Source – Tax Writer
What does the roll-out of Making Tax Digital (MTD) mean for you? There is a mountain of misunderstanding out there about what accountants and businesses need to do and when.
What is MTD – the first myth?
Making Tax Digital (MTD) is mis-named – the process should more accurately be described as Making Accounting Digital, but that would be MAD, so we can see why HMRC stuck with the MTD acronym.
The first function of MTD for income tax self-assessment (MTD ITSA) is to get all businesses and landlords to record data from their business transactions in a digital format, and to process that data in a way that avoids manual intervention. HMRC say that taking human hands out of the processing will eliminate errors such as mistyping figures, entering data in the wrong box on the tax return, and omitting transactions from the records.
These claims of error-reduction have yet to be proven in a controlled environment, though HMRC is claiming that MTD for VAT has helped reduce errors. But it is the case that digitisation of the accounting process can save time in the long run for business owners. A digital accounting system may also be interrogated to provide better and more timely management information about the business’ performance.
What about tax?
The second purpose of MTD ITSA is to transfer the data needed to calculate the tax liability directly to HMRC from the digital accounting records, without manual intervention. This process is undertaken by MTD-compatible software that includes an Application Programming Interface (API).
The API could be described as a programming pipe that sucks specific data from the business’s accounting system into HMRC’s computer. A different API may automatically push information back to the taxpayer or agent, to help the taxpayer understand their tax liability.
MTD is being introduced tax by tax, which means there are different processes for MTD for VAT and income tax self-assessment (MTD ITSA). Eventually it is planned to extend to corporation tax.
What is a digital format – another myth to bust?
Recording
data from a business transaction in a digital format creates a digital
record.
You can choose a digital format that suits your needs. This can be as simple as
a spreadsheet or as complex as an entire accounting package, or something in
between. You don’t have to use a cloud-based accounting system to comply with
MTD, but that will suit some businesses.
You are only required to digitally record the following data points from each transaction for MTD:
- Date of the transaction
- The expense category (for income tax)
- Amount or value
- Rate of VAT charged on a sale (for VAT)
- Amount of VAT to be claimed on a purchase (for VAT)
As you can see from this list, there’s nothing that couldn’t be recorded in a spreadsheet, and as long as you can digitally link that spreadsheet with suitable bridging software (see below) you’ll be compliant for your quarterly updates.
In practice you will want to record more information about each transaction, such as the identity of the purchaser or supplier, and when the payment for the sale was received. Retail businesses can record the total of sales for each day’s trading instead of recording every sale separately. Supplier’s invoices may also be treated as one record in certain circumstances.
Myth: New systems are needed to maintain digital links
Digital links replace human hands in the accounting process.
They are computerised processes that transfer data between different parts of the accounting system and ultimately into the HMRC system via an API. Spreadsheets can be adapted to include an API function, and such API-enabled spreadsheets are compliant with MTD for VAT.
If, as is often the case, the spreadsheets being used for business records are not API enabled then one solution is to use ‘bridging software’ with API functionality to import the data from the spreadsheet first and then send it on to HMRC.
Once that data has been recorded, the MTD regulations stipulate that there should be “digital links” that move the data around the accounting system. This means the data should not be retyped or copied by human hands once it has entered the system.
You can use bridging software to submit VAT returns under MTD (see examples in VAT Notice 700/22). The equivalent HMRC guidance on digital links for MTD ITSA hasn’t been published, yet but the use of spreadsheets as digital records was accepted by HMRC in 2017 when MTD was initially building towards quarterly income tax reporting. In a recent article Dean Shepherd, director of product compliance at TaxCalc looked at exactly what HMRC have specified so far in terms of what is acceptable as a digital record in the VAT rules and argued that it was hard to see this changing drastically for MTD ITSA.
HMRC
needs to receive just the sum totals of the business transactions (sorted by
category for income tax) for the relevant period. The detail of each individual
transaction is not sent to the tax
authority. For VAT it is the totals which have always been reported
in the nine boxes on the VAT return.
MTD does not require you to have an electronic link from your bank account into your accounting system (known as a bank feed). This may suit some businesses, but not everyone.
So, whilst it’s true that many businesses may benefit from the extra information and functionality they’d get with a complete accounting software system, many landlords, and simpler businesses will be perfectly fine with keeping a spreadsheet as a digital record, and even file their quarterly updates provided that they link it digitally with suitable bridging software. Indeed many are already doing this for VAT, and the basic ITSA quarterly update requirements are very similar.
When must my business comply?
Each tax has a different MTD process and a different timetable to mandation.
MTD for VAT was mandated for most VAT-registered businesses in 2019, and the remaining VAT registered businesses must comply with the MTD for VAT regulations for periods starting on and after 1 April 2022.
Self-employed sole traders will have to comply with the MTD ITSA regulations from 6 April 2024, and most partnerships will start reporting under MTD ITSA from 6 April 2025.
Eventually, corporation tax returns will come under the MTD protocols, but there is no rush to do that because company accounts and tax returns are already submitted to HMRC digitally.
What will MTD ITSA involve – yet another myth?
MTD ITSA seeks to replace the process of submitting an individual’s self-assessment tax return and calculating the tax due, but there are additional reports to HMRC required under MTD as follows:
1. Submit totals of income and expenses each quarter (Quarterly Updates)
2. Submit accounts for the year (End of Period Statement: EOPS)
3. Submit Final tax return (Finalisation/Crystallisation Statement)
The Quarterly Update is a data dump of totals from your digital records, delivered up to one month after the end of the quarter. These updates prove to HMRC that the business is digitally recording its accounting data in a relatively timely manner. HMRC will feed back to the taxpayer an estimated amount of their tax liability after receipt of each quarterly update, but the taxpayer doesn’t have to do anything with that information.
The accounts for the business will be submitted by 31 January after the tax year end on a return known as the End of Period Statement (EOPS). The figures for the EOPS are drawn from the accounting system but are not (except in the very simplest of cases) a sum-total of all the quarterly updates.
The finalisation/crystallisation statement is the replacement for your self-assessment tax return. It will pull in all your other income and claims which need to be reported for income tax.
Far from being the death of the annual tax return, as heralded back in 2015, MTD ITSA will lead to even more filings, especially for those with more than one trade, or accidental landlords. However, for simpler affairs spreadsheets are likely to be an acceptable method of keeping the digital records and filing quarterly updates, with digital links to software that can handle the more complex EOPS and Finalisation /Crystallisation statement.
How do I comply with MTD ITSA?
Each of the three types of reports must be submitted to HMRC using MTD-compatible software. The choice of this software will be an important decision for your business.
You need to look ahead and consider what MTD obligations you have now (eg VAT), and what you will be required to submit in the future.
TaxCalc has been providing award-winning tax and practice management solutions to the profession for the last eighteen years. They are committed to providing sensible and practical solutions to all the challenges facing accountants – not least that posed by the advent of MTD