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The UK government’s Making Tax Digital (MTD) initiative is ushering in a new era of digital tax reporting for businesses.
By 2027, all VAT-registered businesses and self-employed individuals will be required to keep digital records and submit tax returns electronically.
This article will serve as a comprehensive guide to help businesses understand and prepare for the changes ahead.
Feel free to skip ahead to the section most relevant to you:
- What is Making Tax Digital & How Will it Affect My Company?
- What is MTD Compliance?
- Is Making Tax Digital Going to Happen?
- How Much Do You Have to Earn to Make Tax Digital?
- Is Making Tax Digital a Legal Requirement?
- Is Making Tax Digital Free?
- Who is Exempt from Making Tax Digital UK?
- Do All Self-Employed Individuals Have to Go Digital?
- Do Sole Traders Need to Go Digital?
- When Did Making Tax Digital Become Compulsory?
- How Do I Set Up Making Tax Digital?
- What is MTD Compatible Software?
What is Making Tax Digital & How Will it Affect My Company?
Making Tax Digital is a government programme to modernise the UK’s tax system. The goal is to make tax administration more effective, efficient and easier for taxpayers.
Under MTD, businesses above the VAT threshold (currently £85,000) have been required to keep digital tax records and submit VAT returns using MTD-compatible software since April 2019.
The scope of MTD will continue to expand in the coming years.
By April 2026, individuals with gross income over £50,000 from self-employment and/or property will be required to follow the MTD rules for income tax.
And by April 2027, the requirement will extend to individuals with gross income between £30,000 and £50,000.
Those earning less than £30,000 will not be mandated to comply at this time, but this decision will be reviewed in the future.
What is MTD Compliance?
To be MTD compliant, businesses must:
- Keep digital records of their income, expenses and financial transactions.
- Submit VAT returns or income/self-assessment tax information to HMRC using MTD-compatible software. The software will handle the formatting and transfer of the data in the required format.
- Provide a complete digital audit trail of all financial transactions, including categorising and coding each transaction.
Maintaining this level of digital record-keeping and submitting returns electronically are the core requirements for MTD compliance. Businesses that fail to meet these obligations risk facing penalties from HMRC.
The potential penalties for non-compliance with Making Tax Digital include:
- Failure to keep digital records: Businesses can be fined up to £500 per failure.
- Failure to submit tax returns using MTD-compatible software: Businesses can be charged a penalty of £100 for the first failure and then escalating penalties of £200 for each subsequent failure.
- Late filing of tax returns: Businesses may be subject to the standard HMRC late filing penalties, which can range from £100 to £1,600 depending on how late the return is.
- Inaccuracies in tax returns: If HMRC finds inaccuracies in a business’s tax return, it can impose penalties of up to 100% of the extra tax due.
HMRC has stated they will take a “light touch” approach to penalties in the first year of MTD implementation. However, businesses should still ensure they are fully prepared and compliant to avoid potential fines down the line.
The severity of penalties will depend on the nature and frequency of the non-compliance. Businesses that make a genuine effort to meet the new digital requirements but encounter occasional issues are less likely to face harsh penalties than those that completely disregard the rules.
Maintaining thorough digital records, using HMRC-approved software, and submitting returns on time are crucial steps to avoid penalties for Making Tax Digital.
Is Making Tax Digital Going to Happen?
Yes, Making Tax Digital is definitely happening. The UK government has legislated for the rollout of MTD, and businesses can no longer ignore these new digital tax UK reporting requirements. Failing to comply can result in penalties from HMRC.
How Much Do You Have to Earn to Make Tax Digital?
The current MTD for VAT rules apply to any VAT-registered business with a taxable turnover above the £85,000 VAT registration threshold.
For MTD for Income Tax Self-Assessment (ITSA), the specific income thresholds are: –
- From April 2026: Individuals with gross income over £50,000 from self-employment and/or property
- From April 2027: Individuals with gross income between £30,000 and £50,000
- Those earning less than £30,000 will not be mandated to comply at this time, but this decision will be reviewed in the future
The thresholds apply to total gross income, which includes all trading and property income.
