Making Tax Digital for Income Tax
The biggest change for businesses, which has yet to coming into effect, is reporting under Making Tax Digital (MTD).
Around 4 million self employed traders and landlords, who pay income tax and are not VAT registered, will need to start making submitting 4-quarterly submissions and a fifth year-end update for each trade and property business they have. This all starts from 6 April 2023.
What is MTD for income tax?
MTD is the name given to the Government’s plan to move to a fully digital tax system. With some limited exceptions, businesses will be required to keep their records digitally and to make quarterly reports, of their business income, expenses and profits, to HMRC through their digital tax account. It is hoped MTD will help record keeping and tax accounting move into the 21st century.
The aim of MTD is to put an end to the self-assessment tax return and to move tax into the digital age with businesses reporting their taxable profits in a more or less real-time environment.
MTD was announced in March 2015 by the former Chancellor, George Osborne. The headline announcement was that the completion of an annual Tax Return would be abolished.
For many businesses, MTD will represent significant extra administration work together with the cost of buying and learning how to use an appropriate software package and possibly extra accountancy fees.
Initially, this is expected to be a digital submission of three summary totals, of income, expenses and profit or loss. In time, this may lead to submission of every single accounting transaction of the business in the quarter to HMRC.
Employers have for several years been submitting payroll data for their employees every payday under the Real Time Information (RTI).
Bank and building societies etc are also submitting details to HMRC of interest paid to tax payers on a regular basis.
All this information will be consolidated in a taxpayer’s Business or Personal Tax Account. Therefore, rather than having to find details of a taxpayer’s annual taxable income after the end of the tax or accounting year and then preparing a Self-Assessment Tax Return, most of this information regarding taxable income will already have been prepopulated into their tax account during the tax year.
Rather than completing the annual tax return once a year more submissions will be required and on a regular basis.
Four quarterly submissions
A set of four quarterly submissions will be required for each business undertaken by the taxpayer. Therefore, a self-employed person who also has rental income will have to submit a set of quarterly submissions for their self-employed business, and another set of quarterly submissions for their rental business.
Draft regulations indicate that non-corporate landlords will have to make separate quarterly submissions for each category of property business e.g. long term letting, furnished holiday lettings and overseas rentals.
End of period statement (OSPS)
To help businesses with filing quarterly submissions, HMRC has said it will not expect quarterly submissions to be 100% accurate. Any inaccuracies contained within the four quarterly submissions will be adjusted through a fifth post-year-end submission. The fifth submission will be called the ‘end of period statement’. A separate end of period statement will be required for each business undertaken by the taxpayer.
The end of period statement must be filed within ten months of the business' accounting year-end, or by the 31 January following the tax year end, whichever is sooner.
The end of period statement submission is expected to contain year-end accounting adjustments, such as stock changes, prepayments, accruals, and any corrections made to the in-year four quarterly submissions which are determined whilst preparing the year-end accounts.
This is the new name for the annual tax return. The final declaration is needed to report any income which has not been reported to HMRC through an end of period statement, such as investment income and employment income, and to make any necessary claims. The deadline for submitting the final declaration is as before, and will be 31 January after the end of the tax year.
HMRC has stated that taxpayers will therefore need to check and confirm that the information already uploaded to their Tax Accounts, (e.g. business and rental profits, investment income, employment income etc) is correct rather than having to complete a Tax Return from scratch.
HMRC originally required all taxpayers to capture and store all purchase and expense invoices digitally, but they later retracted that requirement.
The laughable thing is that HMRC think that this will only cost businesses around £200 a year. Most accountants find HMRC’s comments completely unbelievable and it demonstrates their total lack of understanding in how small businesses currently keep their accounting records. Just the initial four quarter-end submissions are going to take time to review and make changes to before making the submissions. If you do that five times a year rather than the current once a year then that is a lot more work.
Businesses will also need to buy new software, train their staff and for most small businesses completely change their recordkeeping e.g. from manual paper records or spreadsheets to full blown accounting software.
What this means
The introduction of MTD is one of the biggest changes in tax administration for 20 years, following the introduction of Self-Assessment. The underlying tax rules are not changing.
MTD has been a major talking point for accountants and tax advisors for many years. HMRC have stated that business will need to do their recordkeeping in software that is capable of performing quarterly submission. The rational is that this will reduce tax-leakage and generate more tax collection by HMRC.
Many small businesses use Excel spreadsheets to manage their businesses and report their income and expenditure. Initially, HMRC said that they would not accept spreadsheets as a digital method of recordkeeping and reporting under MTD. They relaxed this requirement following revolt by small businesses and their advisors. HMRC now accept spreadsheets, but only in conjunction with digital 'bridging' software capable of reading key data from spreadsheets and making the required MTD submissions.
