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31 Mar 2019

HMRC's new digital VAT system starts tomorrow - and 1m businesses still haven't signed up

Find out if you need to register for Making Tax Digital

Only 4% of UK businesses have registered for Making Tax Digital, the government's new initiative to digitalise the tax return process, leaving more than 1m yet to sign up as the deadline to do so approaches.

Fintech firm Float made a Freedom of Information request to HMRC, and also discovered that even if businesses continue to register at the current rate of 3,000 a day, only 402,000 more will have signed up by August - when most digital quarterly VAT returns will be due for submission.

But HMRC claims that even back in December 2018 more than 80% of businesses required to join Making Tax Digital were aware of the changes and had already started to make preparations for them.

To follow the Making Tax Digital rules for VAT, you must keep digital VAT records, sign up for Making Tax Digital for VAT, and submit VAT returns using compatible software.

Here, we explain who needs to register and what the changes will entail.

What is Making Tax Digital?

Making Tax Digital is a government initiative which aims to make it easier for businesses and individuals to submit their tax figures, and reduce the number of reporting errors.

Mistakes and lack of care taken when people submit their tax returns can mean people pay too much or too little tax.

In fact, such mistakes reportedly accounted for a £33bn 'tax gap' in 2016-17 - that's the difference between what the Exchequer expected to be paid and what was actually received.

Under the new digital system, you'll use software to send your income and expenses summary to HMRC every three months. Then, at the end of each accounting year, you can send a final report and add in any allowances and reliefs.

Plus, as VAT and income tax returns will be stored online, people will be able to check their spending and get tax estimates throughout the tax year - meaning the days of getting a nasty surprise when your tax bill arrives should be over.

While there have been calls to delay the roll-out of Making Tax Digital to allow businesses more time to prepare for the changes, the government has stuck to its 1 April deadline.

Find out more:tax-deductible expenses

Who will be affected by Making Tax Digital?

HMRC has written to all businesses it has identified that will need to make the switch to digital VAT returns this year, with details on the changes that need to be made, and when.

For the first step of the process - submitting digital VAT returns - only businesses with a taxable turnover of more than £85,000 are required to join from 1 April. Those with smaller turnovers can sign up voluntarily.

Some businesses will have been deferred for an extra six months, meaning they do not need to follow the Making Tax Digital rules until 1 October 2019.

The deferral group includes businesses where the following apply:

  • Part of a VAT group or VAT division
  • Based overseas
  • Is a trust
  • Is a not for profit organisation that is not set up as a company
  • Submits annual returns
  • Is a local authority
  • Is a public corporation
  • Makes payments on account
  • Uses the VAT GIANT service

If your business qualifies for a deferral, HMRC should have already been in touch to let you know.

Potential exemptions

You can apply for an exemption to the Making Tax Digital practice under the following conditions:

  • Your religious beliefs are incompatible with the use of electronic communications
  • It's not reasonably practical, due to your age, disability, remoteness of location or another reasonable explanation
  • You are subject to an insolvency procedure
  • Your business is voluntarily registered for VAT and the turnover is under the VAT threshold.

When and how should you register?

While the new VAT system comes into force on 1 April, you need to make sure you're registered one week before your first VAT return is due for the period beginning after 1 April.

This means the first quarterly Making Tax Digital VAT filing would be after 1 July; HMRC says that the majority of people who file quarterly won't need to make their first Making Tax Digital VAT return until August.

Those in the deferral group will have to follow the rules from their first VAT return period starting after 1 October 2019.

Sole traders or business owners can register their businesses for themselves, or agents working on behalf of a business client can register on their behalf.

The data sent to Float revealed that while 88% of businesses with a turnover above the VAT threshold use an agent for their taxes, only 13,427 businesses that had signed up by 18 March were signed up by agents, suggesting slow take-up by agents could be part of the problem.

What software do you need?

You're left to choose which software you want to use to make VAT returns - HMRC simply states that it must let you submit VAT returns, and must be compatible with the Making Tax Digital format.

HMRC has provided a guide to software available now, and other software still in development. However, there's no indication of product prices or how it functions - individuals must choose from hundreds of options for themselves.

In terms of costs, HMRC says that there are 11 products available for free, with varying conditions of use, and many more at a 'low cost'.

It says costs will depend on the complexity of your tax situation, size of your business and what kind of functionality you want the software to have.

What's more, most businesses will be able to claim any costs for hardware and software as expenses against their tax bill.

Find out more:self-employed tax allowable expenses

How disruptive will the changes be?

This really depends on how you currently process your VAT returns - some businesses will already be using Making Tax Digital-compatible software, in which case they're ready for the changes now.

If you're using spreadsheets or an older system? 'Bridging software may the best way to go,' says Mike Parkes, director of GoSimpleTax - makers of the Which? tax calculator.

'In effect bridging the technology gap, this is a very cost-effective way to stay compliant as it requires minimal investment of both money and time.'

The biggest change will be to any businesses using paper VAT returns. You'll need to set up the company on relevant software and add all transactions for the quarterly period you're reporting on.

Find out more:self-employed VAT return

What if you're not ready in time?

While Making Tax Digital for VAT comes into force tomorrow, you won't need to file a quarterly return until 1 July at the earliest.

There's also some leniency on how you file your digital returns for the first year. Mike Parkes says: 'HMRC are starting with a one-year soft landing, meaning you don't need to have a digital link between how you record your transactions and how you submit you VAT return.'

This means you can use bridging software to submit your figures, while continuing with your usual VAT system.

But you could still face penalties under the existing VAT rules.

Until April 2021, there will be a default surcharge if you miss more than one VAT return deadline. The amount you're charged depends on how much tax you owe and how late you are in paying it. After this time, the government plans to introduce a points-based system, but the details are yet to be confirmed.

There's also a general regulatory penalty for failing to comply to certain regulatory requirements.

If you haven't failed to comply with regulations in the previous two years, you'll be fined £5. If it's only happened once in that time you'll be fined £10. In any other cases you'll be fined £15.

The penalty rate is applied to the number of days a failure continues, up to a maximum of 100 days.