Making Tax Digital: The Definitive Guide

Posted 20th August 2018

In Large Business, Making Tax Digital, Small Business, Software, VAT

Making Tax Digital (MTD) is just under a year away and is set to be the biggest shake-up of the UK tax system yet.

Hopefully, you’re all set and ready for MTD.

However, if you have no idea what Making Tax Digital is. How it might affect your business, we have put together a definitive guide outlining everything you need to do and know in order to be compliant and MTD-ready.

What is Making Tax Digital?

MTD is the government’s way of digitising record keeping, with businesses throughout the UK needing to submit all business-related transactions and tax affairs via MTD-compliant online accounting software. This move marks the end of traditional making tax digital annual accounting, as businesses will now be required to submit their tax information more frequently.

There have been a lot of concerns surrounding MTD, particularly for British businesses that have historically used spreadsheets, desktop software, or just kept records manually. There’s no doubt that this will be a huge change for those businesses.

As much as Making Tax Digital is about HMRC plugging a rather large gap in missed tax (in the year between 2016-17 the tax gap was £33 billion), MTD is a great opportunity for small businesses to future-proof how company finances are managed.

Why is HMRC making me change how I manage my finances?

HMRC wants to bring the tax system into the 21st century and improve the quality of the record-keeping done by businesses. The benefits of Making Tax Digital for a business completely outstrip the benefits for HMRC.

MTD should mean that companies will have more accurate data to work, plan and make better decisions from. Surely, that’s what any forward-thinking business owner wants, too, right?

The benefits MTD will have on businesses include:

The opportunity for less manual entry, therefore fewer mistakes
No nasty surprises – calculating tax will be more accurate. As a result, being hit by a huge tax bill or owed money is more unlikely for businesses and individuals
Less stress! An easier, faster and more efficient way of record-keeping and accounting compliance

Making Tax Digital: who is affected?

In a nutshell, MTD will affect the vast majority of businesses and individuals at some point over the next couple of years.

HMRC wants to digitise and streamline its processes and how it interacts with companies and individuals. If you’re still using spreadsheets and updating records manually to submit VAT and self-assessment tax returns, your business will be affected.

MTD will affect the following individuals and businesses:

VAT registered businesses
Unincorporated businesses with annual sales between £10,000 – £85,000
If you’ve business has voluntarily registered for VAT
Self employed
Sole traders
Partnerships
Landlords with property income
Trading subsidiaries of charities and not for profit organisations
Those who have a secondary income that exceeds £10,000

When does Making Tax Digital affect my business?

HMRC is currently undergoing a pilot scheme for Making Tax Digital with selected businesses.

The first phase for MTD starts on 6th April 2019. Here is the proposed rollout:

Phase 1 - April 2019	Phase 2 - April 2020	After April 2020
VAT registered businesses with turnover above the VAT threshold (currently £85,000 excluding VAT).	VAT registered businesses with turnover above the VAT threshold (currently £85,000 excluding VAT).	Sole traders, partnerships, landlords and trading companies will need to use MTD compliant software or apps to keep a digital records of financial transactions for income and corporation tax purposes. The precise start date for MTD for income and corporation tax will be decided by HMRC following successful roll out of phases 1 and 2.

Is anyone exempt from Making Tax Digital?

You will not need to comply with the new Making Tax Digital policies if:

You’re part of a religious society whose beliefs prevent you from using computers
Age, disability or your location (where access to an internet connection is limited) prevents you from keeping digital records

Unincorporated businesses with an annual turnover of less than £10,000 will not need to file digital income tax returns.

Making Tax Digital: What’s changing?

One of the things HMRC makes pretty clear is that accounts staff need to avoid exporting or importing data manually. A company’s sales, purchases and expenses information needs to be transferred digitally.

VAT returns must be created from digital records using HMRC-approved online accounting software. This cloud accounting software sends information to HMRC using an API (Application Programming Interface).

Making Tax Digital will mean:

Keeping records using desktop software, spreadsheets or manually will become obsolete over time*
Submitting VAT returns by post or via the HMRC site will no longer be possible
MTD-compliant accounting software must be used to submit transactions and tax returns to HMRC
Keeping regular income and corporation tax records

*Whilst spreadsheets are permitted by HMRC in the short term, there are more steps required to submit information to HMRC. Using spreadsheets will take longer, and there is more margin for error. Over time, it’s clear that spreadsheets will be phased out.

From April 2020, there must be a mandatory “digital link” between submitting information. I explain what digital links constitute in the next section.

To clarify, if you’re not using online accounting software, keeping records in a digital format and submitting necessary information to HMRC will inevitably be more complicated for your business.

