Comply with Making Tax Digital for VAT

Making Tax Digital (MTD) for VAT requires all VAT-registered businesses to keep digital records and submit VAT returns using compatible software. This has been mandatory for all VAT-registered businesses since April 2022.

If you are newly VAT-registered, HMRC will automatically sign you up for MTD. Existing VAT-registered businesses should already be using MTD-compatible software.

What Making Tax Digital requires

MTD for VAT has three core requirements:

• You must keep your VAT records digitally in functional compatible software.
• You must submit VAT returns to HMRC through your software, using an Application Programming Interface (API), not manually through the online account.
• Data must pass digitally between any software programs you use, without manual re-keying or copy-and-paste.

You cannot use HMRC's online VAT account to file returns unless you have an approved exemption.

Digital record keeping requirements

Under MTD, certain VAT information must be kept digitally within your software. This does not mean all your records must be electronic - supporting documents like invoices can still be paper-based - but the core VAT data must be in digital form.

What records you can keep outside software

You can still keep supplementary records on paper or in separate systems, provided:

• The core VAT data is in your MTD-compatible software
• You can provide the underlying records if HMRC requests them during a compliance check

For example, you might keep paper copies of supplier invoices filed in folders, as long as the VAT information from those invoices is recorded digitally in your software.

Choosing MTD-compatible software

You need software that meets HMRC's functional requirements and can connect to HMRC's API to submit your VAT returns. There are several options:

Types of software available

Full accounting software

Products like Xero, QuickBooks, Sage, or FreeAgent handle your full bookkeeping, generate VAT returns, and submit them directly to HMRC. This is the simplest option for most businesses.

Benefits:

• All-in-one solution
• Automatic VAT calculations from your transaction records
• Built-in digital links
• Often includes invoicing, bank reconciliation, and reporting

Bridging software

If you prefer to keep your VAT records in spreadsheets, bridging software connects your spreadsheet to HMRC without requiring you to change your record-keeping method.

Choosing between full software and bridging

Consider full accounting software if you:

• Want an integrated solution for all your accounting
• Have multiple transaction types and need automatic VAT calculations
• Want to reduce manual data entry
• Are comfortable moving away from spreadsheets

Consider bridging software if you:

• Are happy with your current spreadsheet system
• Have simple VAT requirements
• Want to minimise disruption to existing processes
• Have limited budget for software subscriptions

HMRC publishes a list of recognised MTD-compatible software, including both full accounting packages and bridging tools. Some providers offer free versions suitable for businesses with basic needs.

When you choose software, check whether it will handle e-invoicing.

Digital links requirement

This is the most commonly misunderstood aspect of MTD. If you use more than one piece of software or spreadsheet to manage your VAT records, data must transfer between them digitally - not by copy-and-paste or manual re-keying.

Common digital links scenarios

If you use one piece of software for everything (recording transactions and submitting returns), digital links are automatic - the software maintains them internally.

If you use a spreadsheet with bridging software, your spreadsheet holds the transaction data. The bridging software reads the VAT return figures from designated cells. This is a digital link because the bridging software extracts the data electronically.

If you have separate spreadsheets for sales and purchases, data must transfer between them using formulas, links, or exports/imports - not copy-and-paste. Use cell references that pull data from one spreadsheet to another.

If you have separate point-of-sale, stock, and accounting systems, data flowing between them must be transferred digitally. Most modern business software supports CSV exports, API connections, or integration tools.

Copy-and-paste is not permitted

Selecting data in one application, copying it, and pasting it into another is not a digital link. This manual transfer breaks the audit trail that MTD requires.

Copy-and-paste is acceptable only when moving data into software purely for storage or backup purposes, not when transferring data that will be used to calculate or submit your VAT return.

Setting up your software

Once you have chosen your software, follow these steps to set it up for MTD:

Testing before your first submission

Before submitting your first VAT return through the software, test that everything is working correctly:

• Run a test VAT return. Most software lets you preview a return without submitting it, so check the figures match your expectations.
• Check the API connection. Some software offers a test connection to HMRC's systems, so use it before your return is due.
• If you use more than one system, check that data flows correctly between them without manual intervention.
• If you have submitted returns before, compare the new software's calculations with your previous method to spot any differences.

Start using MTD-compatible software well before your next return is due. A good rule is to allow at least one full VAT period to get comfortable with the new system before you must submit.

If you need an exemption

Some businesses can apply for exemption from MTD if they cannot use digital tools due to specific circumstances.

Getting help with MTD

If you find MTD requirements challenging, several options are available:

• An accountant or bookkeeper can use their own MTD-compatible software to submit returns on your behalf. You provide them with your records (which can still be paper-based), and they handle the digital submission.
• Most MTD software providers offer tutorials, guides, and customer support to help you get started.
• HMRC runs free webinars explaining MTD requirements and provides detailed written guidance.
• Many accountancy bodies and software providers offer training courses on using MTD software.

Remember: MTD does not require you to be a technology expert. The software handles the complex parts - you just need to record your transactions and check the VAT return before submitting.

Common mistakes to avoid

• Leaving setup too late. Start using MTD software well before your return is due. Last-minute setup leads to errors.
• Using copy-and-paste between systems. This breaks digital link requirements. Use exports, imports, or formula-based links instead.
• Not authorising your software. It needs permission to access HMRC systems. Complete the authorisation process or submissions will fail.
• Mixing VAT periods. Make sure transactions are recorded in the correct VAT period based on the tax point date, not when you happen to enter them.
• Forgetting to submit. Unlike the old online account, software does not always remind you when returns are due. Set your own reminders.
• Ignoring error messages. If HMRC's systems reject a submission, your software will show an error. Do not assume the return was filed - check and resolve errors immediately.

Penalties

HMRC treats the digital record and software rules separately from the deadlines for filing and paying. All of these are civil penalties assessed by HMRC, and there is no penalty if you have a reasonable excuse.

Not keeping digital records or not filing through software

The Making Tax Digital rules are in the VAT Regulations 1995, made under powers that section 62 of the Finance (No. 2) Act 2017 added to Schedule 11 to the VAT Act 1994. Breaking a requirement in those regulations can lead to a regulatory penalty under section 69 of the VAT Act 1994. HMRC can assess it only if it has sent you a written warning in the 2 years before. The penalty is £5, £10 or £15 a day, depending on how often you have failed in the previous 2 years, for up to 100 days, or £50 if that is more.

Filing or paying late

For VAT periods starting on or after 1 January 2023:

• Late returns: each late return, including a nil or repayment return, earns a penalty point. At the threshold (2 points for annual returns, 4 for quarterly, 5 for monthly) you get a £200 penalty, and another £200 for each later late return while you stay at the threshold.
• Late payment: there is no penalty if you pay within 15 days. After that, the penalty is 3% of the VAT unpaid at day 15, plus 3% of what is still unpaid at day 30, then a daily penalty at 10% a year from day 31 until you pay. A Time to Pay arrangement can reduce or remove these penalties.