These changes will apply to the approximately 1.1m VAT registered businesses with taxable turnover below the current VAT threshold that are not currently required to operate Making Tax Digital (MTD) for their VAT reporting and record keeping obligations. HMRC’s policy paper is reproduced below.
General description of the measure
MTD and its extension forms a crucial building block in the government’s 10-year strategy to make the tax system more resilient and effective, to boost business productivity, and support taxpayers.
These changes extend MTD requirements to smaller VAT businesses from April 2022. They build on the successful introduction in April 2019 of MTD for those VAT businesses with taxable turnover above the VAT threshold.
There is a growing body of evidence, from research and insights from taxpayers within MTD for VAT, which demonstrates that MTD is securing a range of benefits for those that use it in practice.
These benefits include reducing or eliminating paper-based or manual processes through use of software and an integrated approach to business administration and tax, allowing for greater accuracy in tax returns. This reduces the time businesses spend on administration, providing businesses more time to maximise business opportunities, productivity and profitability. MTD’s intention is that, for the majority of businesses, tax will be made easier to get right and harder to get wrong.
About a quarter of VAT registered businesses below the VAT threshold have voluntarily chosen to join MTD, demonstrating that a modern, digital approach to managing tax can work for businesses of every size.
MTD aims to tackle that part of the tax gap caused by error and failure to take reasonable care, by removing opportunities to make certain types of mistakes in preparing and submitting tax returns.
Under MTD, businesses must keep digital records and use third-party software to submit their tax returns to HMRC. Under the changes, those who do not already keep their records digitally will need to start doing so for their VAT obligations. The process of then sending returns to HMRC will become more straightforward, with their returns generated and sent directly from the software they are using to keep their records.
The software these businesses use must be capable of receiving information from HMRC digitally via HMRC’s Application Programming Interface (API) platform.
The fundamental benefits of a modern, digital business model are well understood with millions of businesses routinely securing orders, banking, paying invoices, and filing their returns online.
Many businesses now expect to be able to manage their affairs digitally, including tax, and MTD meets this need. Businesses that move to real-time record keeping using accounting software may experience significant productivity benefits, as their software provides an up-to-date picture of their finances, and may also provide additional functionality to integrate record keeping with other business processes.
This can further reduce time spent on administration, allowing businesses to spend their time serving customers, innovating, growing and creating jobs. For example, the Lloyds Bank UK Business Digital Index 2019 found that digital channels saved small businesses, on average, a day a week in administration.
The Enterprise Research Centre, in their State of Small Business Britain Report 2018, found that for micro-businesses, web-based accounting software could improve efficiency by 11.8%.
MTD does not change businesses’ tax liability or payment obligations, but reduces scope for error. This in turn contributes to a reduction in the tax gap, supporting public services and levelling the playing field for businesses. The projected gains to the Exchequer resulting from MTD reflect the reduced scope for error.
Businesses will therefore also save time through processes that help them get their taxes right first time and reduce the chances of time spent putting errors right at a later stage.
Less time spent on tax administration has scope to cut stress and allow businesses to focus on their most pressing business priorities.
Background to the measure
Originally announced at Budget 2015, and following formal consultation in 2016, the first phase of MTD for VAT was implemented from April 2019.
For VAT periods starting on or after 1 April 2019, VAT-registered businesses with a turnover above the VAT registration threshold have needed to keep their records digitally and provide their VAT return information to HMRC through MTD-compatible software.
In July 2020, the government published ‘Building a trusted, modern tax administration system’, which set out a vision for the future of tax administration in the UK, designed to improve its resilience, effectiveness and support for taxpayers.
A long-term strategy of focused, collaborative and transparent improvement of the tax administration system has the potential to yield huge benefits, both for individual taxpayers and businesses. It also contributes to the collective strength and resilience of the country as a whole.
