Introduction to Making Tax Digital (MTD)
Making Tax Digital (MTD) is a UK government initiative aimed at modernising and simplifying the tax system by using digital technology to make it easier for individuals and businesses to manage their tax affairs. The initiative was introduced by HM Revenue & Customs (HMRC), the UK's tax authority, with the goal of creating a more efficient and accurate way of recording and submitting tax information.
Under the Making Tax Digital initiative, businesses and self-employed individuals are required to keep digital records of their income and expenses using compatible accounting software like Liberty Accounts. These records are then used to calculate and submit various tax returns, including VAT (Value Added Tax), income tax, and corporation tax.
The key components of Making Tax Digital include:
Digital Record Keeping
Businesses are required to maintain digital records of their financial transactions using approved accounting software. Manual record-keeping using spreadsheets or paper-based methods is being phased out.
Digital VAT Reporting
VAT-registered businesses are required to submit their VAT returns using digital methods directly from their compatible accounting software. This aims to reduce errors and streamline the VAT reporting process.
Digital Income Tax Reporting
Self-employed individuals and landlords with annual business or property income above a certain threshold are required to use digital tools to report their income and expenses to HMRC.
Quarterly Reporting
Instead of submitting an annual tax return, businesses and self-employed individuals might be required to submit quarterly updates to HMRC through their digital systems.
Digital Links
There should be a digital link between the various pieces of software used to record financial transactions and calculate tax liabilities. This reduces the risk of errors that could occur during manual data entry.
This shift enables a tax system that is more aligned with real-time reporting.
Benefits of Making Tax Digital
MTD offers numerous benefits to taxpayers, including improved accuracy due to reduced manual data entry. With the automation provided by MTD-compatible software, taxpayers can save time and effort. Additionally, the real-time data offered by MTD allows for better financial management and decision-making.
Understanding Making Tax Digital
MTD for VAT
MTD is a mandatory requirement which began with MTD for VAT in April 2019 and was applied primarily to VAT-registered businesses with a taxable turnover/income above the VAT threshold, set at £85,000.
However, MTD will eventually cover all businesses and individuals as the HMRC gradually extends the initiative.
All VAT registered organisations are now required to use MTD for VAT and HMRC will sign up businesses automatically unless they are exempt or have applied for exemption.
MTD for Income Tax
MTD for Income Tax Self Assessment (ITSA), for self-employed individuals and landlords with property income is set to begin on 6th April 2026 if you have annual business or income from property of more than £50,000.
From 6th April 2027 the threshold will be reduced to £30,000.
The consultation for MTD for corporation tax was conducted and may be expected in the future.
Exemptions from MTD
You can apply for exemption from following the rules for MTD for VAT if it's not reasonable or practical for you to use software or the internet because of your age, a disability or where you live or you object to using computers on religious grounds. You are automatically exempt if you or your business are subject to an insolvency procedure.
How to begin using MTD
To begin with MTD, create a digital tax account with the HMRC. This account will serve as a central hub for all tax-related activities. Create an account in MTD-compatible software for example Liberty Accounts and authorise it with your Government Gateway credentials.
Our accounting and payroll software will help maintain digital records like all taxable income, sales, expenses and purchases, and any other relevant financial information, and you will be able to send quarterly updates with income and expense totals to HMRC. Updates should be made every three months but you have the flexibility to update more frequently if you prefer. Digital records are more accurate, secure, and easier to access than traditional paper records.
Before finalising your records for the tax year, send updates, make adjustments, and confirm the accuracy of your end-of-period statement. This should be done per business if you have multiple businesses. After confirming the statement, you'll receive an updated tax bill estimate.
What is taxable income?
Taxable income refers to the amount of an individual's or company's income that is subject to taxation. This is determined by subtracting any allowances and deductions from the total income.
For individuals:
Taxable income is any earnings above the Personal Allowance, which is subject to Income Tax. For the 2023/24 tax year (from April 6, 2023, to April 5, 2024), the Personal Allowance is £12,570. It can be increased by the Marriage Allowance or Blind Person’s Allowance, or decreased for income over £100,000.
The tax rates applied to taxable income in the UK for the tax year 2023/24 are:
- 0% rate for income up to £12,570, the standard Personal Allowance
- 20% (basic rate) for income from £12,571 to £37,700
- 40% (higher rate) for income from £37,701 to £125,140
- 45% (additional rate) for income exceeding £125,140
Note: Tax rates may differ in Scotland.
For self-employed, sole traders, and limited company directors:
Income Tax is based on profits and salary, calculated at the appropriate rates. Limited company directors' Income Tax is determined through the PAYE system, based on a monthly salary exceeding 1/12th of the Personal Allowance.
Corporation Tax:
UK resident companies pay tax on worldwide profits, including trading and investment profits and capital gains. Non-resident companies operating in the UK are taxed on profits from UK trading through a permanent establishment (PE) or capital gains on UK property. The main rate is 25%, with a lower rate for smaller profits.
Taxable income includes:
- Government stocks, unit trusts, wages, pensions, benefits-in-kind, dividends.
- Sales or services subject to VAT.
Non-taxable income includes:
- State benefits, injury compensation, educational grants, employer-sponsored courses, foster care receipts.
- For charities, income from donations and grants
Please note: The tax information presented here reflects the tax law at the time of publication and may be subject to change.
Submitting VAT Returns through MTD
To submit VAT returns through MTD, taxpayers need to sign up for the service on the HMRC website. Once registered, they can connect their MTD-compatible tax software like Liberty Accounts to their digital tax account. From there, taxpayers can send their VAT returns directly to the HMRC. It is essential to submit VAT returns on time to avoid any potential penalties.
Conclusion
Making tax digital is a step forward towards a more efficient and transparent tax system. It simplifies the tax process, provides real-time insights, and reduces errors. By maintaining digital records and submitting tax returns online, businesses and individuals can enjoy time savings, and better financial management. As the initiative continues to unfold, it is vital for businesses and individuals to stay informed and prepared to adapt to the digital tax landscape. Liberty Accounts is MTD for VAT compatible software - start using it today for streamline tax management.
