Making Tax Digital for Income Tax: What You Need to Know Now

Introduction 

Making Tax Digital (MTD) for Income Tax represents a significant shift in the way taxpayers record and submit their tax information to HM Revenue & Customs (HMRC). This initiative is part of a broader digital transformation to make tax administration more effective, efficient, and easier for taxpayers through a fully digital tax system.

Taxpayers and professionals need to grasp the scope of MTD for Income Tax, as it affects self-employed individuals and landlords initially. You will find that understanding MTD is crucial not just for compliance but also for leveraging its potential benefits such as real-time tax calculations and reduced errors through automated processes. This overview will shed light on the purpose of MTD, its benefits, and why a thorough understanding is essential for smooth adaptation to these changes.

Understanding MTD for Income Tax Self-Assessment (ITSA) 

Making Tax Digital for Income Tax Self-Assessment (MTD for ITSA) is an initiative by HM Revenue and Customs (HMRC) aiming to modernize the tax system. This transformation requires taxpayers to maintain digital records and use software to submit their tax returns. 

Phased changes 

The implementation of MTD for ITSA will occur through a phased mandate approach. This strategic rollout allows for a smoother transition into the new system. The timeline is as follows: 

• From April 2026: Self-employed individuals and landlords with annual business or property income above £50,000 will be required to follow MTD for ITSA. 

• From April 2027: The threshold lowers, mandating those with income between £30,000 and £50,000.

Income Thresholds and Criteria 

Specific income thresholds determine registration into MTD for ITSA. Here is what you need to know about the criteria: 

• Eligibility: If your income from self-employment or property exceeds the designated thresholds within a tax year, you are required to comply with MTD for ITSA rules. 
• Multiple Incomes: Should you have several sources of income that cumulatively cross the threshold, you are also brought into the scope of MTD. 
• Income Calculation: The total income is calculated before any allowances or expenses. It includes the sum of all income from self-employment and property.

MTD for ITSA revolutionizes how taxpayers report income and expenses to HM Revenue & Customs (HMRC). Quarterly updates are now a cornerstone of this new reporting framework, requiring taxpayers to submit income and expense information every three months. This approach aligns closely with the rhythm of business operations, aiming to provide a more real-time view of one’s tax situation.

Here is what you need to know about the reporting process: 

Digital Record-Keeping 

Taxpayers must maintain digital records of their business transactions. This ensures that the quarterly submissions are based on accurate, up-to-date information. 

Quarterly Submissions 

Each quarter, you are expected to submit a summary of your business income and expenses through compatible software. The idea is to reflect the performance of your business periodically rather than just once at year-end. 

Cumulative Calculation Periods 

Rather than treating each quarter in isolation, MTD for ITSA uses cumulative calculation periods. This means that each quarterly update builds upon the last, culminating in a comprehensive year-end report. 

If you manage multiple businesses or property ventures, you will need to give special consideration to how you organize your records and reports: 

• Separate Updates for Each Business: You must send separate quarterly updates for each trade or property business you have. This separation ensures clarity in reporting and reflects the distinct performance of each venture. 
• Cumulative Data: Despite separate updates, your annual tax responsibility considers the cumulative results across all businesses. 

By maintaining clear digital records and understanding these obligations, you can ensure compliance with MTD for ITSA requirements without unnecessary stress at year-end.

Maintaining Records and Software Compatibility 

Embracing MTD for ITSA requires adopting certain technological tools. One important tool is API-enabled software, which helps with tax record-keeping and return submission. HMRC requires the use of approved software that has API capabilities. These specialized tools ensure data security, accuracy, and smooth communication with HMRC servers. 

Using Spreadsheets with MTD 

If you are used to using spreadsheets for record-keeping, there is good news. You can still incorporate spreadsheets into your digital workflow under MTD for ITSA. This flexibility allows you to use familiar tools while following the new regulations. 

However, there are some guidelines for using spreadsheets: 

• Data must be digitally transmitted from the spreadsheet or original source to HMRC 
• Summary information should not be retyped into another package 

Bridging Software for Spreadsheets 

To meet these requirements, you can use bridging software. This type of solution acts as a digital ‘bridge’, transferring data from your spreadsheet to HMRC in a compliant way. It effectively connects your existing workflow with the needs of MTD for ITSA. 

Choosing the Right Software 

It is important to choose software that aligns with HMRC’s rules for digital record keeping and return submissions. You can refer to a list of MTD compatible software to help you find the best tool for your needs. 

The shift towards digital tax management may seem challenging at first, but remember that these changes are designed to make processes smoother and more efficient. 

Exemptions, Deferrals, and Penalties in MTD for ITSA 

Not all entities will need to navigate the waters of MTD for ITSA; certain groups are exempt from these requirements. 

Exemptions 

• Non-resident companies, those not based in the UK (United Kingdom), fall outside the scope of MTD for ITSA. 
• Trustees, executors, and administrators managing estates also find themselves exempt, easing the administrative burden during what can be a complex fiduciary process. 

Deferrals 

General partnerships have been granted additional time to prepare for MTD for ITSA. MTD for ITSA for these business structures has been deferred, with a new commencement date yet to be announced. This gives general partnerships valuable breathing space to ensure they are fully compliant once their start date arrives. 

Penalties 

A new penalty regime has been established to ensure compliance with MTD obligations: 

• The system is points-based, where non-compliance instances accumulate points leading to financial penalties. 
• For each submission deadline missed, a point is accrued. 
• Once a certain threshold is reached, a penalty is charged. 
• This regime encourages timely submissions without immediately penalizing those who may miss a single deadline. 

By being aware of these exemptions and deferrals and understanding the penalty framework, you can better navigate the nuances of MTD for ITSA compliance. 

Benefits and Potential Impacts of Embracing MTD for ITSA 

The shift to MTD for ITSA has significant advantages, not just for HMRC but also for taxpayers. These benefits are realized through the adoption of MTD processes, which are designed to make tax filing simpler, more convenient, and less prone to errors. 

Benefits for Taxpayers 

MTD’s digital approach promotes real-time record-keeping, facilitating a continual view of your tax situation. In essence, this means you can: 

1. Avoid the stress of annual tax deadlines 

2. Easily monitor income and expenses 

3. Make informed financial decisions 

Embracing this technology-driven initiative can also lead to increased efficiency in managing your tax affairs. With automated data entry and calculations, MTD software minimizes the risk of making mistakes. Accuracy is paramount in tax management – one minor error could lead to significant issues down the line. 

Benefits for HMRC 

HMRC also stands to gain from this shift. A streamlined system means fewer resources spent on rectifying errors and chasing up late payments, allowing them to focus on more pressing matters. 

Conclusion 

MTD for income tax requires taxpayers to keep their accounting data electronically. Those who earn income over £50,000 will need to comply with MTD from April 2026 while those earning between £30,000 to £50,000 will need to comply from April 2027. Under the MTD, taxpayers will be required to make quarterly filings of their income and expenses in addition to one final declaration to be filed after the end of the tax year to settle the tax affairs for that year. 

If you are worried about complying with MTD for income tax, do not hesitate to contact Pearl Accountants in London who will take care of your compliance worries. Give us a call today to find out how we can help.