On the first of April 2019 Making Tax Digital (MTD) was introduced to the United Kingdom as part of a government initiative to simplify businesses and individuals’ tax monitoring and tax payments.
One year later in April 2020 the global Coronavirus pandemic placed the next stage of the Making Tax Digital rollout – Phase 2 – on hold. However, as of March 2021 the government has announced plans to recontinue its planned Making Tax Digital Phase 2 rollout, which means that approximately 1.1 million businesses must begin preparations.
At the start of the 2019 rollout – Phase 1 – Making Tax Digital was only mandatory for VAT registered businesses who had a turnover exceeding the VAT threshold. Going forward from 2021, all VAT registered businesses who are required to complete and file their tax returns must make the switch to Making Tax Digital.
We’ll detail what changes Phase 2 will bring, as well as provide a refresher of the Making Tax Digital scheme in this blog.
What is Making Tax Digital?
In summary, Making Tax Digital is a government initiative created by the UK Government and HMRC. The purpose of the scheme is to make it quicker and easier for businesses, sole traders and individuals to file, record and understand their taxes electronically.
It should be noted that Making Tax Digital is not the same as filing tax returns online, as businesses and individuals have been able to do for years. Making Tax Digital is a completely redesigned approach to filing and reporting on tax information, and for individuals, Making Tax Digital all but signifies the end of the self-assessment tax return.
The main advantage of Making Tax Digital is its ability to reduce complex paperwork needed for the filing of tax returns. Accounting and bookkeeping software, such as our Xero accounting software, can be integrated directly into Making Tax Digital, and away from software HMRC will collate different information from different areas automatically.
For example, HMRC will be able to request financial data from businesses, banks, building societies, employers and other branches of government, as well as collate information relating to earnings and pension information, and then automatically and seamlessly update this into a Making Tax Digital account.
This significantly reduces the amount of information gathering and reporting that a business owner, accountant or individual needs to do, which can only be a good thing. From an accounting point of view, “static” information, such as budgets and net worths, should only need to be provided once which also all but halves the amount of administrative work required.
In addition quarterly and yearly tax returns will disappear as instead both annual and quarterly returns will be submitted directly from accounting software.
What does Making Tax Digital aim to do?
The purposes of Making Tax Digital have been outlined by the Government as the following:
- To provide a comprehensive overview of all of yours, or your businesses, tax information, entitlements and liabilities, essentially providing you access to your own digitised tax account.
- To reduce errors by increasing the accuracy, transparency and simplicity involved in the filing and reporting of taxes, so that tax overpayments are a thing of the past.
- To provide an accurate, concise and up-to-date understanding of how much a business or individual owes, and the tax payments that are required to be made. Instead of waiting until the close of the financial year, businesses and individuals are instead able to understand their tax obligations and make necessary adjustments in the present moment instead of blind estimations. This should make business bookkeeping much easier!
- To make the process of filing and reporting financial information quicker and easier, meaning businesses spend less time on complicated financial returns and more time on growing their business.
- To reduce the chances of compliance checks and audits from HMRC due to lessening the room made for errors in the Making Tax Digital submission system. If you need to double check the things that can trigger a HMRC audit, we detail them here.
- To simplify the filing and reporting process through providing hints and prompts to ensure the correct information is being captured and reported in the correct section and at the right time.
- To utilise an online payment system which means that individuals and businesses can pay their taxes almost immediately if they wish.
What changes will Making Tax Digital Phase 2 bring?
Under Phase 2 of Making Tax Digital, from the first of April 2022 businesses must adhere to the following changes regarding their filing and reporting of financial information.
- A business’ or individuals’ accounting records must be maintained on suitable accounting or bookkeeping software which allows for live submissions to be made to HMRC. Bridging software – that is software which did not integrate directly with HMRC but was allowed in the transition period – will no longer be accepted after the ‘soft landing’ period closes.
- Digital links will be a mandatory requirement between the computer systems the business or individual uses for their business processes, and must be automatic and secure so that no human interference can occur. Digital links refer to a digital connection which must be made between the businesses or individuals’ digital records, the VAT Return and then between the VAT Return and HMRC to, in essence, form a digital chain. Put simply: HMRC will require businesses to all but create a digital audit trail which clearly displays the journey from the digital record to the VAT return then submitted to HMRC.
