The UK government’s Making Tax Digital (MTD) scheme is revolutionizing tax administration, and will expand to include income tax. (Making Tax Digital for VAT has been in place since April 2019.) For small business owners and sole traders, understanding the MTD scheme for income tax is vital to ensure compliance and streamline tax processes. In this blog post, we will provide a comprehensive guide covering everything small business owners and sole traders need to know about the UK government’s Making Tax Digital scheme for income tax (MTD ITSA).

Understanding Making Tax Digital

Making Tax Digital is an initiative by HM Revenue and Customs (HMRC) aimed at digitizing tax administration, making it more efficient, accurate, and easier for businesses to manage their tax obligations. The scheme replaces manual record-keeping and paper-based tax returns with digital records and online submissions. MTD for income tax and MTD for corporation tax are both supposed to be introduced in the next few years, although it is doubted that all deadlines will be fulfilled.

Benefits of Making Tax Digital for Small Business Owners and Sole Traders

1. Enhanced Accuracy: Digital records reduce the risk of human error, ensuring accurate tax calculations and submissions.
2. Time and Cost Savings: Automation of tax processes saves valuable time and reduces the costs associated with manual record-keeping and tax return preparation.
3. Real-time Visibility: Digital records provide businesses with up-to-date financial information, enabling better decision-making and financial planning.
4. Improved Compliance: MTD reduces the likelihood of errors and omissions, minimizing the risk of penalties and investigations.

MTD for Income Tax: Key Points

1. Scope and Timeline: MTD for income tax will be mandatory for most self-employed individuals and landlords with annual business or property income above £10,000 from April 2026. However, voluntary participation is allowed for those below the threshold. The implementation date for Making Tax Digital ITSA has been pushed back several times, originally slated for 2023.
2. Digital Record-Keeping: Small business owners and sole traders must maintain digital records of their income, expenses, and other relevant financial information. This includes invoices, receipts, bank statements, and records of business-related transactions.
3. Compatible Software: Businesses need to use compatible accounting software to keep their digital records. The software must be capable of submitting tax returns directly to HMRC’s systems.
4. Quarterly Reporting: Under MTD for income tax, businesses will be required to submit quarterly updates to HMRC. These updates will include summary information about income, expenses, and profits. However, the actual payment of income tax will still be made annually.

5. Digital Links: There should be digital links between different software systems used for record-keeping, ensuring seamless data transfer and accuracy. This means that data should flow digitally from one software to another without manual intervention.
6. Exemptions and Exclusions: Some small business owners and sole traders may be exempt from MTD for income tax if they meet certain criteria. For example, those with religious objections, insolvency cases, or those with limited internet access may be eligible for exemptions.
7. Penalties for Non-Compliance: Failure to comply with MTD for income tax can result in penalties and fines imposed by HMRC. Small business owners and sole traders must understand the requirements and deadlines to avoid any potential penalties.

Preparing for Making Tax Digital

To ensure a smooth transition to MTD for income tax, small business owners and sole traders can take the following steps:

1. Evaluate Current Record-Keeping Practices: Assess the current record-keeping processes and identify any gaps or areas that need improvement to meet the digital requirements of MTD.
2. Choose Compatible Accounting Software: Research and select accounting software that is compatible with HMRC’s systems and meets the MTD requirements. Consult with software providers or an accountant if needed.
3. Implement Digital Record-Keeping: Transition from manual record-keeping to digital record-keeping using the chosen accounting software. Ensure that all income, expenses, and relevant financial information are accurately recorded and stored digitally.
4. Establish Digital Links: If using multiple software systems, set up digital links to enable seamless data transfer between them. This will ensure accurate and efficient reporting.
5. Familiarize Yourself with Reporting Obligations: Understand the reporting requirements under MTD for income tax, including the deadlines for quarterly updates and annual tax returns. Stay informed about any changes or updates from HMRC.

As the UK government expands the Making Tax Digital scheme to include income tax, small business owners and sole traders must familiarize themselves with the key points to ensure compliance. By embracing digital record-keeping, choosing compatible software, establishing digital links, and understanding the reporting obligations, small business owners and sole traders can streamline their tax processes, enhance accuracy, and benefit from the time and cost savings that MTD offers.

Neil Smith Accountancy has been serving clients in Essex and London for over fifteen years. If you want to ensure your small business is MTD compliant, or have any other questions, get in touch online or call 01376 512 637.