Making tax digital: how tax changes might affect you

HMRC announced its new Making Tax Digital (MTD) initiative in the March 2015 Budget but since then, there have been few details released about how it might work and what it will mean for small businesses.

It has now published consultation documents to lay out its stall, explaining how it sees MTD working in more depth and inviting small business owners and their accountants to comment on the proposals.

We recommend you read the consultation documents and send any comments to HMRC – but in the meantime, here’s a quick summary from Emily Coltman FCA, chief accountant at FreeAgent, which provides cloud accounting software for freelancers and small businesses.

Who would Making Tax Digital apply to?

At this stage, the Making Tax Digital proposals only apply to sole traders and partnerships – the consultation doesn’t address limited companies or their directors, which will be covered in a separate consultation later this year.

HMRC is also proposing that Making Tax Digital would only apply after £10,000 annual income or turnover, so a sole trader with one small business that makes sales under £10,000 a year would be exempt from MTD. However, a sole trader with two businesses, each making sales of £6,000 a year, would have to comply with MTD, because his/her total income for the year is £12,000.

Businesses with an annual income of not far above that level (and under a threshold yet to be determined) may, under the proposals, have an extra year to comply with the MTD rules.

HMRC has clarified that, “The small minority who genuinely cannot use digital tools will not have to do so,” for example due to religious reasons. Also excluded are those for whom “online filing is not reasonably practicable for reasons of disability, age, remoteness of location, or any other reason”. HMRC consider that anyone with access to 2Mbps broadband or faster will be able to send their updates online.

How would Making Tax Digital work?

Contrary to popular belief, Making Tax Digital would not require businesses to file four tax returns every year. Instead, businesses will send summary data to HMRC about their business each quarter, or more often if the business prefers. The summary data will consist of total income and total expenditure, with the expenditure broken down into categories such as travel and advertising.

Businesses will need to send this information from online accounting software such as FreeAgent – HMRC has confirmed that they will not be providing their own bookkeeping / accounting software and that the use of “digital record keeping software that links to and updates business’s digital accounts with HMRC” will be mandatory, except for taxpayers who are exempt from MTD.

Each business will have a proposed nine months after the year end to file an “End of Year declaration”, submitting final figures. This would be a month less than the current tax return filing deadline, which is just under 10 months after the end of the tax year.

Because businesses have the option to report more often than quarterly, this would introduce flexibility for seasonal businesses, because the report would not have to be regular. For example, a teacher could report each half term and then send a separate report for each period of holidays.

Here are a few details of note:

– The business won’t have to keep any additional paper records.

– If the business is registered for VAT, one report would cover both income tax and VAT reporting requirements.

– If the business needs to make accounting adjustments, such as revaluations of closing stock (which would apply mainly to businesses who are not using the cash basis of accounting) then they could do this either mid-year or at the end of the year.

– Allowances and reliefs, such as Annual Investment Allowance, could also be notified to HMRC either in-year or at the end of the year; for instance if an asset has been bought, the suggestion is that HMRC could be told at the time the asset is bought that it’s going to be eligible for Annual Investment Allowance.

– HMRC believes that the cash basis of accounting should be extended to larger businesses, as this will be simpler for them to use. It has suggested doubling the current entry threshold, which matches the VAT registration threshold – so a business would be able to begin using the cash basis of accounting if it has sales up to £166,000, using today’s VAT registration threshold.

When will Making Tax Digital start?

MTD is planned to start in April 2018, but for the smallest businesses that come within its scope, a year’s extension has been suggested. Again, the threshold for what “smallest businesses” means has yet to be set so we’ll need to wait for more details.

In the consultation, HMRC has asked for readers’ opinions on whether MTD should be introduced for each business. The three options are:

– For its first accounting year starting on or after 5th April 2018, or

– Taking quarters during the accounting year, for the first quarter starting on or after 5th April 2018, or

– For its first VAT return starting on or after 5th April 2018, if the business is registered for VAT.

How will tax payments work?

HMRC is not planning to change the current payment dates, but they have asked as part of the consultation if they should review the payment on account regime, to which I would give a resounding “Yes” as they are complicated and can severely compromise a small business’s cash flow in its early stages.

Under MTD, businesses may have the right to make “voluntary payments” towards their tax liabilities, which would be aggregated together. HMRC has tentatively suggested it may need to be warned of upcoming voluntary payments.

HMRC has also said:

“Under Pay As You Go, the customer will decide how often and what amount they want to pay. Payment will not have to be at any fixed time, or at regular intervals; the customer will retain control and choice, so they feel confident that they have made the right decision for their circumstances, and have the opportunity to amend their choices if circumstances change. There will be no such thing as a missed voluntary payment.”

It may also be possible for businesses to claim a repayment of their voluntary payments if they need the cash for working capital.

It will be interesting to see how voluntary payments are allocated to different taxes with different payment deadlines, such as income tax and VAT.

How will penalties work?

HMRC is proposing to abolish the current penalty system for late submissions and instead impose a “points” system similar to driving licence penalty points, with a financial penalty to be imposed only when the points reach a set level. That level is suggested as four points, with the slate cleaned after 24 months after the last points were added. Penalties for inaccurate information would only apply to the End of Year update and VAT quarterly returns.

In the first year of MTD there would be a “soft landing” for the penalty regime, so penalties will not be in full effect.

*Emily Coltman FCA is Chief Accountant at FreeAgent, who provide an award-winning online accounting system specifically designed to meet the needs of freelancers, small businesses and their accountants. Try it for free at www.freeagent.com.