What is Making Tax Digital?

Everything you need to know about Making Tax Digital as a Contractor, Freelancer or Small Business owner

Making Tax Digital (MTD) is here

MTD was first announced in the 2015 Spring Budget and is designed to modernise and digitally transform the UK tax system to make it easier and more accurate for taxpayers.

But do you know how it will affect you? Despite the importance of MTD, some contractors, sole traders and small business owners are still unaware of what it means and how it will impact them.

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What is Making Tax Digital?

MTD legislation mandates digital record-keeping and tax return submissions in order to make the tax system more efficient, effective and easier for both taxpayers and the HMRC.

MTD is a key part of the Government’s wider Tax Administration Strategy with the aim of making HMRC one of the world’s most digitally advanced tax administrations and is currently in a phased rollout.

After April 2019, all VAT-registered businesses with a taxable turnover above the mandatory VAT registration threshold were required to file their VAT returns on a quarterly basis using MTD-compliant software. Some businesses already filed their VAT returns every three months, but now must also record all transactions digitally on MTD-compliant tools, like FreeAgent accounting software.

In April 2021 digital links became mandatory for MTD for VAT. This was a further step towards digitally automating tax as it compelled small businesses to make changes including using formulas in spreadsheets, using XML and CSV imports and exports, or automated data transfer such as using API’s if a set of software programs, applications or products are being used. The goal here was to reduce errors by stopping values being copied and pasted or manually uploading data.

After April 2022 all VAT-registered businesses irrespective of turnover must comply with MTD legislation and store and submit their VAT returns digitally using MTD-compliant software.

In April 2022 a pilot scheme for MTD for income tax self-assessment (ITSA) was also introduced. The next phase begins in April 2026 with the wider rollout of MTD for ITSA becoming mandatory for Sole Traders and Landlords with a turnover over £50,000

From April 2027 Landlords and Sole Traders with a turnover of £30,000 or more will also need to comply with MTD for ITSA.

Why is HMRC Implementing Making Tax Digital?

The Government is aiming to improve the UK tax experience by introducing MTD, to improve efficiency and make submissions easier as well as reducing errors. Through MTD HMRC also intends to close the tax gap. The tax gap is the theoretical difference between the amount of tax that should be paid to HMRC, and the amount that is actually paid.

There are many factors that contribute to the tax gap including criminal attacks, non-payment, tax evasion and avoidance, failure to take reasonable care and the hidden economy. In the 2020-21 tax year, errors in submissions contributed 9% of the tax gap which equates to £3bn lost revenue to HMRC.

The Government aims to close this tax gap by receiving quarterly tax reports and mandating the storage of crucial documents and records in digital form, as well as digital submissions.

Many contractors, freelancers and small business owners still keep paper-based records or use Excel spreadsheets to keep track of their expenses or invoices. This, of course, can cause serious mistakes, such as lost documents or calculation errors which can often result in an HMRC investigation and penalties.

Who's Affected by Making Tax Digital?

At first, MTD applied to all VAT-registered businesses with a taxable turnover above the mandatory VAT registration, although businesses with a turnover below this figure could opt to get ahead and join the scheme early. Once inside the Making Tax Digital for VAT, a business needs to remain in MTD unless it’s no longer registered for VAT.

After April 2022, all VAT-registered businesses have to comply with MTD legislation irrespective of their turnover. This means that if your taxable turnover was £50,000, for example, you still had to register for MTD and submit your returns through MTD-compliant bookkeeping software.

From April 2026, sole traders and landlords will have to comply with the rules as well. You can see more about this below.

In short, Making Tax Digital affects – or will affect – contractors, sole traders, landlords, locums and small business owners. All VAT-registered businesses must comply with Making Tax Digital for VAT including non-UK businesses registered for UK VAT and trusts and charities.

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What Information Do You Need to Record Digitally?

With the introduction of MTD, you have to store certain information as digital records. You must record and store each individual transaction digitally, especially as HMRC requires records to be as current as possible.

You will also have to store your business name, place of business, VAT registration number and rate of VAT charged digitally. The accounting software you use must be capable of displaying the audit trail between records and VAT returns and submit your returns to HMRC digitally.

In addition, you must keep details on supplies you made and received, as well as their time and value. Your records will need to be stored digitally for six years.

It’s important to consider digital links too which are necessary for MTD compliance.

Examples of digital links include:

  • Linked cells in spreadsheets such as cell number/return functions
  • Transferring a set of digital records onto a portable device and physically giving this to someone else to import that data into their software
  • Emailing a spreadsheet containing digital records so the information can be imported into another piece of software
  • Using API’s
  • Automated data transfers
  • XML, CSV imports and exports and download and upload of files

Using copy & paste to select and move data is not considered a digital link by HMRC.

The Benefits of Making Tax Digital

As contractor accountants, we understand that Making Tax Digital feels like a big change; however, we also know there are significant benefits to the introduction of this legislation and using MTD compatible software.

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Concerns with Making Tax Digital

From online shopping to banking to accounting, digitalisation and technology are now an integral part of our daily lives and the next step is for the tax system to be fully digitised. However, while many businesses are affected by MTD, not all understand exactly what that means.

