Making Tax Digital

MTD for VAT was first introduced in April 2019 for businesses with taxable turnover above the VAT registration threshold. It was extended to all VAT-registered businesses — including those registered voluntarily with turnover below the threshold — from 1 November 2022. Since that date, every VAT-registered business must:

• Keep digital records of VAT-relevant transactions using MTD-compatible software
• Submit VAT returns to HMRC using that software's digital link to the HMRC API — you can no longer manually enter figures into HMRC's online portal

MTD-compatible software ranges from full accounting packages (Xero, QuickBooks, Sage, FreeAgent) to bridging software that links your existing spreadsheets to the HMRC API. If you currently use spreadsheets to calculate your VAT return and then enter the figures manually, you need either to migrate to accounting software or add bridging software between your spreadsheet and HMRC's system.

HMRC publishes a list of software products that are compatible with MTD for VAT. When choosing software, check whether it covers all the VAT schemes you use (Cash Accounting, Annual Accounting, Flat Rate, etc.) and whether it integrates with your existing bookkeeping tools. Many businesses have found that moving to full accounting software as part of MTD compliance has also improved their financial management generally.

MTD for Income Tax Self Assessment (MTD for ITSA) will fundamentally change how self-employed people and landlords report their income to HMRC. Instead of a single annual self-assessment return, you will be required to make quarterly updates to HMRC summarising your income and expenditure for each quarter, followed by a final declaration at the year end.

The phased rollout is:

• April 2026: Mandated for self-employed individuals and landlords with qualifying income (gross income from self-employment and/or property) above £50,000
• April 2027: Extended to those with qualifying income above £30,000
• Those with income below £30,000 will not be mandated in the immediate term, though HMRC has indicated further rollout is planned

Qualifying income means gross income — not profit. If you have gross rental income of £55,000 but expenses bring your profit down to £10,000, you are still in scope from April 2026. Partnerships will be mandated at a later date to be confirmed. The self-assessment return for other income (employment, investments, etc.) will ultimately be replaced by the final declaration under MTD for ITSA.

To comply with MTD for ITSA you will need HMRC-recognised software that can:

• Record income and expenses digitally from the point of transaction (or import them digitally from another source)
• Produce the quarterly update summaries in the correct format
• Submit those summaries to HMRC via the API
• Produce and submit the end-of-period statement and final declaration

HMRC publishes a list of software compatible with MTD for ITSA, which is growing as the April 2026 mandation date approaches. Major accounting software providers (QuickBooks, Xero, Sage, FreeAgent, IRIS) all have or are developing MTD for ITSA-compliant products. Bridging software solutions are also expected for those who want to continue using spreadsheets for their primary records while meeting the digital submission requirements.

The digital records requirement means that paper receipts must be digitised — you cannot simply keep a paper records system and manually summarise it into the software. Photographs of receipts using your phone or a scanning app, automatically imported into your accounting software, are typically sufficient to meet the digital records requirement.

HMRC uses a points-based penalty system for late submissions under MTD. Each missed submission deadline earns you a penalty point. When your points total reaches a threshold (which varies depending on how often you are required to submit), you receive a £200 financial penalty. After that, each further late submission while you are above the threshold generates an additional £200 penalty. Points expire after two years of full compliance.

For MTD for ITSA, with four quarterly updates plus one final declaration per year, the threshold for a financial penalty is five points. Missing all five submissions in a year would therefore trigger one £200 penalty immediately. Points are reset once you have submitted all required returns for a 12-month period with no missed deadlines.

Separate late payment penalties apply if you do not pay the tax you owe on time. These are a percentage of the outstanding tax based on how long it has been overdue: 2% of unpaid tax after 15 days, a further 2% after 30 days, and 4% per annum thereafter until paid. Interest also accrues on unpaid tax at the late payment interest rate, which is linked to the Bank of England base rate.

HMRC has indicated that there will be a soft landing period for the early phases of MTD for ITSA, during which penalties may not be strictly applied while businesses adapt — similar to the approach taken for MTD for VAT. However, the details of any soft landing are not yet confirmed, and businesses should aim to be compliant from day one rather than relying on HMRC's discretion.