Making Tax Digital (MTD): What UK Businesses Need to Know

What Is Making Tax Digital?

Making Tax Digital (MTD) is HMRC's programme to modernise the UK tax system. The core idea is simple: businesses keep digital records and submit tax returns through compatible software, eliminating paper-based processes and manual data entry.

MTD has been rolled out in phases:

• April 2019: MTD for VAT became mandatory for businesses above the VAT threshold
• April 2022: MTD for VAT extended to all VAT-registered businesses
• April 2026: MTD for Income Tax Self Assessment (ITSA) begins for self-employed individuals and landlords with income over GBP 50,000

Who Must Comply?

MTD for VAT (Now)

All VAT-registered businesses must comply. This includes sole traders, partnerships, limited companies, and any other entity registered for VAT - regardless of turnover.

MTD for Income Tax (From April 2026)

Self-employed individuals and landlords with annual income over GBP 50,000 must comply from April 2026. The threshold drops to GBP 30,000 from April 2027.

The Three Pillars of MTD Compliance

1. Digital Record-Keeping

You must maintain your business records digitally. This does not mean you need to scan every receipt (though that helps). It means your financial records - sales, purchases, expenses - must be stored in a digital format within compatible software.

Records you must keep digitally include:

• Business name, address, and VAT registration number
• VAT accounting scheme used
• VAT period dates
• For each supply: time, value, and rate of VAT
• Total outputs and inputs for each VAT period
• Any adjustments

2. Compatible Software

You must use software that is recognised by HMRC as MTD-compatible. This software must be able to:

• Store your digital records
• Submit VAT returns directly to HMRC via API
• Receive information back from HMRC

Xero is one of the most popular MTD-compatible platforms. When paired with tools like SortBooks for automated categorisation, the entire chain from transaction to submission is digital.

3. Digital Links

If you use multiple software tools, data must flow between them via digital links - not manual re-keying. Acceptable digital links include:

• API connections between software
• CSV or XML file imports and exports
• Automated data transfers

Copying figures from one system and typing them into another is NOT a digital link and breaches MTD requirements.

What Counts as Compatible Software?

HMRC maintains a list of compatible software on their website. The major options include:

• Xero - Cloud accounting with built-in MTD submission
• QuickBooks Online - Another popular cloud option
• Sage - Traditional accounting software with MTD features
• FreeAgent - Designed for freelancers and small businesses

Bridging software is also available if you want to keep using spreadsheets. Bridging tools connect your spreadsheet to HMRC's API, but you still need to maintain the digital link chain.

How to Submit a VAT Return Under MTD

The process with compatible software is straightforward:

1. Categorise all transactions for the VAT period with correct VAT codes
2. Reconcile your bank accounts to ensure all transactions are captured
3. Review the VAT return generated by your software
4. Submit directly to HMRC through the software's MTD connection
5. Save the submission confirmation for your records

The software handles the API communication with HMRC. You review the figures, authorise submission, and the return is filed. Most businesses can complete this in under 30 minutes if their bookkeeping is up to date.

Common MTD Compliance Issues

Using spreadsheets without bridging software - Spreadsheets alone do not meet MTD requirements. You need either compatible accounting software or bridging software that connects your spreadsheet to HMRC.

Breaking the digital link chain - Every step from recording a transaction to submitting the return must be digitally linked. Manually copying a total from your accounting software to a spreadsheet and then submitting from the spreadsheet breaks the chain.

Not authorising software with HMRC - Your software needs to be linked to your HMRC account. This is a one-time setup through the Government Gateway, but businesses sometimes forget this step.

Incorrect VAT codes - MTD does not fix data quality issues. If your transactions are miscategorised, your digitally submitted return will still be wrong. Automated categorisation tools help prevent this.

Penalties for Non-Compliance

HMRC can issue penalties for:

• Not keeping digital records
• Not using compatible software
• Breaking digital link requirements
• Late submission of VAT returns
• Late payment of VAT

Currently, HMRC has taken a relatively lenient approach to digital record-keeping and software penalties, focusing on education rather than fines. However, this grace period will not last forever, and late submission and payment penalties are already being enforced.

Preparing for MTD for Income Tax

If you are self-employed or a landlord with income over GBP 50,000, you need to prepare for MTD for Income Tax by April 2026:

• Choose MTD-compatible software for income tax record-keeping
• Set up digital record-keeping processes
• Understand the quarterly reporting requirements (you will submit quarterly summaries in addition to your annual return)
• Ensure your digital link chain covers all income sources

The transition is easier if you already comply with MTD for VAT, as the principles are identical.

Key Takeaways

1. MTD is not optional - all VAT-registered businesses must comply now
2. Use compatible software that connects directly to HMRC
3. Maintain digital links between all your financial tools
4. Keep your transaction categorisation accurate - automation helps
5. Prepare for MTD for Income Tax if you are self-employed
6. Good bookkeeping practices make MTD compliance almost effortless