It’s crucial that sole traders, locums and contractors remain on top of the latest news regarding MTD so that they stay compliant – Gorilla Accounting can help you do that. As expert technology-focused accountants, we’ll clarify any confusion about this legislation so that you don’t have to worry about possible fines and penalties.

Another concern about MTD is internet speed. Rural areas can suffer from slow broadband speeds and poor connectivity, leading to issues and difficulties for business owners. MTD relies on good connectivity, so self-employed individuals may find it hard to update HMRC quarterly if their Internet speed is slow.

It’s also expected that some businesses will find it difficult to transition from paper-based processes to digital ones.

Making Tax Digital for Income and Corporation Tax

Currently MTD is only mandatory for VAT, but this will change in time as the phased rollout continues. MTD will be mandated for income tax self-assessment from April 2026 for sole traders and landlords with a turnover of £50,000 or more, and from April 2027 if they have a turnover of £30,000 or more.

Just like with MTD for VAT, you can get ahead and start keeping ITSA records digitally before it becomes mandatory and update HMRC regularly instead of filing a self-assessment return, although it’s not obligatory before 2026. This would mean in addition to your self-assessment, you would also need to submit five reports: four quarterly and one year-end submission.

The dates for these reports are:

  • Q1 – from 6 April to 5 July (deadline is 5th August)
  • Q2 – 6 July to 5 October (deadline is 5th November)
  • Q3 – 6 October to 5 January (deadline is 5th February)
  • Q4 – 6 January to 5 April (deadline is 5th May)

The end-of-year statement needs to have all required information and documentation asserting that everything is correct and complete and must be filed by 31st January after the relevant tax year.

Businesses will have the chance to start complying with MTD for Corporation Tax in a pilot initiative soon, but it won’t be compulsory before April 2026.

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What About Non-Compliance with Making Tax Digital?

The MTD for VAT penalty system was revised in January 2023 and the same penalty system will also apply to MTD for ITSA.

The MTD penalty system is points based with 1 point usually being applied for a late submission. Once you accumulate a certain number of points, a £200 penalty will be applied.

The points threshold to trigger a penalty is dependent on how frequently you have to make a submission to HMRC. Accruing 2 penalty points for annual submissions, 4 for quarterly submissions or 5 for monthly submissions will all result in a £200 fine. There can be further fines if, during the surcharge period, you miss payment deadlines.

Penalty points will expire after a 2 year period starting from the month after the penalty point was issued. There are separate points totals for each submission obligation you have, so it will be possible to receive penalties for MTD for ITSA and corporation tax, when they are introduced, in addition to MTD for VAT.

If you don’t use functional and compatible software to file your returns you could receive a penalty of £400 for every return you file.

If you make an MTD for VAT payment within 15 days of the due date you won’t be penalised but if you make a payment 16 – 30 days late there will be a penalty of 2% of the amount you owe.

If after 30 days you still have unpaid tax, there will be a penalty of 2% of what you owed on day 15 and 2% of what you owed on day 30. From day 31, a penalty will be applied daily of 4% of the amount owed.

Compliant taxpayers who make an occasional error are unlikely to be penalised. The penalty system is designed to tackle taxpayers that persistently don’t comply with MTD rules.

Penalties can be appealed through the HMRC reviews and appeals process but you must have a reasonable excuse as to why a deadline was missed.

You will likely be fined if your VAT return contains errors, so it’s important that it’s correct. As contractor accountants, we can help you stay on top of your returns to ensure they are timely and accurate, as well as getting you up and running with FreeAgent.

Using FreeAgent as Your MTD-Compliant Software

Multiple award-winning FreeAgent accounting software is fully MTD-compliant and is provided free of charge to all Gorilla Accounting clients.

As well as ensuring you are fully MTD-compliant, there are many benefits of using FreeAgent.

FreeAgent’s clever inbuilt functionality, features and automation simplifies previously laborious and repetitive accounting and admin tasks which will free up more of your time to focus on your day to day and growing your business with minimal accounting and admin distractions.

  • VAT returns are generated automatically while you work and can be electronically submitted to HMRC
  • Upload receipts and manage your expenses on the go to keep on top of your bookkeeping throughout the year
  • FreeAgent’s time tracking functionality enables you to log the time you spend on projects and tasks so you can bill your clients easily and accurately
  • You can create and send professional, personalised invoices and payment reminders and set them to be automatically chased
  • Unpaid invoices can be tracked to eradicate missed payments
  • Self-assessment tax returns can be prepared and submitted to HMRC based on the income received from your limited company and any income received from other sources
  • Payment gateway integration makes it easy for your clients to pay you quickly and securely online
  • Automated bank feeds upload transactions from your bank account each day so you can easily reconcile and categorise your bank transactions

FreeAgent is cloud-based so you can access your accounts at any time on any device with an internet connection to get a comprehensive real-time overview of the financial position and health of your business.

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Get in Touch with Gorilla Accounting

Ensuring your compliance with Making Tax Digital is vital and peace of mind is priceless. Our expert Gorilla Accounting team will handle MTD for you, so you won’t have to stress about non-compliance, freeing you up to focus on what really matters: your business. We have many years of financial experience and vast knowledge of UK legislation, which we put to good use for all of our customers.

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