Making Tax Digital Phase 2 set for April 2021

Hands and laptop

Making Tax Digital (MTD) is an ongoing scheme that aims to transform VAT returns into a fully paperless process. Its first phase was launched in April 2019, and the second phase was due to begin a year later. Due to the coronavirus pandemic, this has been postponed until April 2021.

So, what does MTD mean for processing tax returns, and what will change? Read on for a simple summary of the previous and planned changes.


A recap of Making Tax Digital

HMRC introduced the Making Tax Digital (MTD) initiative to move towards paperless VAT returns, meaning paper records no longer meet the requirements of tax legislation.

It makes it essential for businesses to return their taxes and keep accounting records digitally through compliant systems that can access HMRC’s API. This change makes it easier for businesses to ensure accuracy and streamline processes while reducing lost taxes through manual error. Prior to MTD, HMRC estimated that £9 billion in taxes went unreported each year.

MTD is being gradually rolled out, and phase one came into effect in April 2019. This affected VAT-registered businesses with a taxable turnover of over £85,000.00, while those below this can choose to get started. The initial phase came with a ‘soft landing’ to ease businesses into the changes without the threat of fines, however this ends when the next phase begins in April 2021.


Phase Two of Making Tax Digital

Phase two of MTD brings in tighter regulations around tax returns. It requires businesses to digitally link their VAT processes from start to finish in a way where no human interference is required. In other words, if more than one accounting system is used, they must be linked digitally to create a ‘digital journey’.

For the first time since the scheme was introduced, penalties for non-compliance will also come into effect. These are expected to be up to 15% of due VAT in addition to up to 100% of the undeclared VAT.

Phase two was initially set to commence in April 2020, but it was delayed until 2021 to allow affected businesses to manage the unforeseen impact of COVID-19. Around 1.3 million VAT-registered businesses will need to ensure a digitally linked system before then.

Those individuals and businesses not impacted are recommended to do so to make their processes more efficient. However, a study by Tax Advisor Magazine showed 55% of respondents found the opposite.  Plus, only 11% noticed a decrease in errors. This highlights the need for a solution that helps make the process simple with great automation features.


Compliant accounting software for Making Tax Digital

Phase two of MTD will enforce stricter requirements, meaning more robust accounting software is required to be fully compliant and avoid penalties. Rather than manually submitting data, it will be sent directly through the software to HMRC.

Accounting systems will need to be able to submit live financial records on both purchases and sales to meet legislation. This requirement will impact small businesses who may be using more basic software and spreadsheets to manage taxes and expenses. As a result, MTD necessitates an investment in technology.

Good solutions will save businesses time and money through automation and the prevention of errors. Cloud-based systems in particular help to modernise operations and allow greater flexibility at a lower upfront cost.

If you’re affected by the planned changes to MTD, make sure you prepare compliant accounting solutions ahead of April 2021 to avoid penalties. Keep track of the latest tax updates, from IR35 to MTD, on our News section.

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