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Taking tax into the digital world – explaining Making Tax Digital

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Making Tax Digital (MTD) is HMRC’s attempt to take tax into the digital world. So what is the aim of the initiative, who will be affected, how does it work, and what technology is required?

What’s the aim of MTD?

The aim of MTD is to create one of the world’s most digitally advanced tax systems. It will allow businesses and the self-employed to send their tax returns digitally and directly to HMRC from their own software. By requiring businesses and individuals to keep digital records for Self-Assessment and to file this digitally every three months, it aims to bring an end to the annual Self-Assessment tax return. Recently delayed from 2020, this is set to be mandated, at the earliest, by April 2021.

According to HMRC, a key reason for the scheme is because avoidable mistakes that commonly happen when people do their taxes are costing the Exchequer over £9 billion a year. The government department says the majority of customers want to get their tax right, but many find this difficult. Going digital hopes to improve accuracy and reduce the amount of tax lost to these avoidable errors.

With all these benefits, HMRC says MTD will make transforming tax administration more effective and more efficient. The government department says it will make it easier for anyone who has to pay their taxes themselves, and help make sure they get their taxes right.

Who does it affect?

MTD, which started its first phase on 1 April 2019, currently affects VAT-registered businesses earning more than £85,000 – the VAT registration threshold. Any individual or business above this VAT threshold will need to start keeping their records digitally and submitting their VAT returns using MTD-compatible software. For VAT registered businesses below this threshold, MTD could still be rolled out to them in the future too.

The government scheme is set to be mandated for income and corporation tax from April 2021 at the earliest.

How does it work?

MTD for VAT involves using software that connects to HMRC’s Application Programming Interface (API) via a digital link (so the information doesn’t need be re-keyed in order to file the returns). Once connected, individuals can upload digital VAT returns and other required information to a portal and send it to the government department. Using the software, businesses can keep digital records of this information and send summaries to HMRC every three months.

Individuals set to be affected by MTD for income tax can sign up to a pilot scheme to test the service. This allows them to test out this way of working out their taxes, while seeing an estimate of how much tax they might owe over time, instead of waiting until the end of the tax year. Taking part in the pilot scheme involves using software to link to HMRC and sending income and expenses summaries to the government department every three months. Individuals will also finalise their income and expenses at the end of the accounting year. They will receive reminders when updates need to be sent. There’s also the option to send updates to HMRC more often, if an individual prefers.

HMRC-compatible software is key

The right software is important because it’s needed to be compliant for MTD. As the software links up to HMRC, it needs to be compatible with the government department’s systems. This allows individuals to keep digital records and send returns directly to HMRC, without rekeying the data. There is a wide range of software available, with some still in development, which is compatible with MTD for VAT and for income tax.

Choosing the right software that’s compatible with MTD for VAT can often come down to which additional features suit an individual or business’s specific needs. For example, as well as features to view submitted VAT returns and VAT payment history, other features can include invoice generation and payroll submissions. There’s also bank integrations, forecasting, and other ways to help give you a better overview of your company financials. The software also has options to provide accessibility, such as assisting users who are visually impaired or have hearing difficulties.

For individuals and businesses who keep their records in a spreadsheet format, and don’t need features like those listed above, bridging software is an option to consider. It connects non-compatible software, such as spreadsheets, to HMRC’s systems. While being a lot cheaper, it is still compliant with MTD software requirements. If you’re not sure what type of software to buy, many software providers offer a free trial, so you can see what’s best suited to your business needs.

Receiving penalties

In the first year of implementation of MTD for VAT, HMRC has said it would take a “light approach” to penalties for late filing and record-keeping mistakes for businesses trying to establish a digital link. However, this is for those businesses that are doing their best to comply. Those business that are seen to not be doing their best to comply with VAT filing and record keeping could be issued with a penalty.

Regardless, you must also always ensure that your VAT bill is paid on time. If you haven’t filed the VAT return compliantly and you haven’t paid it on time, you would likely receive a penalty notice. To avoid the risk of any potential penalties, it is best to comply once MTD is applicable to you.

Getting ready for a digital tax world

MTD is affecting, and set to affect, millions of businesses in the UK. If you’re worried about MTD and not sure whether or not it will affect you, it’s best to make sure you’re compliant and ready for the scheme. It’s wise to start keeping digital records now and trial some of the software available to see how it work and get used to sending tax information digitally.

As HMRC takes tax for UK businesses into the digital world, it will be interesting to see how well MTD performs. How effective will the technology be, how will people respond to it, and will the UK government succeed in creating one of the most digitally advanced tax authorities in the world?

James Foster, Senior Commercial Manager SJD Accountancy

James Foster is the Senior Commercial Manager at SJD Accountancy. SJD is the UK's largest specialist provider of fixed fee, limited company accountancy services to contractors and freelancers. The award-winning accountancy has been acting for contractors across the UK since 1992 and has more than 14,000 clients. It is the only national specialist firm of accountants with offices across the UK. SJD also have more qualified staff than any other firm in its market.