Extending Making Tax Digital is a critical building block for this, so as part of the Legislation Day announcements on 21 July 2020, the government set out its roadmap for the further rollout of MTD with the expansion of mandatory MTD for VAT from April 2022 and the introduction of mandatory MTD for ITSA from April 2023.
From their first VAT period starting on or after 1 April 2022, VAT registered businesses (including self-employed and landlords) that are not already required to operate MTD under the requirements applying from 1 April 2019 will have to:
- keep their records digitally (for VAT purposes only)
- provide their VAT return information to HMRC through Making Tax Digital compatible software
The rules for digital record keeping are set out in regulations 32A to 32C of the Value Added Tax Act Regulations 1995.
To enable the extension of the operation of MTD to all VAT registered businesses, the Finance Act 2021 made a minor amendment to paragraph 6 of Schedule 11 to the Value Added Tax Act 1994 to remove the requirement for an exemption to be made for businesses with taxable turnover below the VAT registration threshold.
The measure makes consequential minor changes to Regulation 32B of the VAT Regulations 1995 to omit the exemption for taxpayers whose turnover is below the threshold for compulsory VAT registration.
Impact on individuals, households and families
This measure will have an impact on individuals who run their own VAT-registered business to the extent reflected in the ‘Impact on businesses’ section.
The measure is not expected to have an impact on family formation, stability or breakdown.
The government has been clear that if a business cannot go digital, it will not be required to do so.
MTD is intended to help businesses get their tax right, with mandatory use of digital record keeping and using MTD-compatible software to provide HMRC updates and returns digitally. It is, however, anticipated that some people with disabilities, those in rural locations with poor broadband services, and those who are digitally excluded for other reasons may find it more difficult to comply.
Businesses that are already exempt from engaging with HMRC through other mandatory digital channels will continue to be exempt and will not have to meet the obligations of MTD.
The exemptions under MTD mirror the VAT online filing exemption. MTD exemptions have operated successfully since the introduction of MTD for VAT businesses with taxable turnover in excess of the VAT threshold since April 2019.
These exemptions will continue to be available to businesses within the expanded scope of MTD. HMRC ensures that clear guidance is provided and information is easily accessible for digitally excluded taxpayers about the exemption process.
Taxpayers may apply to be exempted from MTD requirements through non-digital means.
In order to ensure the widest possible access to software that will meet MTD requirements, HMRC is continuing to work closely with software developers to make sure that there are several VAT software products that cater for those with cognitive, motor, visual and hearing difficulties.
There are filters on HMRC’s software choices viewer on GOV.UK to help customers easily identify these products. Where a person already complies with requirements to send information electronically and uses assistive technology, the MTD requirements should not impose additional costs to meet their accessibility needs.
For those moving to digital, especially those needing extra support, HMRC’s customer support model includes:
- a multi-layered approach stretching across agents, third party software support, through to telephony support, webchat, and HMRC’s Extra Support service
- accessible online content including recorded Webinars, YouTube videos and E-learning
- GOV.UK content including Help pages – signposting to information, guides, and to local or third-party providers of digital skills courses, or support already provided by external providers
HMRC will also continue to work across multiple channels supporting as many taxpayers as possible to move onto digital services.
Apart from the impact on those who are disabled as discussed above, it is not anticipated that there will be impacts on those in other groups sharing protected characteristics.
Impact on business including civil society organisations
This measure is expected to have a significant impact on approximately 1.1 million businesses and civil society organisations with VAT obligations. Businesses within scope that already manage their VAT digitally may incur relatively little cost in moving to MTD, where other, less digitally capable businesses, may be more affected by one-off transitional costs as they move to MTD processes.
In assessing these impacts, HMRC have incorporated findings from the businesses already signed up to MTD, as well as feedback from engagement with external stakeholders about their experience of the costs to businesses in complying with MTD. In particular, HMRC has worked extensively with stakeholders from the accountancy, business and software communities to update its assumptions underpinning the cost estimates, to ensure they are robust and a realistic representation.