What is very clear is that the Government Gateway where individuals and businesses submit their Self-Assessment Tax Returns, PAYE returns, VAT returns etc and where they can check on their tax affairs will cease to be available in the near future.
Digital submissions are going to be compulsory in the future. This will necessitate the use of commercially available software. HMRC have already stated that free software will not be provided by them.
Example of the potential large number submissions
Bob is a self-employed builder. He prepares his annual accounts to 31 May each year. He is VAT registered. He also has two buy-to-let properties and a holiday cottage (i.e. furnished holiday lettings).
Currently, he prepares his annual accounts, a tax return and quarterly VAT returns. He therefore makes 5 submissions to HMRC i.e. a Tax Return and four VAT returns.
With Income Tax MTD, Bob will have to make the following submissions:
4 x quarterly submissions for building trade
4 x quarterly submissions for property buy-to-let
4 x quarterly submissions for property FHL
4 x quarterly submissions for VAT returns (as now)
1 x EOPS for building trade
1 x EOPS for buy-to-let property business
1 x EOPS for furnished holiday lettings business
1 x year end finalisation (like a summary and check 'Tax Return')
That is 20 submissions in total; compared to the current 4 VAT return and 1 tax return.
Those used to submitting payroll, and possibly VAT returns, through software, may already be familiar with a similar process. At the end of the quarter, a business will click the ‘MTD’ submission button and everything will magically be uploaded to HMRC. Well, that is the theory!
Our biggest concern is that businesses and taxpayer just press the ‘MTD’ button without thinking. The experience of many smaller business accountants is that clients often enter transactions to the wrong code, account or wrong column of a spreadsheet. Business owners mix repair expenditure with capital (fixed assets) costs. They also treat personal drawings 'wages'. Smaller businesses also often mix private and business transactions and use their business bank account like a personal piggy bank.
Even clients with their own limited companies, where a higher level of business knowledge usually exists, often misunderstand wages salaries, dividends, expenses and loans to and from the company. The old adage ‘garbage in equals garbage out’ comes to mind. The MTD system is also, in time, to lead to payment of tax based on the quarterly profit submission.
Major software companies e.g. Sage, Xero and QuickBooks have released MTD compliant versions of their software.
Our advice is therefore to now start using one of the leading software providers if you are used to using accounting software. Alternatively, use spreadsheets and 'bridging software.'
The new MTD timetable
Individuals with rental properties will have to use the tax year, of 5 April, as the accounting basis period. However, self-employed traders can use any accounting period.
The quarterly submissions will be due exactly one month from the end of the quarter. This differs to one month and seven days after the end of the quarter for VAT return submissions.
Whilst this article is primarily relating to unincorporated businesses and individuals, let us first look at the general time table for all types of entities. The timetable for starting quarterly reporting under MTD will be determined by the accounting period that starts on or after these dates:
From 1 April 2022: All VAT registered businesses will be required to maintain digital records and submit their VAT returns through software.
From 6 April 2023: Unincorporated businesses (#) with turnover exceeding £10,000 will be required to maintain digital records and report their business income, expenses and profits through software.
From (still tba): All incorporated businesses (i.e. limited companies) which pay Corporation Tax must maintain digital records and report their business income and expenses subject to Corporation Tax through software.
# = The reference to unincorporated businesses includes sole traders, partnerships, property businesses and buy-to-let landlords. Therefore, these people will move to the quarterly reporting regime unless business turnover or gross rental income from each source is less than £10,000.
A business with turnover below the VAT threshold and an accounting date of 31 March will not have to make quarterly digital submissions until the accounting period beginning 1 April 2024.
Unincorporated businesses and rental income start dates
The mandatory MTD for Income Tax start date will be as follows:
Existing property rental: 6 April 2023
New property rental: 6 April following the date when income starts
Existing trading income: first accounting period starting on or after 6 April 2023
New trading income. from the start of accounting period in year three
Individuals who have a combined gross income from all trades and letting businesses in excess of £10,000 per year are within scope of MTD ITSA. These people may not be liable to pay any income tax as the entry test is based on gross income not net, and the personal allowance will cover small profits up to at least £12,570.
Jane starts a new business, as a self-employed consultant, on 1 June 2023 and will prepare her annual accounts to 31 May each year.
She also acquires a buy-to-let property in February 2023. She renovates the property and then first starts to rental the property on 1 July 2023.
Jane will come within the MTD for Income Tax regime from the following dates:
Self-employed trade: from 1 June 2025 (i.e. start of her third year)
Property business: from 6 April 2024 (i.e. 6 April after rental income starts)
You would therefore be advised to use the time to start planning and consider moving to a leading software provider now and possibly using an online recordkeeping provider. The latter should make the review process and any assistance required easier if it can be accessed online.
Of course, HMRC will want to introduce late submission penalties and interest on late payments of quarterly tax.
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