What Making Tax Digital means for contractors: now, and the next phase

Making Tax Digital, or the arguably cooler acronym ‘MTD,’ is well and truly underway. July’s first quarterly deadline for MTD for VAT – where companies sent their VAT tax returns digitally for the first time – has been and gone, as UK businesses attempt to move into a digital tax world.

But the fact that  over 3,800 businesses reportedly missed this deadline, while almost 600,000 businesses still need to sign up to MTD, suggests that many people don’t really understand, nor perhaps care about, or see the value in, the government’s digital tax scheme.

Not wanting to get stung by HMRC however, contractors need to know about MTD and understand where the scheme’s going. So here, exclusively for ContractorUK, James Foster, senior commercial manager at Optionis Group, the parent of SJD Accountancy, outlines what contractors need to keep in mind to stay MTD-compliant.

A brief recap of MTD

MTD is basically a UK government initiative that aims to make it easier for individuals and businesses to get their taxes right. In setting up the scheme, HMRC hopes to create one of the world’s most digitally advanced tax systems, which will see the end of the annual Self-Assessment tax return.

The plan is that, eventually, all businesses and individuals who do their own taxes will send their tax returns digitally and directly to HMRC from their own MTD-compatible software. They will keep digital records and send tax updates and summaries to the government department every three months, rather than just waiting until the end of the tax year.

MTD for VAT was the first phase of the scheme. It launched on April 1st 2019 and affects VAT-registered businesses with taxable turnover above £85,000 -- the VAT registration threshold. MTD is led by revenue, not status, so any VAT-registered individual or business above this threshold should now be keeping their records digitally and submitting their VAT returns using MTD-compatible software.

MTD for VAT – phase two

The second phase of MTD for VAT is not set to be implemented until April 2021 at the earliest. While phase one of MTD for VAT applied to registered businesses above the £85,000 threshold, phase two will apply to VAT registered businesses below the threshold. This means that any VAT-registered individual or business with taxable turnover below £85,000 will need to keep and submit their VAT returns digitally, using MTD-compliant software, from this date. 

It’s worth pointing out that registered businesses with a taxable income under the threshold can currently ‘opt in’ to the scheme. But this is not mandatory until the April 2021 deadline at the earliest.

Advice for Limited Company Contractors

We’re often asked and understandably so -- What about MTD for limited company contractors – how are such contractors affected by Making Tax Digital?

A lot of contractors will be VAT registered, so those that are above the VAT registration threshold should ensure that they are compliant and already keeping digital records and filing their VAT digitally. However, contractors that are below this threshold should still be monitoring their turnover, so they’ll be aware of whether they expect to exceed this threshold. It’s worth noting that the VAT registration threshold is not set to change from £85,000 anytime soon, as the Treasury has frozen it until April 1st 2022.

With the above in mind, it’s clear that a compliant contractor accountant must ensure their contractors are aware and reflecting the requirements of Making Tax Digital, with extra vigilance where turnover is close to the threshold.

Choosing the right software

MTD-compatible software will initially allow you to keep digital records and file your VAT returns directly to HMRC without rekeying any data, but further down the line MTD-compatible software will also need to be able to send summaries to HMRC every three months for other taxes also. The software connects to HMRC’s Application Programming Interface (API) via a digital link. Once the link is set up between your software and HMRC, you can send your VAT returns directly to the government department.

There is a wide range of software available, which is compatible for MTD for VAT. Finding what’s best for you can come down to not just the cost of the software, but also what additional features they have and what suits your needs. For example, a lot of these options will not just be compliant for MTD, but also have various other features such as bank integrations; payroll submissions, invoice generation and forecasting tools.

However, if you’re happy with how you currently keep your records, don’t require any additional features and you want to save money, it’s worth considering bridging software instead. This ‘bridges’ and connects non-compatible software, such as spreadsheets, with HMRC’s systems. This type of software is a lot cheaper and doesn’t force you to change your record-keeping, while still being compliant with MTD software requirements. If you’re still not sure what type of software is right for you, it’s worth being aware that many software providers who are confident in their product will offer a free trial, so you can test out the software first before you decide to buy it.

MTD penalties

When it comes to penalties, there is arguably a lot of confusion about what HMRC will and won’t do. The tax authority has said it will take a “light approach” to late filing and record-keeping mistakes for MTD-affected businesses who are doing their best to comply.

What this means is that they will be more forgiving to those businesses who, for instance, miss a deadline, but are doing their best to establish a digital link and still paying the VAT due.

What it doesn’t mean is that there will be a blanket approach from HMRC in that no penalties will be issued! Basically, you must show that you’re doing your best to comply with VAT filling and digital record-keeping, and of course paying your VAT liabilities. If you don’t, you could be issued with a penalty. So, to avoid the possibility of receiving one, quite simply, it’s best to comply.

Income tax and other taxes

Income and corporation taxes were due to go digital for all businesses in April 2020. However, to focus on supporting businesses to transition, the government announced at Spring Statement 2019 that it will not be mandating MTD for any new taxes in 2020 – with income and corporation tax set to be mandated from April 2021, at the earliest. This applies to all self-employed businesses, partnerships, trusts and landlords, who complete Self- Assessment tax returns.

The government has said it is currently building functionality so that businesses and landlords can eventually use software to send information about all types of income – not just their business/rental income. This includes details like employment income, bank interest, and dividends. But, with the pace of mandating recently being slowed down, this might not happen for some time.

Pilot scheme

In the meantime, if you will be affected by MTD for income tax (when that time comes) you can now sign up to a pilot scheme. The scheme, called Making Tax Digital pilot for Income Tax, allows individuals to voluntarily use software to keep records digitally and send income tax updates to HMRC, instead of filing a Self-Assessment tax return. This means you can test out sending your taxes digitally using the new system and get used to how it works.

Using the system involves sending income and expenses summaries to the government department every three months, and finalising your income and expenses at the end of the accounting year. In doing this, you’ll have a better idea of the tax you owe over the course of the year, rather than waiting until the end of the tax year. You’ll receive reminders when you need to send updates. There’s also the option to send updates to HMRC more often if you prefer.

Planning ahead and support

If you won’t be affected by MTD until April 2021 or far beyond that deadline, the best advice is still to be prepared in advance. So, trial the different types of software available, test out keeping and sending your records digitally to see how it works and feels, and get comfortable with this new way of accounting because, despite calls to suspend or scrap it, MTD is inevitable.

If, on the other hand, you’re feeling a bit overwhelmed by moving to a digital tax world, and aren’t sure if MTD affects you at all, remember there is plenty of help and support available. HMRC is offering webinars to provide help and guidance on the scheme while contractor accountants (including us at SJD of course), can provide you with everything you need to know to ensure you’re clued up and compliant about the world of digital tax now and when it evolves in the future.