Making Tax Digital for VAT a guide for businesses

Making tax digital' – what is it?

Making Tax Digital (MTD) is the UK government’s pioneering initiative to take all tax submissions online, enforcing digital record keeping with computer software. The government’s long-term plan is to make sure all businesses and those who are self-employed individuals keep their tax accounts in an approved way. MTD is an instrumental part of the government’s scheme to make it easier for individuals and businesses to make sure their taxes are correct, as well as revolutionizing HMRC into a leading digital tax authority. HMRC have said that MTD will reduce errors in tax, generating an extra £610 million in revenue in 2020-2021.

The government have also emphasized the benefits of digital record keeping for businesses, such as real-time record keeping. VAT registered businesses will be the first to take part as of April 2019, with other types of business tax being addressed from 2020. Every business which has taxable turnover of £85k or more will have to use approved software to report quarterly figures to HMRC. Businesses need to prepare and have a solution ready in time.

First suggested in 2015, HMRC wanted to remove manual, annual tax returns and for records to be digitized. The original plan was to launch in 2018, however the general election and Brexit delayed the roll out. This guide, based on frequently asked questions about MTD, aims to clear up any surrounding confusion.

The requirements for MTD and VAT are simple. HMRC have declared that VAT businesses with a turnover above the threshold must:

Keep their records in digital form
File their VAT returns using an MTD approved software

While not all business data needs to be held in one place or program, there must be a digital link between the software being used.
With a few small exceptions, MTD is mandatory for processing VAT. The change was phased in for several reasons; previous tax reporting methods that often included transactions being manually recorded in accounting journals resulted in many reporting inaccuracies. By recording transactions online, HMRC hopes that this will reduce miscalculations and lead to a reduction in fraudulent activity.
Businesses under the VAT threshold won’t have to worry too much now, but must keep in mind, that if they go over, they must be compliant with MTD. The best way to do this, is to start keeping digital records using functional, compatible software. It is imperative to keep in mind, that MTD is not solely for digitally filing tax returns, but also for keeping and preserving these records electronically.

To ensure businesses comply with MTD, all software must be digitally linked to create what HMRC are calling a ‘digital journey’ for VAT payments. A digital link is one in which data can be transferred between different software or computer systems. It also includes formulae in spreadsheets as part of VAT calculations. The definition is surprisingly broad, including e-mailing spreadsheets to accountants for them to import the data into their software for calculating and filing VAT liability. It also includes passing your files to your accountant on a USB stick for this purpose. Cutting or copying and pasting information from one spreadsheet to another is not considered a digital link. For example, to comply with the scheme, the ledger for the invoice must be digitally linked to the other ledger or software package through a more automated mechanism like file sharing or integration.

  1. One aim of MTD for VAT is to close the £12 billion VAT gap (the gap is the difference between the tax HMRC calculates it should be collecting and the amount it receives).
  2. Another is to give businesses real-time data. Gone are the days where VAT returns are submitted once a quarter. With this digitized system, HMRC will process its information in real-time, preventing the buildup of payments owed to them. This should also make businesses more efficient – as opposed to reviewing figures at the end of the year, businesses and those who are self-employed will analyze their business activities regularly, helping them understand their financial position.
  3. Improved record keeping and increased awareness of one’s tax liabilities will help to reduce errors and omissions prevalent in the current manual system and generally help with budgeting.
What processes must be adapted?

Businesses and self-employed individuals should look at all processes revolving around VAT returns. This may be time consuming, but the investment here will avoid later penalties. MTD doesn’t mean that you must stop generating paper-based notes or invoices, it just means invoice-level data should be transferred to MTD approved software. For example, it will no longer be legal to simply enter the monthly total of all invoices at the end of the month.

The first step any business needs to take is to purchase or upgrade accounting software to an MTD-compliant software. Set up processes, staff training, and software familiarization are three of the main factors that should be considered as part of the transition.

Using an accountant may also prove to be beneficial – they will be able to advise you on what is best for your company and review your existing processes for efficiency.

Another way to circumnavigate immediate changes and reduce the impact of MTD for VAT as much as possible, is to use bridging software. The sole purpose of this is to connect to HMRC to send VAT information. Essentially, the bridging software does all the heavy lifting for non-MTD-enabled software so that businesses can continue to operate in the way they always have. This will allow individuals and businesses to send VAT returns to HMRC from a spreadsheet. However, using bridging software comes with a few risks:
Bridging software cannot preserve digital records
You must ensure accounting systems relating to VAT are digitally linked – a bridging solution cannot do this
Bridging tools can be used as a temporary measure, however they should be avoided if possible.

Businesses will need to use software appropriate to their business requirements. For example, a property partnership would need software that can record the partners’ details and profit shares.

