A small business guide to Making Tax Digital

What is Making Tax Digital and how does it affect your business?

Making Tax Digital
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Phase One of HMRC’s tax automation initiative landed in April 2019. Here’s what small businesses need to know. 

Paper is out and digital transformation is here to stay. That’s the message behind the government’s Making Tax Digital (MTD) initiative. 

Effective from 1st April 2019, MTD is an umbrella term for HMRC’s forced automation of the UK business tax system. While VAT returns are the focus for 2019, the phased rollout will see MTD extend to corporation and income tax over the next few years.

Removing errors and disparity

Making Tax Digital is compulsory. It puts a stop to the practice of submitting paper-based VAT returns and shutters the government’s online portal for submitting digital returns. All tax record keeping and tax submissions must now be done using approved, fully-featured, and cloud-compliant tax software systems.

Errors reportedly created a £33 billion pound “tax gap” in the 2016/17 tax year…

HMRC has positioned MTD as a way to reduce the persistent submission errors that lead to tax overpayment and underpayment.

Errors reportedly created a £33 billion pound “tax gap” in the 2016/17 tax year, or the difference between what the exchequer expected to take in tax revenues, and what it actually received.

Reducing tax evasion is another objective. 

In stage one, VAT returns can only be submitted via approved software. This is mandatory for any business with taxable revenues in excess of £85,000. Phase two is expected to begin in 2020 for other taxes.

Analysis: A bumpy road to compliance

MTD’s launch has not been without controversy:

  • A 2018 report by the Lords Economic Affairs Committee said HMRC should delay the go-live date for at least a year, as many small businesses were unlikely to be ready for the April 2019 mandated start date.
  • Many SMEs are reporting increased administrative burden, additional software cost, and a lack of clear guidance from HMRC as barriers to implementation.
  • Research from Xero (maker of an approved software package for MTD – see below) found that 32% of SME owners still depend on pen & paper book-keeping.
  • Echoing that finding, a survey by the British Chamber of Commerce (BCC) says a third of 1,000 UK firms surveyed report having to upgrade or purchase new accounting software to prepare for the change – at significant upfront cost, including training.

Compliance matters

Compliance with MTD is proving tough for SMEs. But the government is pressing on. Some 1.2 million UK businesses are now under MTD’s mandate. As the new rules went live, HMRC said nearly 100,000 organisations had already signed up.

But at the current rate of 4,000 sign-ups a day, fewer than 500k companies will have made the switch by August 2019, when most quarterly VAT returns are due.

Businesses falling foul of compliance could be hit by penalties of up to £500.

HMRC says it’s taking a sensible approach to enforcement to give companies time and will adopt a light-touch approach – meaning no fines: for now. 

But the message is clear. Big company or small, size doesn’t matter when it comes to automating your organization’s tax filing process. 

To help make the transition less painful, we’ve compiled this guide to key concepts, dates, requirements, and software packages.

Snapshot: What is Making Tax Digital?

To improve efficiency and recoup lost tax revenues due to error, HMRC wants UK business to go paperless. The initiative requires businesses to keep digital records and use approved software to submit tax returns. 

While the rollout is happening in phases, within a few short years, paper-based tax filing will effectively be outlawed.

The initiative requires businesses to keep digital records and use approved software to submit tax returns. 

HMRC says Making Tax Digital is central to government commitments around making it simpler for SMEs and sole traders to ‘get their tax right and keep on top of their affairs.’

To help people prepare for MTD, HMRC introduced the personal tax account in 2015, designed to make it easier to manage individual tax responsibilities.

Making Tax Digital for VAT began on 1 April 2019. It applies to all VAT-registered businesses with taxable turnover above £85,000.

Is making tax digital only for VAT?

Plans are for MTD to apply to Income Tax and Corporation Tax. It will also be extended to all VAT-registered businesses, though the timeline isn’t perfectly clear. The earliest these changes will be phased in is April 2020.

When will Making Tax Digital happen?

The government’s original plan for MTD was to implement completely in cascading phases from 2018-2021. After industry consultation, it was decided to begin with VAT-registered businesses and make MTD compulsory for them from April 2019.

  • April 2019 – VAT-registered businesses with a taxable turnover above £85,000 (the VAT threshold) must maintain digital records, and submit their VAT returns via MTD compatible software
  • October 2019 – A 6-month deferral for more complex businesses* ends, and these organisations must now be MTD compliant
  • April 2020 (at the earliest) – HMRC plans to implement MTD for Income Tax and Corporation Tax. A pilot project for freelancers and landlords to submit income tax via MTD systems is already underway.

*Complex businesses in HMRC’s definition includes trusts, not-for-profits, and public sector entities like government departments, NHS Trusts, local authorities, public corporations, and traders domiciled overseas.

Will Making Tax Digital Affect Me?

The short answer is yes. If not now, soon. 

Here’s what the planned rollout phases for MTD look like for SMEs and sole traders across the UK:

Making Tax Digital for VAT

MTD currently affects VAT-registered businesses, but eventually, all businesses will have to go digital for tax purposes.

VAT-registered businesses whose annual turnover exceeds the VAT threshold (£85,000) now need to keep digital records and send digital VAT returns.

