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15 Jun 2022

What is Making Tax Digital for income tax, and how will it affect you?

While the tax change won't come into force until 2024, it's worth preparing now

A major tax change is on its way for 4.2 million self-assessment taxpayers, affecting the way you share your income figures with HMRC - yet many people are unprepared for the new rules.

Making Tax Digital (MTD) is part the government’s initiative to modernise the tax system in the UK. So far, it has only applied to VAT reporting, but from 6 April 2024 it will be rolled out income tax returns. 

In a survey of businesses, 93% of respondents said they were aware of the term or concept of MTD,  but over a quarter of these wrongly thought MTD didn't apply to their business, according to research by Yonder, commissioned by HMRC. 

Furthermore, the survey found that only half of those aware of the term or concept of MTD were able to recollect at least one requirement for using it.

With time running out until the new rules become mandatory for income tax, Which? explains what MTD is, and how it will affect you.

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What is Making Tax Digital?

Making Tax Digital (MTD) involves keeping digital records of accounts and sending summaries to HMRC every quarter (ie every three months), instead of filing one final return annually. 

You'll need to use HMRC-approved software to do this; if you're not sure which software to choose, you can check the government guidance

The idea is that keeping digital records, and submitting your figures more often, will help people keep track of how much tax they owe in real time, therefore making it easier to budget for their tax bill. 

In addition, HMRC hopes it will reduce the amount of careless mistakes made, which contribute to the 'tax gap', ie the shortfall in the amount of tax the government had expected to be paid. The most recent figures for 2019-20 showed a tax gap of £34.8bn.

The MTD initiative was originally launched in 2019 for businesses that pay VAT and have a turnover of more than £85,000. This year, it was extended to include all VAT-registered businesses.

It was originally meant to launch for income tax in 2023, but was delayed to give people whose livelihoods were disrupted by Covid-19 more time to prepare.

Companies that pay corporation tax will also eventually join MTD, but not until 2026.

Who will MTD for income tax affect?

On 6 April 2024, MTD will be extended to the 4.2m taxpayers with business and/or property turnover or gross income over £10,000 annually - this is your profits before the deduction of allowable expenses.

All UK residents who are registered for self-assessment before 6 April 2023, and who also meet the income threshold, will need to sign up and declare domestic and foreign earnings. If you are living abroad, however, you only need to use MTD to declare income made in the UK.

If you started earning income as a sole trader or landlord on or after 6 April 2023 won’t have to join the scheme until they have filed their first self-assessment tax return. 

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What will I have to do differently?

MTD will replace the current self-assessment system, which involves submitting an online or paper form to HMRC annually. 

Instead, you’ll need to file digital updates every three months. 

Once you have submitted your quarterly summary, you will get an estimate of the tax due, but you won't have to pay it until the usual 31 January deadline of the following calendar year. 

There are plans to allow people to voluntarily pay taxes as they go throughout the year, but the details are still being decided.

Note that the quarterly summaries are updates, not tax returns. A final report will need to be sent by 31 January, either through your MTD software or via a self-assessment tax return. At this point, your final tax bill for the year will be calculated.

What's not changing?

The main deadlines for finalising your tax affairs and paying the tax you owe are still the same, so 31 January will remain an important day. This is will also remain the deadline for making any balancing payments. 

If you pay tax by payments on account, these deadlines will remain at 31 January and 31 July. 

In addition, you'll still need to keep any relevant business records. This includes things like receipts, invoices, bank statements and any other evidence that can back-up the information you've submitted. 

You must keep this evidence, as HMRC has the right to request to see it if it carries out an investigation into your tax liability. 

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What happens if you're not ready in time?

If you fail to sign up to MTD on time, you could face penalties. While businesses that failed to register in time for the VAT phase of the scheme got off with a warning and given more time to prepare, there's no guarantee HMRC will be as lenient this time.

With this in mind, it might be a good time to get ahead and start keeping your records digitally, if you're not already.

There will be penalties for if you're late submitting your quarterly tax summaries, but they're not as severe as those for submitting a late tax return or tax payment. 

Instead, the penalty system has been tweaked with the intention to make it fairer and encourage good behaviour, rather than as a punishment. 

It will work in a similar way to how speeding fines are issued to drivers, with a point added each time a deadline is missed. 

After a certain number of points is reached, taxpayers will have to pay an automatic fine of £200. The points threshold varies depending on how often you are required to make submissions to HMRC - the more frequent, the higher the threshold.

It’s worth noting, however, that points accrue separately for those who use MTD for VAT and income tax. So if you go beyond the tax threshold for both, you could face two fines of £200 each.

You won't be fined if you're excluded for MTD. This includes those who are already exempt from filing a self-assessment tax return online, or if your turnover is below the specified threshold.

This article has been updated since first being published to clarify that the qualifying income test is based on turnover or gross income rather than net income.