As a business owner, you will have plenty of tax responsibilities. One of those key responsibilities will be managing your company’s Value Added Tax (VAT) commitments. That’s why you need to be aware of Making Tax Digital, introduced by the UK Government in April 2019, which changed the way that companies keep tax records, communicate with HMRC, and prepare VAT Returns.
First of all – what is VAT and should your company be paying it?
Simply put, VAT is a general consumption tax that is assessed on the value added to goods and services. It’s a government tax that applies to most goods and services that are bought and sold for use or consumption in the UK.
Your business is legally required to register for VAT with HMRC if its VAT-taxable turnover is more than £90,000 (the 2024/25 VAT registration threshold) in any 12-month period, or if you expect it to exceed this threshold.
If your taxable turnover is less than £90,000, you don’t need to register for VAT. However, there are several benefits that your limited company could enjoy by becoming VAT-registered.
For more information on VAT and VAT registration in the UK, check out our blog post on VAT registration – the pros and cons.
Making Tax Digital for VAT
Making Tax Digital is a new UK Government service designed to streamline HMRC processes and make paying tax quicker, easier and more efficient for companies doing business in the UK.
The new initiative applies to all VAT-registered businesses, including those who registered voluntarily. It features additional rules on the way in which those businesses are expected to keep digital tax records and use certain software to file their VAT Returns.
Before this initiative, it was common for limited companies and sole traders to keep digital business records and accounts using a piece of software on a computer, tablet or smartphone. They’re often stored on a hard drive or via a cloud-based service, which is a safe way to ensure your company records are all backed up and secure.
Under Making Tax Digital, the government now demands that the software or services being used by businesses to record and store their tax records (and then submit those records to HMRC) can communicate with HMRC’s Application Programming Interface (API) platform whilst upholding new security standards.
These standards came into force for VAT Return periods beginning on 1 April 2019. Therefore, if your business is liable to pay VAT, you need to make sure that your company software or web-based services comply with the new rules.
Exemptions
HMRC allows for several exemptions where compliance with the new Making Tax Digital initiative is concerned. Your business will not need to comply with the government’s new VAT rules if HMRC is satisfied that:
- Your business is run entirely by practising members of a religious society whose beliefs aren’t compatible with the regulations. An example of those beliefs could be if your religion prevents you from using a computer
- It is unreasonable or impractical for you to be expected to use digital record-keeping tools based on your age, a disability, or the remoteness of your location
- Your business is subject to an insolvency procedure
Apart from those exemptions, if your business is ordinarily liable for VAT, you should comply with the Making Tax Digital rules. To help you and your business, we’ve sifted through the regulations to give you a comprehensive guide to the new rules and what your company must do to meet your legal obligations.
Your new digital record-keeping requirements
As a VAT-registered business, you’re obligated to keep certain records and accounts. Under Making Tax Digital, many of those records and accounts need to be digital, and you must use ‘functional compatible software’.
Functional compatible software is a system, software product or application that can record and preserve digital records, provide HMRC with information and returns from the data held in those records using HMRC’s API and receive information from HMRC using that same API platform.
It’s important to note that your business is expected to carry out all these functions using the same piece of software. For example, you might keep records using Microsoft Excel, but then save those records on an encrypted cloud service and submit them to HMRC using a secure client portal or professional accounting software. All that matters is that you are able to comply with each aspect of the functional compatible software requirement.
Another crucial point is that you do not need to store all of your digital records in one place or on just one programme. Digital tax records can be kept using a range of compatible digital formats, as long as they are all accessible and meet HMRC requirements.
The new requirement for Digital Links
Under Making Tax Digital, data transfers or exchanges of information between software programmes, apps, or services must be digital if the information being transferred forms a part of your company’s digital records. After data has been entered into software as part of your records, any new transfer or modification of data needs to be done digitally, and those changes must be linked to demonstrate that information’s digital journey.
Transferring data manually within or between different parts of a set of software programs or apps is not acceptable. An example of a violation of the new rules would be if you were to write down details from an invoice in one online ledger, then use the same handwritten notes to manually update another piece of software that forms part of your company’s functional compatible software system.
Once information has been made digital, it needs to stay digital.
That’s why ‘digital links’ are such an important record-keeping tool for your business under the new rules. HMRC defines a digital link as being the transfer or exchange of data electronically between programmes without the need for manual intervention.
Examples of digital links include:
- Emailing a spreadsheet with digital records to a tax agent so they can import the data into their own software
- Transferring a data set onto a portable device and physically giving that device to a tax agent
- An XML or CSV import
- An automated data transfer
- An API transfer
Simply cutting and pasting data does not count as a digital link.
Rules on submitting VAT information to HMRC
As previously mentioned, under Making Tax Digital, your company must always and only submit information to HMRC via an API. But don’t worry, because chances are that your commercial accounting or record-keeping software already comes VAT-enabled. If not, HMRC has stated that it is willing to accept a couple of alternatives when receiving submissions.