Impacts of MTD?

MTD’s impact on both small and large businesses will be significant. However, MTD is particularly targeted towards smaller businesses who, with the right software, will find it much easier to carry out both their tax returns and their day-to-day accounting.

In line with the expansion of online banking, small businesses will now be able to view their liabilities and entitlements on cloud-based accounting platforms. This is combined with the ability of accounting platforms to reconcile payments with invoices, small businesses will be able to manage all their finances in one place.

For businesses and individuals already using accounting software, the transition should be relatively simple, involving little more than running updates. For those using older software, spreadsheets and manual records, this may not be the case – ways to replace the existing process with software driven approaches should be considered.

If desktop accounting software is being used, this may need updating (if it hasn’t been already) to comply with MTD standards. You may not be able to update older software – in this case, transferring your VAT accounting to more modern software will be required to file a VAT return when MTD comes into effect.

Cloud-based software (data saved on an external server with the ability to access it on any device in real-time) should automatically update itself for MTD.

For several reasons, spreadsheets alone are unlikely to meet all the requirements when it comes to MTD for VAT. If you’re VAT records are recorded using spreadsheets, it should be possible to use an MTD-compatible bridging software. This system will sit between a company’s current system and the new HMRC system. This will take the data you have entered and send it to HMRC in the approved API format. However, using spreadsheets for your tax returns has one significant drawback; HMRC has stated that by law, VAT records MUST be preserved. It is incredibly easy to accidentally change the content of a spreadsheet cell when viewing it – this means the data is no longer ‘preserved’. It is also easy to make errors using spreadsheet formulae which could lead to penalties for incorrect filings.

Making tax digital

HMRC have stated that to comply, the software (or set of programs) must be able to do the following as a minimum:

  • Record business details and all VAT-related transactions for up to 6 years
  • Record the date any information about VAT was paid or withheld for each transaction
  • Calculate what VAT is owed based on incomings and outgoings
  • It must submit VAT returns directly to HMRC via an API (application programming interface)

All good MTD accounting software will be able to handle these tasks. If more than one application is used, all the software must be digitally linked (copying and pasting information from one system to another is not permitted).

As a landlord/letting agent, data that will be required is rental amount, invoice date and expense amount, and expense category.

If more than one software package is used, at least one of them should be able to record and preserve digital records for the purposes of VAT submissions. Records that are not required to complete returns are not required to be kept digitally, although it is good practice to do so. Good accounting packages will also help store the required records digitally. Depending on their situation, some businesses will need to keep more information.

Despite MTD for VAT being a legal mandate (with enforced fines for failing to comply), HMRC have not made any free end user software available. Businesses and individuals will have to purchase their own software from third parties.

End of year declaration

Throughout the year, HMRC are expecting landlords to provide regular updates, generating a picture of what their net income for the year will be. It also important to consider that some businesses will need to make adjustments to this information, e.g. reconsidering which expenses re not allowable for tax. You will then declare that everything is complete and correct in regards to your property business (end of year declaration).

Where multiple properties are held within a property business or by an individual landlord, income and expenditure and only have to be recorded for the property business as a whole – they do not have to be allocated to individual properties. However, there will be a requirement to maintain the details of each property’s address in the digital records. It is also advisable that individual property records are kept, showing you which rentals are making the most money.

The idea of the proposed system for partners and partnerships are:

  • The partnership (as opposed to the individuals) will be responsible for the central requirements of MTD (keeping records of every transaction)
  • A nominated partner will fulfil these duties
  • The option for the nominated partner to push quarterly summaries of information of their share of the profit to each partner’s digital tax account This scenario would produce an estimate of each partners profit to date in the tax year
  • When the end of the year declaration is made, the nominated partner will be obliged to push each partner’s share of the profits to their digital tax accounts.

Some businesses can claim exemption from the program for religious beliefs, age, disability or remoteness, meaning that MTD is not reasonably practical for them. Applying for your VAT return over the phone is another option, but this must be specifically applied for. These businesses make up around 3.5% of all businesses affected.

HMRC will be enforcing a points-based penalty model. Under this model, businesses will receive a penalty point every time they fail to file a VAT return on time. Depending on the frequency of submission obligations, penalties will be charged at certain thresholds. Once the thresholds have been reached, a penalty will be charged for every submission failure as follows:

  • 2 points for annual submissions
  • 4 points for quarterly submissions
  • 5 points for monthly submissions

Making the change by signing up to compliant software for VAT returns may seem overwhelming and it’s all too easy to leave it until the last minute. But it’s quite easy, and filing VAT returns online and keeping digital records will help reduce your workload and improve your businesses agility in the long term.