Making Tax Digital (MTD) Explained: A Guide to VAT and Income Tax

Managing taxes has always been an important, though often stressful, part of running a business. The introduction of Making Tax Digital (MTD) represents a significant shift in how income and expenses must be reported, aiming to simplify tax processes while ensuring accuracy.

Though the transition might appear challenging, it can ultimately simplify and improve how you manage taxes. This article will explain what MTD is, who it affects, when it applies, and how to prepare, helping you to transition smoothly.

What is Making Tax Digital (MTD)?

Making Tax Digital (MTD) is a plan by the UK government designed to modernise the tax system by requiring businesses and self-employed individuals to maintain digital records and submit tax information electronically.

Why is MTD Being Introduced?

MTD is designed to simplify tax management, providing businesses, landlords and sole traders with improved control over finances while minimising the risks of miscalculations and late submissions.

Benefits of Making Tax Digital

While MTD may seem like an inconvenience at first, it actually offers several advantages:

• Less stress at tax time – with quarterly updates, there’s no last-minute rush to gather receipts.

• More accurate tax calculations – automated software reduces errors and helps with paying the correct amount.

• Better financial insights – MTD-compatible tools provide real-time data, helping you make informed decisions.

Making Tax Digital Key Information

MTD for VAT (MTD VAT)

Since April 2022, all VAT-registered businesses must:

• Keep digital records of your income and expenses

• Use MTD-compatible software to submit VAT returns

MTD for Income Tax Self Assessment (MTD ITSA)

This stage focuses on self-employed individuals and landlords.

Key requirements under MTD for Income Tax:

• Keep digital records of all your earnings and business expenses

• Submit quarterly updates to HMRC using MTD-compatible software

• Complete a Final Declaration at the end of the year (replacing the Self Assessment tax return)

Key dates

• From 6 April 2024 you can volunteer to participate in the MTD ITSA program.

• From 6 April 2026, those earning above £50,000 annually from self employment or lettings must implement MTD tax reporting. This threshold applies to income gained from 6 April 2024 – 5 April 2025.

• From 6 April 2027, individuals or landlords with gross annual income of £30,000 will have to join MTD too. This applies to income gained from 6 April 2025 to 5 April 2026.

Notable exemptions

• Sole traders and landlords with combined income below £30,000 are exempt from MTD IT requirements for now. Sign up for our newsletter to get the latest updates, accounting tips, offers and much more.

• Partnerships are not included within current timetable although MTD ITSA is expected to be brought in at some point.

• Those unable to use digital tools due to age, disability, or remote location.

• Trustees, foreign businesses, foster carers.

It is important to note that those seeking exemption must apply to HMRC, providing reasons for their eligibility. For the full list of exemptions, please visit HMRC’s official page on MTD eligibility.

Important points

• The thresholds are based on gross income, which is the total income from self-employment and property rental (if applicable) before the business expenses are deducted.

• Total annual income (turnover) includes combined income from property rental and variety of self employment streams like sole trading, freelancing or any side hustle you may have.

• All other sources of income reported through Self Assessment, such as income from employment (PAYE), a partnership or dividends (including those from your own company), do not count towards your qualifying income.

• While combined gross income determines whether you meet the threshold, each income source must be reported separately.

• MTD ITSA doesn’t change the deadlines for paying income tax which is 31 January following the end of the tax year. For example, if tax year ends 5 April 2025, the payment must be made by 31 January 2026.

• The quarterly periods are set and may not align with VAT periods.

Quarterly timelines and filing deadlines

The quarterly update must be submitted by the 7th of the month following the end of the relevant quarter:

Calendar year quarter end reporting

You can choose to align the submissions periods with the end of the month if that is more convenient. Note that the due dates for the filings do not change. If you do, the periods will be:

What happens at the year end?

At the end of the year taxpayers are expected to make a Final Declaration, which will be very similar to a Self-assessment Tax Return and will also include other relevant information for that taxpayer, for example details of their investment income. Although there may be multiple sets of quarterly updates, if there is more than one business, or source of profit, only one Declaration will be required per taxpayer, rather than per business or profit source. This will consolidate all of the information shown in the quarterly filings.

The submission of the Final Declaration is expected to be in line with the 31st January deadline for Self Assessment Tax Returns.

How to Prepare for Making Tax Digital

1. Check if MTD applies to you

Determine if you meet the income threshold and when you need to transition. If you earn above the limit for VAT or Income Tax, you should start preparing now.

2. Choose MTD-compatible software

To comply with MTD, you must keep digital records and submit tax returns via HMRC-approved software. Options range from simple accounting apps to full-featured platforms like Xero, QuickBooks, and FreeAgent.

Top tip. Choose software that integrates with your existing invoicing or bookkeeping tools to make the transition easier.

3. Digitise your financial records

If you currently track income and expenses using paper receipts or spreadsheets, now is the time to move everything online. Many apps automatically record expenses by synchronising with your bank account, reducing manual work.

4. Get used to quarterly tax reporting

Under MTD for Income Tax, you’ll submit four tax updates per year instead of a single annual return. While this may seem like extra work, it actually spreads the process out, making it easier to manage.

Top tip. Set reminders or automate reports within your accounting software so you never miss a deadline.

5. Seek professional help if needed

If tax matters aren’t your strong suit or you are not comfortable with technology, consider speaking to an accountant familiar with MTD. They can guide you through the transition and ensure you stay compliant.

Don’t have an accountant? Get in touch today.

Frequently Asked Questions About MTD

What software do I require for MTD for ITSA?

You have two choices:

1. Use MTD for ITSA-approved software that allows you to record and submit tax information to HMRC in line with MTD requirements.

2. Opt for bridging software, which connects non-MTD-compatible accounting tools (such as spreadsheets) to HMRC, ensuring your financial data is submitted correctly each quarter and at year-end.

MTD sounds complicated. Do I really need to switch?
Yes if your earnings meet the threshold. However, most businesses find that using accounting software saves time in the long run.

What if I make a mistake on my quarterly return?
The quarterly updates do not need to be perfect - they’re simply a snapshot of your income and expenses. You can make corrections before your Final Declaration at the end of the tax year through software.

What if I miss a deadline?
HMRC has late submission penalties for businesses that fail to comply with MTD. Instead of immediate fines, a new points-based system is being introduced. You will get a point each time you miss a deadline, and after four points, a £200 fine will be applied.