Making Tax Digital (MTD) Phase 2: What you need to know

10 March 2021 - Elizabeth O'Hanlon

If you’re running a business of any size, you’ll know about the government’s Making Tax Digital (MTD) initiative being introduced in phases between 2019 and 2023. Eventually replacing the paper-based  tax return process, MTD makes it easier for you to keep on top of your finances and get your tax returns right.

MTD Phase 2 (due in 2020, but delayed until 1st April 2021 due the COVID-19 crisis) extends these digital practices to every step of the VAT journey. If you’re late with payments or fail to comply, then you could face fines and surcharges under a penalty points system. But it needn’t get to that stage – we’re here to help make MTD easy for you.

Making Tax Digital (MTD) Phase 2 (What You Need To Know)

What is Making Tax Digital?
What is happening in Making Tax Digital Phase 2?
What are the MTD requirements?
What information must be kept digitally?
What are the MTD penalties?
Want to Make Tax Digital without stress?

What is Making Tax Digital?

Introduced in April 2019, MTD requires businesses above the VAT threshold to keep digital financial records and use software to submit quarterly updates and VAT returns. This significantly reduces the chances of errors and saves a great deal of time and manpower spent sifting through spreadsheets, paperwork and forms.

What is happening in Making Tax Digital Phase 2?

While MTD Phase 1 simply dealt with VAT return submission, Phase 2 applies MTD guidelines to the entire VAT journey. From 1st April 2021, all VAT-registered businesses need to have the necessary digital links in place between all their transaction data.

This will eliminate any manual input within the VAT data journey and your return to HMRC.

What are the MTD requirements?

If your business’s turnover is above the UK VAT threshold (currently £85K) you or your accountant must meet these requirements:

  • Keep digital VAT records for your business using MTD-compatible software
  • Use this software to calculate the VAT due to HMRC
  • Submit the 9-box VAT return using HMRC’s dedicated software interface (API)
  • Have digital links between software you use to generate invoices through to HMRC
  • Create new authentication
  • Be able to receive digital information back from HMRC
  • Introduce controls around correcting errors and making adjustments

If you are VAT-registered but currently under the £85k threshold, you can still apply voluntarily to use MTD. As all VAT-registered businesses will need to comply with MTD guidelines from 1st April 2022, regardless of their turnover level, it might be a good idea to start early.

If you are already using software for your business finances, check what plans your provider has for making it compatible with HMRC. If you’re still using spreadsheets, you will need to use ‘bridging’ software to make them link to HMRC.

What information must be kept digitally?

Note that the various records and information you need to store digitally don’t have to be in the same place or using the same software. As long as data passes digitally between each, and they are ultimately linked to HMRC, then you’ll be fine.

Your digital records should include:

  • Your business name and principal address
  • Your VAT registration number
  • Details of any VAT accounting schemes you use
  • As per your current VAT records, for each sale entry:
    • Time of supply (tax point)
    • The supply’s value (net of VAT)
    • VAT rate charged
  • For goods and services you’ve purchased:
    • Time of supply
    • Value excluding VAT
    • VAT paid
  • If using a retail VAT scheme, your daily gross takings

Also, on each VAT return:

  • Reverse charge transactions where you are both buying and selling goods
  • If using a flat rate scheme, items where you can reclaim the VAT

While you should record the details of all transactions in a digital format or software, you do not need to scan paper receipts or invoices.

What are the MTD penalties?

If you don’t meet the requirements for Making Tax Digital – either through missing payments or not making the best effort to record information digitally – then a penalties system is in place. This will apply from your first VAT return submitted on or after 1st April 2021.

There is initially some leeway with late payments, but surcharges then rise over time and according to monies owed.

On your first default, there is no surcharge, and if you pay within 15 days, no fine either. However, any further defaults within a 12-month period will lead to sanctions (although businesses with a turnover of less than £150,000 get one extra chance).

Surcharges for additional defaults start at 2% of monies owed and rise to 15% by the 5th or 6th instance. HMRC will also charge interest on any late payments, although the rate is halved if settled 15-30 days after the due date.

HMRC also operates a points system that leads to fines. Each missed VAT return or non-compliance with MTD will incur a penalty point, with points staying on the record for two years before they expire. If your business accrues four points, then an additional fine or surcharge will be levied.

Want to Make Tax Digital without stress?

If you are confused about how MTD will work for your business, or need help setting up compliant digital systems, then get in touch with the Scrutton Bland team. Our MTD experts will quickly be able to identify all the options available to you and get your business ready for MTD Phase 2.

With our Sb Digital you’ll learn how you would benefit from upgrading your existing software, whether you could use bridging software to link to HMRC or if you need to introduce new systems. And they can even apply to HMRC for an extension if your circumstances merit it.

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