Making Tax Digital for VAT: Compliance Requirements for UK Businesses
The UK government has made significant strides in modernising the tax system, primarily through its flagship initiative: Making Tax Digital (MTD). Aimed at reducing errors, improving efficiency, and making the tax process more transparent, MTD represents a seismic shift in how businesses interact with HM Revenue and Customs (HMRC). For UK businesses that are VAT-registered, the first and most immediate implication has been the requirement to comply with Making Tax Digital for VAT.This article provides an in-depth overview of the compliance requirements under Making Tax Digital for VAT, explores the practical steps businesses must take, and highlights the role that a value added tax consultant can play in ensuring businesses remain compliant and efficient.
Understanding Making Tax Digital for VAT
Making Tax Digital for VAT is a government mandate that requires VAT-registered businesses in the UK to keep digital records and submit their VAT returns using compatible software. The initiative was first rolled out in April 2019 for businesses with a taxable turnover above the VAT threshold (currently £90,000 as of April 2024). As of April 2022, MTD for VAT became mandatory for all VAT-registered businesses, regardless of turnover.
At its core, the aim of MTD is to reduce the margin for human error and bring tax reporting into the digital age. Paper-based and manual processes are being phased out in favour of digital platforms that offer real-time data access and seamless integration with HMRC systems.
For many small and medium-sized enterprises (SMEs), especially those with limited in-house accounting resources, navigating the requirements of MTD can be challenging. This is where a value added tax consultant can provide invaluable support, offering expert guidance on software selection, digital record-keeping, and compliance reviews.
Key Compliance Requirements
For businesses to remain compliant with MTD for VAT, there are several fundamental requirements that must be adhered to:
1. Digital Record-Keeping
All VAT-registered businesses must maintain digital records of their VAT transactions. This includes:
- Business name, address, and VAT registration number.
- The VAT accounting scheme used.
- Details of sales and purchases, including time of supply, value of supply, and rate of VAT charged.
These records must be stored using MTD-compatible software or a combination of software products that can communicate via digital links. HMRC defines a "digital link" as a transfer or exchange of data that is made electronically without the need for manual intervention, such as copying and pasting.
2. MTD-Compatible Software
The software used must be able to:
- Maintain digital records as required by MTD.
- Prepare VAT returns using the digital records.
- Communicate with HMRC digitally via an Application Programming Interface (API).
There is a wide range of MTD-compatible software available, from industry leaders like copyright and Xero to HMRC-recognised bridging software that works with spreadsheets. Businesses must ensure the software they choose meets both their operational needs and MTD requirements.
3. VAT Return Submission
All VAT returns must be submitted to HMRC using MTD-compatible software. Businesses can no longer manually enter their figures into HMRC’s online VAT portal (except for a small minority of businesses granted exemptions). The VAT return process is now fully digital, and any errors or inconsistencies in digital records can lead to delays or penalties.
4. Digital Links Between Systems
Businesses often use more than one piece of software to manage different aspects of their finances (e.g., one for sales and another for expenses). In such cases, these systems must be digitally linked. Manually copying and pasting data between systems is not allowed under MTD rules. Acceptable digital links include:
- XML, CSV import/export between systems
- Automated data transfer between software using APIs
- Use of spreadsheets that link cells using formulas
A value added tax consultant can assist in establishing compliant digital workflows, ensuring that every data transfer meets HMRC’s strict definition of a digital link.
5. Deadline Adherence
VAT returns must continue to be filed quarterly (or as agreed with HMRC), and businesses must pay any VAT due by the normal deadline. Missing deadlines or submitting incorrect data can result in penalties under the new points-based penalty regime introduced in 2023.
Penalties for Non-Compliance
With the implementation of MTD comes a shift in HMRC’s approach to penalties. The new system is designed to be more proportionate but can still be severe for repeat offenders.
Under the points-based system:
- Each missed VAT return earns a penalty point.
- Once the threshold is reached (typically 4 points), a £200 penalty is applied.
- Further missed returns incur a £200 fine each.
Additionally, there are separate penalties for late VAT payments and for submitting inaccurate information. The best way to avoid these penalties is by maintaining accurate digital records and ensuring timely submissions—areas where expert guidance from a value added tax consultant can prove especially beneficial.
Exemptions and Special Cases
While MTD is mandatory for most VAT-registered businesses, there are limited exemptions:
- Religious beliefs incompatible with the use of electronic communications.
- Age, disability, or remote location making it impractical to use digital tools.
- Insolvency procedures where MTD is deemed inappropriate.
Businesses seeking exemption must apply to HMRC and provide adequate justification.
Choosing the Right MTD Software
Selecting suitable software is crucial for MTD compliance. Businesses should consider:
- Compatibility with existing accounting systems
- Integration with bank feeds and other third-party services
- Scalability as the business grows
- User-friendly interface and customer support availability
Popular MTD-compatible software options include:
- copyright Online – Ideal for SMEs and integrates well with various apps.
- Xero – Cloud-based and known for ease of use.
- Sage Business Cloud – Offers more advanced features for growing businesses.
- FreeAgent – Designed with freelancers and contractors in mind.
Consulting with a value added tax consultant during this selection process can help businesses match the right tool to their specific operational and compliance needs.
Steps to Achieve and Maintain Compliance
To ensure ongoing compliance with Making Tax Digital for VAT, UK businesses should take the following steps:
- Assess current processes: Identify which records are still kept manually and evaluate current software capabilities.
- Select MTD-compatible software: Choose a solution that meets HMRC’s requirements and fits your business needs.
- Digitise your records: Convert all necessary VAT data into digital format and ensure it’s updated in real time.
- Establish digital links: Ensure seamless data transfer between all systems used.
- Train staff: Make sure all relevant employees understand how to use the new systems and are aware of compliance requirements.
- Monitor compliance: Regular audits or reviews can catch issues early and prevent penalties.
- Engage expert support: Regular consultations with a value added tax consultant can ensure your business remains compliant, even as regulations evolve.
Conclusion
Making Tax Digital for VAT is not just a regulatory requirement—it’s an opportunity for UK businesses to modernise their tax processes, reduce administrative burdens, and gain clearer financial insights. However, achieving compliance requires more than just switching to digital software. It demands a strategic approach, ongoing monitoring, and often, professional guidance.
Businesses that embrace this transformation, supported by reliable software and expert advice from professionals such as a value added tax consultant, are better positioned not just to comply, but to thrive in the digital age of taxation.