The first alternative is bridging software, which is a digital tool that can be used to connect accounting software to HMRC systems. It allows the necessary VAT information to be sent to HMRC digitally.
The second acceptable alternative to API-enabled software is to use API-enabled spreadsheets, which can:
- combine with accounting software to submit the necessary VAT information digitally to HMRC, or
- be used to keep digital records and be submitted directly to HMRC
What VAT records do you need to keep digitally?
There are several kinds of records and different data types that you are expected to keep digitally under Making Tax Digital. The first type of information that you must keep digitally is called designatory data, which includes:
- your business name
- your business address
- your VAT registration number
- any VAT accounting schemes used by your business
In addition to designatory data, you are expected to digitally record the following information for every single supply that you make:
- time of supply
- value of supply (which is the net value, not including VAT)
- rate of VAT that you charge
These record-keeping requirements only apply to the goods or services you supply that are VAT-liable. If you carry out a supply that is exempt from VAT, you don’t need to record the above information digitally.
The same reporting requirements apply to supplies received. However, instead of recording the rate of VAT that you charged as part of a supply, you are obliged to record the amount of input tax that you are planning to claim.
In cases where more than one supply is included in an invoice, under the new rules you’ll be allowed to record the totals from the invoice. Likewise, if you don’t know the actual amount of input tax that you’re going to claim, you should just record the total amount of VAT adjusted for any irrecoverable VAT.
You’ve also got to record certain data about any third-party agent that arranges to supply goods to or on behalf of your company. HMRC does include a caveat in the regulations, pointing out that in some cases this may not be possible or practical to record digitally on a daily basis. So it’s okay to record third-party information as a single digital invoice.
Other changes which may affect your business
These regulatory changes could also impact the way in which your company records reverse-charge transactions. If your business software records reverse-charge transactions, you won’t need separate entries for the self-supply and the purchase.
If your business software does not currently record reverse-charge transactions, you’ll now need to record them two times – the first as a supply made; and the second entry as supplies received.
You must also digitally record summary data as part of each VAT Return you submit to HMRC. This means that your functional compatible software will need to contain digital records of the total tax that your company:
- owes on sales
- owes on acquisitions from other EU countries
- needs to pay on behalf of your suppliers under a reverse charge procedure
- is entitled to claim on business purchases
- needs to pay or can reclaim following a correction or error adjustment
You’re expected to record any other adjustment allowed or required by VAT rules, and it is important to note that a total of each adjustment must be recorded as a separate line in your software system.
How does Making Tax Digital affect accounting schemes?
As a consequence of the new digital record-keeping and reporting requirements that Making Tax Digital imposes upon VAT-liable companies, several common accounting schemes are affected by the new regulations.
First and foremost, if your business accounts for VAT using a VAT retail scheme, you will need to keep a digital record of your Daily Gross Takings (DGT). You’re not required to keep a separate record of the supplies that make up your DGT in your functional compatible software.
If you use the Flat Rate Scheme to account for VAT, the following rules now apply:
- You do not need to keep a digital record of your business purchases unless those purchases count as capital expenditure goods on which input tax can be claimed
- You don’t need to keep a digital record of the relevant goods used to determine whether your business must apply the limited-cost business rate
If your business uses software that doesn’t have a Flat Rate Scheme setting or doesn’t enable you to include any rate of VAT other than the standard rate, reduced rate, or exemption rate, you’ll need to record each supply as either one standard-rated supply or one zero-rated supply.
The Gold Special Accounting Scheme
Does your company account for VAT using the Gold Special Accounting Scheme? If it does, then you need to keep a digital record of the following pieces of data for every sale you make as part of the scheme:
- value of sales made
- total output tax on purchases
If your company uses margin schemes, you are not required to keep additional records for those schemes in digital form – and you’re not expected to keep the calculation of the marginal VAT charged in digital form, either. But those records need to be kept in some way.
The bottom line
As with the introduction of any new HMRC rules, Making Tax Digital initiative sounds a little daunting, but once you delve into the fine print, the new regulations are actually quite straightforward. Businesses have slowly been transitioning to a largely digital direction for decades, so Making Tax Digital is just the next step in bringing HMRC’s services in line with the convenience and efficiency that UK companies deserve.
You’re expected to think a bit harder about how you create, share, and store digital records, and you need to ensure that all of your accounting software and systems are compatible with HMRC’s new service. By and large, however, the chances are that your business was already doing some or all of the new tasks.
If you have any questions at all about Making Tax Digital, you should contact HMRC for support immediately. When in doubt, it is always worth seeking the advice of a professional accountant to ensure that your business is doing everything it can to comply with the new rules.
Want to learn more about VAT and limited company tax requirements? Check out the Rapid Formations blog for all sorts of information about how to register for VAT, how to get your company’s Unique Tax Reference, and how to inform HMRC of changes within your company.