Alongside the costs of making the transition to MTD, there are significant, wider benefits and cost efficiencies available for many businesses as part of going digital, once they have moved to digital record keeping. Some, but not all, of these are measurable in cost terms. For businesses, these benefits may offset wholly, or in part, any costs of complying with MTD.
Standard Cost Model (SCM) methodology was used to estimate administrative burden impacts. This methodology allows HMRC and HMT to apply a standard set of principles for estimating administrative burdens across all impact assessments. The assessment only considers the costs and savings strictly related to meeting MTD tax obligations. It does not include the wider benefits that HMRC expects businesses may see, such as through:
- an improved customer experience
- an easier process for managing tax affairs
- improved record keeping
- greater accuracy in returns
- reduced time spent on wider elements of business administration
- improved efficiency and greater productivity
- better business management
- a streamlined, digital experience
It also does not reflect the broader picture of taxpayer experience and cannot measure all consequential and longer-term benefits. The SCM only captures the costs to business of retaining and/or disclosing information to HMRC or to third parties and therefore cannot be used to estimate wider benefits of MTD to businesses.
Once businesses are used to operating the new MTD processes, HMRC anticipates that they will find that MTD makes it easier for them to get their tax right first time and reduces errors, making the management of tax affairs simpler.
HMRC expects this to, in turn, improve businesses’ experience of dealing with the department. MTD also has the ability to support business efficiency and productivity through the use of digital channels.
HMRC project that these changes will also have positive impacts on agents acting for businesses. Businesses may find MTD software means that they can do more in relation to recordkeeping and tax.
Civil society organisations may potentially see an increase in requests for help and support from less digitally engaged individuals and business in transitioning to the new requirements.
Through MTD, VAT-registered businesses will be required by law to keep digital records.
This will involve a transitional cost for businesses not already doing this. They will need to purchase, or acquire a free version of, software and become accustomed to using it.
HMRC has been working with the software industry to ensure that businesses needing to update their accounting systems will have access to affordable software products. Supporting MTD for VAT, the industry has produced software at a range of price points and offering different levels of functionality.
This includes bridging software for those who want to continue to use spreadsheets for record-keeping, right the way through to fully integrated accounting software that provides additional functionality to help users better understand and plan for their business.
When MTD for VAT was introduced, more than 250 existing subscription VAT software products were updated at no cost to customers to provide MTD for VAT capability. The industry has also provided a number of free products. Within the MTD for VAT software market there is huge choice and competitive pricing with over 450 products on the MTD for VAT software choices page on GOV.UK.
Invariably, costs will differ from business to business and are influenced by factors including size and complexity of business, degree of digital capability and cost and functionality of software solution employed.
Transitional one-off costs could include some or all of the following:
- time spent in familiarisation with the new MTD obligations (digital record keeping and making of MTD-compliant VAT returns)
- in-house training
- the purchase of new hardware or upgrading of existing hardware (expected to affect a small minority)
- additional accountancy or agents’ costs
Transitional costs can be offset against the business’ profits for tax purposes.
The majority of VAT businesses with taxable turnover below the VAT threshold already report their VAT quarterly and electronically. Those businesses already using digital tools and processes to manage their VAT affairs are already likely to have the necessary hardware and will be accustomed to using software, so we would expect them to incur lower transitional costs than those moving from paper-based accounting processes.
Continuing costs could include:
- cost of software subscription for those moving to MTD compatible software, from either paper or spreadsheet systems (although for businesses with the most straightforward affairs there is free software available)
- cost of bridging software to provide MTD compatibility for those who prefer to continue using spreadsheets
- marginal increases in some existing software costs to provide MTD compatibility (although many VAT subscription-based software packages have been updated for MTD for free)
This measure is expected to improve businesses experience of dealing with HMRC as managing their tax affairs will be simpler. Once businesses are used to operating the new MTD processes, we anticipate that they will find that MTD makes it easier for them to get things right and reduce errors.
If you have any questions about this change, please contact Ady Garrett by email at: [email protected].