If your taxable turnover is less than £85,000, you can still put yourself forward for Making Tax Digital. Compulsorily or voluntarily, HMRC say the digital records businesses need to keep include:

  • Key information about your business, including business name and principal address
  • The value of the supply (net excluding VAT), the time of supply (tax point), and the rate of VAT charged 
  • Your VAT registration number and details of any VAT accounting schemes you already use

Approved compatible software needs to be used to submit VAT returns (see examples of compatible software below). The software will pull information from your digital records, which need to be held for up to six years.

Spreadsheets can be used to calculate VAT transactions and work out what information you need to send to HMRC. Eventually, however, you will need to fully switch over to MTD-compatible software, even for day-to-day tax-related bookkeeping. 

You might also need to install ‘bridging software’ (see an example here), which converts records to the correct format before submission.

Making Tax Digital for Income Tax

MTD for individuals is coming, but it’s not here yet.  Self-employed people and landlords who want to get an early look can sign up for a digital tax returns pilot scheme.

Participants can keep their tax records digitally and send them to HMRC instead of submitting a Self-Assessment form. Landlords who rent out UK property and sole traders with income from one business are both eligible. 

But note that…

  • HMRC requires you to use compatible software to keep records and submit an expense and income summary every three months
  • Benefit: You’ll get up-to-date estimates of how much tax you’ll owe
  • At the end of the accounting year, you’ll submit a final report after which tax owing will be calculated. Then you can claim any reliefs or allowances

Making Tax Digital for Corporations

HMRC are observing the first phase of MTD’s rollout this year before confirming dates and details for the next phase: Corporation Tax. This could be phased in as early as 2020, though more recent reports indicate that will be pushed back to 2021.

Making Tax Digital: Our thoughts

While there’s a nuisance factor around any new compliance mandate, an alternative view of MTD is that it can help make small business more efficient by minimising time-consuming admin tasks that distract from core business-building activity.

According to accounting software maker Sage (Sage One is MTD compliant), UK businesses spend an average of 120 working days each year on administrative tasks – by their calculation a cumulatively wasted effort that costs more than £9.5bn annually

The digitisation and automation of tax, however, is rolling onward, and regardless of size and resources, [businesses will] need to catch up. 

Initial pain but long-term benefits

Freelancers and SME’s spend less time on accounting and IT-upskilling, and as such will feel the pain of MTD compliance most acutely.  The digitisation and automation of tax, however, is rolling onward, and regardless of size and resources, they’ll need to catch up. 

For many businesses, MTD will bring some initial discomfort, but tax experts see benefits in the medium-to-long-term.

“Ultimately, Making Tax Digital can add business value,” says Petya Kitanova, Senior Advisor at KPMG. “Through better understanding of their financials, up to date bookkeeping and regular review of key financial reports, business owners can analyse profitability and drive the business forward.”

There are other potential benefits to tax digitisation, including better record and bookkeeping, better data back-up, faster access to data during audits, and better reporting.

Petya Kitanova, Senior Advisor at KPMG

There are other potential benefits to tax digitisation, she says, including better record and bookkeeping, better data back-up, faster access to data during audits, and better reporting. 

Accounting software typically includes built-in reporting tools such as Profit and Loss, Balance Sheet, Cash Flow, so that small business owners can analyse and understand their figures.

If it meets the objective of reducing error and increasing business efficiency, MTD may well turn out to be a net positive.

Software Options for Making Tax Digital

In order to be MTD compliant businesses will need to use approved software capable of transmitting tax returns digitally, and in the correct data format. 

If your business isn’t already using accounting software then a one-off cost is inevitable. Estimates of the cost vary.

The government says Making Tax Digital software will cost SMEs £70 per year, while the ICAEW, ACCA and FSB estimate the cost will be in the thousands: £1,250, £2,000 and £2,770, respectively.

Some of that additional cost will be in the form of training staff to use the software properly, and in compliance with Making Tax Digital submission processes and formats.

The product you use to submit digital tax returns needs to be compatible with HMRC. 

Here are some of the more popular options:

QuickBooks

QuickBooks is a cloud-based solution made by Intuit, one of the first providers of desktop accounting software. You sign-up and access the software through a web browser. Freelancers can take advantage of the basic package which helps you track self-employed income. Small businesses will find it useful for things like VAT and payroll.

Xero

Xero is another big player in cloud accounting software, offering easy-to-use functional modules for invoicing, payroll, inventory, and expense claims. You can use it to import banking, credit card, and PayPal data. Xero also offers a mobile app for iPhone and Android, allowing access to your accounts on the move.

Zoho Books

Zoho Books is part of an overall suite of cloud-based software products which include Zoho Invoice and Zoho Expense. The software can link-up to your bank account for real-time updates on cashflow. It can also integrate with a number of other accounting and business management apps.

FreshBooks

The benefits of cloud-based FreshBooks include having a user-friendly interface that aims for simplicity and conversational language. It is designed with accessibility in mind for freelancers and small businesses with basic accounting needs. FreshBooks is great for tasks related to invoicing and expense tracking. It also integrates with apps like PayPal and customer service platform Zendesk.

Sage One

Sage is a well-known provider of enterprise-level accounting solutions for big business. Its cloud-based offering for small businesses is called ‘Sage One’. It offers essential functions like cash flow management, invoicing, and payroll.  Sage One is MTD ready and can be used today for VAT submissions under Making Tax Digital.

Not ready to buy?

As an alternative, ‘bridging software’ is also available to small businesses. This acts as a secure link between HMRC systems and non-compliant software like Excel. Free software is also available for businesses with more straightforward tax affairs.