- Businesses or individuals must record the date and value of sales and purchases made, as well as the rate of VAT charged. The difference in this requirement relates to many businesses previously entering daily or monthly totals into an accounting system or recorded transactions from statements. From 2022, most businesses will now need to provide information for each individual transaction but exemptions for retail businesses will continue.
How does Making Tax Digital affect VAT?
Businesses who are VAT-registered and have a taxable turnover above the VAT threshold of £85,000 are now legally required to adhere to Making Tax Digital guidelines by creating and keeping digital records as well as using software to submit their VAT returns.
However, businesses who are below the VAT threshold are not exempt from voluntarily joining the Making Tax Digital scheme now.
Whether your business is above or below the VAT threshold, it is advisable to begin making preparations now for the transition to Making Tax Digital. Businesses over the threshold should certainly begin to undertake the procedure as from April 2022 they especially will be required to adhere to Making Tax Digital guidelines regarding their first tax return starting on or after April 2022.
There are pros and cons to registering for VAT. Check whether it’s the right move for your business here. Or read more about how Making Tax Digital affects your businesses VAT here.
How should my business prepare for Making Tax Digital?
To prepare for the transition to Making Tax Digital, businesses can use the following tips to help them get ready:
- Check the business’ VAT status
Businesses that are VAT-registered are now required to complete and file their tax returns digitally with Making Tax Digital. Previously this only applied to VAT-registered businesses who exceeded the turnover threshold.
If your business is not VAT-registered but looks set to either meet or exceed the threshold in the near future, it may be worth registering for VAT in advance and in doing so, aligning your businesses financial information with the requirements of Making Tax Digital processes.
Likewise new businesses or those seeing early stages of growth may also find themselves affected and should consider income forecasts to identify whether or not they may be faced with Making Tax Digital changes sooner than expected.
Remember businesses who are VAT registered, and do not look to exceed the threshold in the near future can still voluntarily register with Making Tax Digital, and this is most likely worth doing.
In line with Britain’s exit from the European Union, Postponed VAT Accounting is also now in place. For businesses unsure of how PVA affects their VAT accounting, click here.
- Source accounting or bookkeeping software
Making Tax Digital is making everything digital, which means that businesses who previously relied on physical paper trails will need to make some drastic digital changes.
Accounting and/or bookkeeping software is a vital integration with HMRC’s Making Tax Digital system as the two interlink with one another via the aforementioned “digital links”. Whilst most accounting and bookkeeping software is fairly straightforward to use, there may still be a period of adjustment for businesses who are not used to filing and reporting electronically.
In these scenarios, it’s best to talk to an accountant who can advise you on the correct accounting and/or bookkeeping software for your business to use.
- Check your accounting or bookkeeping software is MTD Compliant
The digital communication process between computer systems and Making Tax Digital software – called “digital links” by HMRC – means that previously installed accounting and bookkeeping software must be Making Tax Digital compliant.
To this end it is worth checking with your businesses accounting or bookkeeping software providers as most providers are issuing updates which ensure their platforms are compatible with Making Tax Digital software.
For example, accounting packages such as Xero, as used by us at iFinance Department, are already prepared to support the Making Tax Digital transition and allow us as accountants to track cash flow, raise invoices and schedule payment reminders. In the near future Xero technology will also enable us to submit VAT information directly to HMRC, on an annual or quarterly basis.
- Review your Making Tax Digital Plan
When a business undergoes any major change there is always a strategy or plan, and Making Tax Digital is no different.
If your business already utilises accounting software then complete checks with your software provider to ensure the software you are using will have Making Tax Digital availability, and check when this will happen if the provider is still in the process of scheduling updates.
If your business needs to make a digital switch, it could be worth evaluating when the most practical time to undertake this switch is, for example at the close of year-end.
Businesses using spreadsheets and working manually must also put in place a plan of action for training staff in digital software, if necessary.
Businesses working with an accountant should also run their Making Tax Digital plan past them, as it’s likely we’ll be able to offer advice and insights.
- Talk to an expert
Finally, the switch to Making Tax Digital can be overwhelming for businesses of any size and setup, but it needn’t be a thing of dread – especially if a business will be transforming from manual working to digital.
Speaking to an expert, such as accountants like us at iFinance Department can help simplify the transitional process for your business and cause minimal disruption to your day-to-day operations, as well as your existing filing and reporting financial information processes.
For more information on Making Tax Digital, for help with your businesses transition, or to run a Making Tax Digital plan past us book your free virtual consultation with us today. We’re happy to help!