For example, if a sole trader has a trading income of £29,000 and rental income of £22,000, their combined income would exceed the £50,000 threshold, necessitating compliance with MTD for ITSA from April 2026.
Individuals mandated into MTD for ITSA can only become exempt if their qualifying income falls below the £30,000 threshold for three consecutive tax years.
Is Making Tax Digital a Legal Requirement?
Yes, Making Tax Digital is a legal requirement set by HMRC. Businesses that fall within the scope of MTD rules must comply with the new digital record-keeping and reporting obligations. Failure to do so can result in penalties from HMRC.
Is Making Tax Digital Free?
No, Making Tax Digital is not free for businesses.
While there is no direct cost to register for MTD, businesses will need to invest in the following to ensure they can meet the new digital tax requirements:
- Compatible accounting software
- Digital tools
- Potentially staff training
While the government does not provide grants for costs related to Making Tax Digital, it offers various forms of support, such as access to resources and general guidance to help businesses adapt to digital tax reporting requirements. See more on the Gov UK website here.
Who is Exempt from Making Tax Digital UK?
There are a few exemptions from the Making Tax Digital rules:
- Businesses below the £85,000 VAT registration threshold (until April 2027).
- Businesses run entirely by practising members of a religious society or order whose beliefs are incompatible with using electronic communications or keeping electronic records.
- Businesses that can demonstrate it’s not reasonably practical for them to use digital tools for tax, for example, due to age, disability, remoteness of location or other circumstances.
Do All Self-Employed Individuals Have to Go Digital?
No, the Making Tax Digital rules for self-employed individuals and sole traders will only apply to those with annual business or property income above £50,000 starting in April 2026.
From April 2027, those with income between £30,000 and £50,000 will also need to comply.
Those earning less than £30,000 per year will not have to follow the MTD for income tax requirements.
Do Sole Traders Need to Go Digital?
Yes, sole traders will need to comply with Making Tax Digital once the rules come into effect for their business income and self-assessment tax.
This applies to sole traders with gross income over £50,000 from April 2026 and those earning between £30,000 and £50,000 from April 2027 onwards.
When Did Making Tax Digital Become Compulsory?
The MTD for VAT rules became compulsory for VAT-registered businesses above the £85,000 threshold in April 2019.
In the future, the MTD for income tax rules will become compulsory as follows:
- From April 2026 for individuals with gross income over £50,000 from self-employment and/or property
From April 2027 for individuals with gross income between £30,000 and £50,000
How Do I Set Up Making Tax Digital?
To set up for Making Tax Digital, businesses will need to take the following steps:
- Choose compatible accounting software or apps that can connect to HMRC’s MTD platform. Popular options include Xero, QuickBooks, FreeAgent, and Sage.
- Ensure all business transactions and financial records are kept digitally, with a clear audit trail.
- Link the accounting software to HMRC’s MTD platform.
- Submit VAT returns or income/self-assessment tax information using the MTD-compatible software.
- Maintain a full digital audit trail of all financial transactions.
J Dauman & Co accountants are on hand to help you become set up and ready for MTD compliance. Reach out to us today to discuss your needs.
What is MTD Compatible Software?
Some popular examples of MTD compatible software include:
- Xero
- QuickBooks
- FreeAgent
- Sage
Businesses should check that their current software is MTD compliant or migrate to a solution that is.
MTD compatible software refers to any digital tools, apps or accounting packages designed to connect directly with HMRC’s Making Tax Digital platform. These solutions allow businesses to keep digital records and submit tax returns electronically in the format HMRC requires.
Making Tax Digital represents a significant change for UK businesses
By understanding the requirements, important deadlines and how to set up for compliance, companies can get ahead of the curve and ensure they are prepared for the new digital tax landscape.
J Dauman & Co. are experts in MTD and can help guide your business through this transition successfully. Contact us today to discuss how we can help you get ready for Making Tax Digital.
