individuals must keep records of their income and expenses digitally. This can be done through spreadsheets or accounting software that is compatible with MTD.

2. Using compatible software: The digital records must be stored and submitted using HMRC-approved software. Popular accounting software such as QuickBooks, Xero, and Sage have developed tools that integrate with MTD, allowing businesses to submit their tax returns easily.

3. Digital submission: Instead of submitting a manual tax return, businesses use the software to file their returns digitally to HMRC. This is now the standard way of filing VAT returns under MTD.

4. Quarterly updates: For VAT, MTD requires businesses to submit quarterly updates to HMRC, giving the government more frequent insight into the business's financial situation.

Who Does Making Tax Digital Apply To?

MTD applies to a wide range of businesses and individuals, with different roll-out timelines depending on the type of tax.

1. VAT-registered businesses: Since April 2019, VAT-registered businesses with a turnover above the VAT threshold (£85,000) have been required to follow MTD rules for keeping records and submitting VAT returns digitally.

2. Voluntary VAT-registered businesses: From April 2022, businesses voluntarily registered for VAT (those below the £85,000 threshold) were also required to comply with MTD for VAT.

3. Self-employed individuals and landlords: From April 2026, MTD for Income Tax Self-Assessment (MTD for ITSA) will apply to self-employed individuals and landlords with business or property income of over £50,000 per year. This will be extended to those with an income of over £30,000 per year from April 2027.

4. Corporation tax: MTD for Corporation Tax is expected to come into effect in the future, although the timeline has yet to be fully confirmed by HMRC.

What Taxes Does Making Tax Digital Cover?

Making Tax Digital currently covers:

• VAT: VAT-registered businesses are required to use MTD-compliant software to submit their VAT returns.

• Income Tax Self-Assessment (ITSA): MTD for ITSA will require landlords and self-employed individuals to submit digital income tax returns from April 2026.

• Corporation Tax: MTD for Corporation Tax is planned for the future, with businesses eventually needing to submit their corporation tax returns digitally.

Benefits of Making Tax Digital

1. Reduced Errors: By using digital tools to record transactions and submit returns, MTD reduces the chance of human error when completing tax returns.

2. Real-time updates: With quarterly updates, businesses have more control over their financial position and can manage cash flow more effectively.

3. Better record-keeping: MTD encourages businesses to keep better digital records, which can reduce the time and effort needed to prepare for tax submissions.

4. Improved communication with HMRC: Businesses and individuals have direct communication with HMRC through MTD-compliant software, meaning queries and issues can be resolved faster.

5. Time-saving: Using software to track finances and file tax returns simplifies the tax process, saving businesses time.

Challenges of Making Tax Digital

1. Costs of software: Some businesses may need to invest in new accounting software or upgrade existing systems to ensure compliance with MTD. This could be a burden for small businesses or individuals.

2. Digital skills: Some business owners, especially smaller or older businesses, may struggle with the technical skills required to manage MTD-compliant software.

3. Quarterly reporting: For some businesses, the requirement to submit quarterly updates might increase the administrative burden.

4. Initial adjustment: Transitioning from a manual system to a digital system can take time and effort, particularly for businesses that have historically relied on paper records.

How to Prepare for Making Tax Digital

If you are required to comply with MTD, there are several steps you can take to prepare:

1. Assess your current record-keeping methods: Ensure that your records are up to date and stored digitally. If you're still using paper records, now is the time to switch to a digital system.

2. Choose MTD-compliant software: HMRC provides a list of approved software providers on its website. Choose a software solution that fits the needs of your business, whether it’s a basic package for a small business or a more comprehensive system for larger operations.

3. Get familiar with the software: Once you’ve chosen the software, make sure you and your staff are trained to use it effectively. Many software providers offer tutorials or support to help you get started.

4. Stay informed about deadlines: HMRC has set different deadlines for different types of taxes, so ensure you know when you need to start complying with MTD for your business.

5. Consider professional help: If managing your tax affairs digitally feels overwhelming, consider working with an accountant or tax advisor who can help you navigate the MTD process.

Filing Deadlines for Making Tax Digital

The deadlines for MTD compliance vary depending on the type of tax:

• VAT: VAT-registered businesses above the VAT threshold have been required to submit VAT returns digitally since April 2019. Voluntary VAT-registered businesses were required to comply from April 2022.

• Income Tax Self-Assessment (MTD for ITSA): Landlords and self-employed individuals with income over £50,000 will need to comply with MTD rules from April 2026. Those with income over £30,000 will need to comply from April 2027.

• Corporation Tax: The timeline for MTD for Corporation Tax has not been confirmed, but it is expected in the future.

Conclusion

Making Tax Digital is transforming how businesses and individuals manage their tax affairs in the UK, pushing them towards digital record-keeping and submission processes. While the transition may come with some challenges, such as adopting new software or changing administrative processes, MTD aims to simplify tax reporting and reduce errors.

To comply with MTD, businesses and individuals must maintain digital records, use MTD-compliant software, and submit their tax returns digitally. By preparing early, businesses can make the transition to MTD smoother and take advantage of the benefits of digital tax management.