Making tax digital (MTD) is the biggest shake-up to the tax system ever and in this guide, I explain more about it including:
- What it is;
- What it means for small business owners and the self-employed;
- The impact it has on bookkeeping & tax calculations.
Table of contents
Making Tax Digital for Income Tax Self Assessment (ITSA)
MTD is the complete digitisation of the entire tax system. This means mandatory quarterly tax reporting into HMRC along with regular tax payments by businesses and individuals via digital bookkeeping.
HMRC estimated that errors and mistakes result in over £9 billion lost taxes annually. This is a loss they feel they can hugely reduce by making people switch from manual bookkeeping to digital bookkeeping. Essentially business will need to:
- Maintain their bookkeeping electronically;
- Report VAT and income & expenses digitally to HMRC on a quarterly basis via approved software;
- Make quarterly tax payments to HMRC.
The first group to be affected by MTD were businesses registered for VAT. In other words, those with a VAT taxable turnover of over £85,000. These businesses must now submit their VAT returns directly to HMRC using an HMRC compliant bookkeeping software.
2. MTD VAT Reporting
From the 1st April 2019, all VAT returns need to be sent to HMRC via a MTD compliant software, using digital record-keeping. Digital record-keeping basically means entering every sales and purchases transaction that make up the figures on your VAT return, one by one into a bookkeeping software.
This means if you add your VAT up either manually from your invoices or with a spreadsheet, then input the figures into a VAT return on the Government Gateway, you’ll need to make some changes. For each sale and purchases transaction you’ll need to record:
- Date or Tax Point
- Value of Supply
Rateof VAT used
The approved MTD bookkeeping systems, like Xero, all require you to enter this information as standard. Your bookkeeping system will then work out your VAT figures and transmit them straight to HMRC from the system (once you approve the figures).
Making tax digital does not affect how you keep copies of your business sales and purchase invoices. That part of business record-keeping remains unaffected. However, HMRC don’t want to see all your invoices each time you submit a tax return; they just want to know that you have used one of their approved software to work out your VAT.
3. How Making Tax Digital for Income Tax Self Assessment (ITSA) Will Work for Sole Traders
The Making Tax Digital rollout will continue with sole traders and the self-employed for accounting periods starting on or after 6 April 2026, with business turnovers above £50,000. Then those with a turnover over £30,000 will be now mandated to join from April 2027.
MTD promises to make it easier for sole traders to help them stay on top of paying taxes with quarterly payments to HMRC. But, it also signals the end of the annual self-assessment tax return form due by 31 January each year.
Once MTD takes effect, sole traders will need to file quarterly tax returns online using an approved bookkeeping software along with the option of a fifth return once numbers for the tax year have been finalised. So, if you are using a bookkeeping spreadsheet, you’ll need to consider moving to something like Xero by April 2026, if you’re affected.
The initial rollout for the self-employed and sole traders was intended to take place in April 2020 but this was delayed in part due to Brexit and then the subsequent Covid-19 pandemic.
4. HMRC Compliant Software for Making Tax Digital
Most of the market-leading options for cloud accounting have now been approved by HMRC as officially being compliant for Making Tax Digital, this includes Quickbooks and Xero.