The rules on how to keep VAT records and submit VAT returns changed on 1 April 2019.
It's all about Making Tax Digital - the government's plan to transform the way taxpayers communicate with HMRC.
There's lots of coverage about Making Tax Digital (MTD) and Making Tax Digital for VAT but many business owners are still in the dark about what they have to do to comply with HMRC's new system.
Here's what you need to know to make sure you are compliant.
What is Making Tax Digital?
With Making Tax Digital, the government's long-term goal is for all taxpayers, including businesses, sole traders and landlords, to file their tax information using digital apps on a quarterly basis.
It's a big change. But Making Tax Digital is being introduced gradually - and it started this April with VAT returns.
What is Making Tax Digital for VAT?
Since 1 April 2019, all VAT-registered businesses with a taxable turnover above the VAT registration threshold (currently £85,000), have been required to submit their VAT returns using an approved app. This system is called Making Tax Digital for VAT.
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MTD for VAT will affect more than one million businesses in the UK. The vast majority of these businesses will have to change the way they keep their VAT records and submit their VAT returns.
According to the Institute of Chartered Accountants in England and Wales (ICAEW), 54% of VAT-registered businesses currently use accounting software while 13% still rely on paper-based records. However, even if you currently use accounting software, you will need to check if it is MTD-compatible.
If you run a VAT-registered business with turnover above the threshold, then you will be required to keep digital VAT business records and send returns using MTD-compatible software. This software is likely to be a cloud-based app that you can use from your smartphone.
It means that once you have input all your information, the app will be able to communicate with HMRC at the touch of a button.
VAT-registered businesses already have to report VAT quarterly, so the frequency of the reporting is not changing and the information you have to input will be the same. The big change is the fact that it is now compulsory (with very limited exceptions) to use approved software.
If your taxable turnover drops below the VAT registration threshold at any point after 1 April 2019 you will still have to keep digital records and submit your VAT returns using MTD-compatible software. However, this does not apply if you de-register from VAT or if you are exempt from MTD for VAT.
HMRC has written to VAT-registered businesses to tell them about the changes. Businesses submitting their VAT returns must now keep digital records, sign up for Making Tax Digital for VAT and use compatible software or suitable "spreadsheet bridging software".
HMRC has published a VAT Notice (VAT Notice 700/22) which explains the rules for Making Tax Digital for VAT.
When did the new HMRC rules for VAT start?
VAT-registered businesses had to start using HMRC-approved software to keep VAT records and submit VAT returns for VAT periods starting on or after 1 April 2019.
Does Making Tax Digital for VAT apply to me?
The introduction of Making Tax Digital for VAT applies to all VAT-registered businesses with a taxable turnover above the VAT threshold (currently £85,000).
If this is you, you must use an approved app to keep VAT records digitally and to submit your VAT return.
A small number of VAT-registered businesses with what HMRC calls "complex requirements" will not have to comply until 1 October 2019. These include:
- Not-for-profit organisations that are not set up as a company;
- VAT divisions and VAT groups;
- Traders based overseas;
- Those required to make payments on account;
- Annual accounting scheme users.
How do I choose the right accounting software for Making Tax Digital?
There is a wide range of accounting software solutions that are compatible with Making Tax Digital. These are all commercial products; most of them work on a subscription basis.
The first step is to make sure that your preferred software is what HMRC calls "functional compatible software". In other words, can it connect to HMRC via an Application Programming Interface (API)?
If you already use software to keep your business records, check with your software provider to find out if it is MTD-compatible.
There is a list of all MTD-compatible software on the government website.
What should I look for in an accounting app?
There are some key functions and services that you may need to look for when choosing software for Making Tax Digital. These are some of the questions you should ask about accounting software:
- Is it MTD-compatible?
- Does it have VAT capabilities?
- Does it automatically calculate the tax I owe?
- Can it pull transaction data straight from my bank?
- Can it also get information from my POS system?
- Does it update my transactions every day?
- Does it support payroll?
- Can it handle different currencies?
- Is training and support offered?
Can I carry on using spreadsheets for my VAT accounts?
The government has said that spreadsheets can be a part of digital record-keeping under Making Tax Digital.
For now, cut and paste will be an acceptable way to transfer information into an app from a spreadsheet. Alternatively, you could use "spreadsheet bridging software" to automatically extract the data from the spreadsheet and digitally either send it directly to HMRC or to MTD-compatible software. From 31 March 2020, only digitally integrated spreadsheets will be permitted.
How do I prepare my VAT accounts now?
Once you have selected your chosen MTD software, you need to start inputting all your usual VAT records into the app. Key VAT information includes:
- The value of all the sales you have made, excluding VAT;
- Details of all your purchases (excluding VAT);
- The specific rate of VAT charged on individual sales and purchases;
- The date of all transactions;
- Any trade with EU countries;
- The name of your business and its principle address;
- Your VAT registration number;
- Details of any VAT accounting schemes you use.
How much will it cost to comply with Making Tax Digital?
Most MTD-compatible software solutions operate on a subscription basis. Costs vary but most packages cost between £10 and £30 a month, depending on functionality. For more basic spreadsheet bridging software there are a few cheap options from £15 for a year, or even possibly free software.
There maybe some additional set-up costs for your business. You may want to invest in a new laptop or a better smartphone for example. You will also need to consider the time it takes you to input information into the new system.
Does Making Tax Digital affect how I use my accountant?
If your accountant normally files your VAT return for you, then they may continue to offer that service and bear the cost of the necessary software.
In this instance, your accountant is an "agent" who is acting on your behalf. Under Making Tax Digital, accountants can continue to make VAT submissions on behalf of their clients; they will be able to file other types of MTD return in the future as well. You just have to authorise them to act on your behalf.
It is also possible to input all your VAT information into an approved app yourself but then ask your accountant to check it before they submit it to HMRC.
If, like a lot of small businesses, you file your own VAT returns, then an accountant will be able to guide you when choosing the right software.
How will Making Tax Digital affect my business in the long term?
If you're not VAT-registered, you're probably breathing a sigh of relief right now. But in time, Making Tax Digital will apply to other taxes including corporation tax and income tax eventually. So you'll need to start using an accounting app eventually anyway.
In the Spring 2019 Statement, the government says Making Tax Digital will not now be extended to smaller companies or mandated for taxes other than VAT during 2020. At some point beyond 2020, all tax return information will have to be submitted via an app on a quarterly basis - a radical change from the annual self-assessment process.
Some businesses, sole traders and landlords are already participating in Making Tax Digital for income tax as part of a live pilot study. If you are self-employed, run your own business or are a landlord you can voluntarily use software to keep your business records digitally and send income tax updates to HMRC using an app rather than filing a self-assessment tax return.
What's good about Making Tax Digital?
There's no doubt that HMRC is hoping that Making Tax Digital will be good for the government coffers. Small business owners and sole traders, however, may be wondering what's in it for them. Indeed, many are worried about increased administration costs and a steep learning curve. However, in the long term, Making Tax Digital should have advantages for small firms and the self-employed:
- Keeping accurate records will be easier;
- Apps offer time-saving ways to create invoices, manage payroll and keep on top of expenses;
- Business owners will have a clearer idea of how their business is performing in real-time;
- The information generated will help businesses spot threats and opportunities more quickly;
- It will be easier to keep on top of cashflow;
- There won't be a last-minute scramble to file yearly tax returns.