What is a digital link?

HMRC describes a digital link being:

“When data has been entered into software used to keep and maintain digital records, any further transfer, recapture or modification of that data must be done using digital links. Each piece of software must be digitally linked to other pieces of software to create the digital journey.”

Although this list is not exhaustive, as far as HMRC is concerned, for the purposes of Making Tax Digital, a digital link is:

emailing a spreadsheet containing digital records to a third party so that someone can import data into their software. For example, this may be done to work out a Partial Exemption calculation.
transferring a set of digital records onto a portable device such as a memory stick or flash drive and physically giving this to an agent to import that data into their software
the download or upload of XML or CSV files
automated data transfer
API transfer

Some of the options listed above seem a little backward and require more effort than should be necessary.

If your business has legacy systems in place, although more complex, there should be a suitable option above to use in order to be MTD compliant.

What is bridging software?

Bridging software allows VAT information to be reported digitally to HMRC and information to be sent digitally back to the business from HMRC. Incorporating relevant Making Tax Digital APIs and bridging software will help businesses connect spreadsheet-based accounting software to HMRC’s systems.

The issue around bridging software at the moment is there are lots of software providers offering completely different technical approaches. Furthermore, any talk about the use of bridging software is pretty elusive. Working alongside software providers, HMRC is confident that appropriate bridging software will be ready for April 2019.

What software can I use for Making Tax Digital?

Cloud-based software. Software that you can access anytime, from any place, on any device, and send data in real-time via an internet connection.

According to a survey of 2,900 small businesses and landlords towards the back of 2017, research showed that only 26% used software.

Additionally, most of the businesses surveyed keep financial records using spreadsheets and paper – by April 2019, the paper will no longer be an option.

Using cloud accounting software, businesses will be able to send figures directly to HMRC. This is by far and away the easiest route to being MTD-ready. Furthermore, any software purchase is also tax deductible.

The diagram below gives you an idea of how online software would work.

There are a whole host of software suppliers to choose from. The following software suppliers have both tested their products in HMRC’s test environment and demonstrated a prototype of their software to HMRC:

If you’re currently using a desktop version of Sage, you will need to upgrade your accounting software to a cloud-based version.

There are no free software options. However, there are some extremely competitive solutions for even the smallest business.

What you need to do next to be Making Tax Digital compliant

If you keep your own records manually, you will need to:

find out when your business is affected by Making Tax Digital. From 6th April 2019, you could be affected.
be using compliant online accounting software – one of the software brands listed above. If you’re unsure which software to choose, we often recommend Xero or Quickbooks to our clients
in a position where your accounting software generates a complete tax return. You will no longer be able to make manual adjustments to your returns

If you use an accountant or bookkeeper, have they talked to you about MTD?

Have they suggested software to you that fulfils the requirements for MTD?

If you own a business or you’re self-employed, it is your responsibility to make sure you are MTD compliant – not a third-party bookkeeper or accountant.

If you still want to use spreadsheets for MTD

Spreadsheets have largely been ignored throughout Making Tax Digital discussions.

Although we, or HMRC for that matter, wouldn’t recommend it, you can still work with spreadsheets. However, as you’ll see from the diagram below, it’s far more complicated and will create more work.

In the diagram below, there are two spreadsheets to maintain records and a third spreadsheet. The third spreadsheet receives information from the record-keeping spreadsheets and prepares the VAT Return. This third spreadsheet is digitally linked to bridging software, which submits the VAT Return to HMRC.

The best option long term is to move to compliant accounting software. First of all, make sure it has the functionality to maintain the mandatory digital records. Secondly, that your preferred software can prepare the VAT Return and submit this to HMRC.

Although it might seem a little daunting, moving to new online software should in fact free up a lot time.

How MNE can help get you ready for Making Tax Digital

The introduction of Making Tax Digital is a good opportunity for businesses to review their current processes for record keeping.

We’re certified advisors of leading software brands Xero and Quickbooks. There are lots of advantages to moving to online accounting software for your business going forward:

automatically calculate the tax you owe (including VAT and payroll tax)
pull transaction data straight from your bank, your invoicing software or your POS system
to update your transactions every day. Stay on top of income, expenses and profits.
create digital records of paper receipts just by photographing them with your mobile phone. We use AutoEntry to to feed data directly into either of these platforms.

Our clients already meet the requirements of Making Tax Digital. In the same way, we can ensure your business is compliant with the new MTD policies.

If you have a question about anything you’ve read, make sure to get in touch with our team of expert business accountants.