What Freelancers Need To Know About Making Tax Digital
MTD will require freelancers, contractors and sole traders to keep digital tax records and submit VAT returns using software approved by HMRC. Are you ready for the new era of tax automation?
Paper-based tax returns are out, and digital transformation is in – ready or not.
That’s the thinking behind Making Tax Digital – the government scheme to move UK taxation into the digital age.
Instead of filing an annual VAT return, most self-employed taxpayers will be obliged to update HMRC in ‘real time’ about their tax affairs through an approved digital tax software package.
While VAT is the focus for this year, the phased rollout will see MTD extend to corporation and income tax in fairly short order.
The new rules are mandatory for any business with taxable revenues in excess of £85,000 (the VAT threshold).
HMRC describes it as a way to bring down tax evasion and tax underpayment due to errors – which were cumulatively responsible for a 33-billion pound ‘tax gap’ in 2016/17 (the difference between what the exchequer expected to get in tax revenues, and what it actually took in).
Not everyone is happy
Making Tax Digital has caused confusion amongst freelancers. And the rollout has generated some controversy.
The Lords Economic Affairs Committee recommended last year that HMRC delay the go-live date by a year, since many sole traders said they wouldn’t be ready for an April 2019 start date.
But the government pushed forward, placing some 1.2 million businesses under MTD’s mandate.
Nearly 100,000 organisations had already signed up when the programme went live in April, but at the current rate of 4,000 signups a day, less than half a million will have migrated over by August when quarterly VAT returns are due.
Breaking the rules could land freelancers a penalty of up to £500, though HMRC says its taking a light approach to enforcement for the time being.
The message is clear however. Sole trader or mid-sized business, automating your tax filing process is now compulsory.
To help make the transition less painful, we’ve compiled this guide to key concepts, dates, requirements, and software packages.
In four bullets: What is Making Tax Digital?
- To clawback lost tax revenues and improve efficiency, HMRC is making UK business go paperless. MTD requires all organizations under its mandate to maintain digital records and using only approved software to file returns.
- The rollout is happening in phases. Within a few short years, expect to see all paper-based tax filing banned under UK tax law.
- HMRC says it wants to make it simpler for startups and sole traders to ‘get their tax right and keep on top of their affairs.’
- Making Tax Digital for VAT began on 1 April 2019. It applies to all VAT-registered businesses with taxable turnover above £85,000.
What do I need to know today?
MTD currently affects VAT-registered businesses, but eventually, all businesses will have to go digital for tax purposes.
VAT-registered businesses whose annual turnover exceeds the VAT threshold (£85,000) now need to keep digital records and send digital VAT returns.
If your taxable turnover is less than £85,000, you can still put yourself forward for Making Tax Digital. The digital records businesses need to keep include:
- Key information about your business, including business name and principal address
- The value of the supply (net excluding VAT), the time of supply (tax point), and the rate of VAT charged
- Your VAT registration number and details of any VAT accounting schemes you already use
Approved compatible software needs to be used to submit VAT returns (see examples of compatible software below). Software will pull information from your digital records, which need to be kept for up to six years.
Spreadsheets can be used to calculate VAT transactions and work out what information you need to send to HMRC before submission. Eventually however you will need to fully switch over to MTD-compatible software for day-to-day tax record keeping.
What’s the timeline for Making Tax Digital?
The government’s original plan for MTD was to implement completely in cascading phases from 2018-2021. After industry consultation it was decided to begin with VAT-registered businesses and make MTD compulsory for them from April 2019.
- Today – VAT-registered businesses (those with taxable turnover of over £85,000) now need to maintain digital records, and submit VAT returns via approved accounting software
- April 2020 – HMRC plans to bring Income Tax and Corporation Tax under MTD’s umbrella.
- Also: A pilot project for freelancers to submit Income Tax via MTD systems is already underway.
Does Making Tax Digital apply to Income Tax?
Participants maintain tax records and send them to HMRC digitally, instead of using a Self-Assessment form. However:
- HMRC mandates the use of approved MTD-compatible software to take part in the trial
- You’ll need to submit an expense and income summary every three months.
- You’ll also need to submit a final report at the end of the accounting year, after which tax for the year will be calculated.
- It’s at that point you can claim any allowances or reliefs
How will it affect my Side Hustle?
HMRC says businesses with annual sales under £10,000 won’t be mandated to take part in MTD – though they are free to opt in if they want to take part.
Is anyone exempted from Making Tax Digital?
HMRC has made exemptions from MTD for the ‘digitally excluded’ and charities. Digitally excluded refers to people who are unable to use or engage with digital accounting software for reasons of:
- Remoteness of location
Making Tax Digital: 3 Wise Bear’s Verdict
Freelancers and contractors spend less time on accounting and IT-upskilling than larger businesses. That means MTD’s changes will have a heavier near-term impact on the self employed.
But digital transformation of the tax system is rolling onward, and regardless of size or resources, freelancers will need to catch up.
It may well be that MTD can help make sole traders more efficient by minimising the admin tasks that distract from more valuable activities.
From sales to operations, admin to inventory all business is rapidly going digital. It seems only fitting that tax should follow suit.
Freelancers, contractors, and sole traders will experience some initial pain. There will be a hard cost for software purchase or upgrade, and some time will need to be spent getting to know the software, then embedding it in everyday tax affairs.
If your business isn’t already using accounting software then a one-off cost is inevitable. While HMRC suggests software costs will be in the order of £70 a year for most freelancers, the Institute of Chartered Accountants in England and Wales puts it at closer to £1,250.
Once that cost and effort has been absorbed, we would expect freelancers to see the following benefits:
- Having real-time access to a full picture of your business’s tax affairs.
- Saving time and frustration by having all your business’s tax info in one place.
- Better ability to plan and budget with an up-to-date calculation of how much tax you owe.
Compliant Software for Making Tax Digital
Under MTD freelancers must use government-approved software to transmit their VAT returns digitally. Here are some of the more popular options:
FreeAgent is aimed specifically at freelancers and very small businesses. It’s core functions are in invoicing, expense management, and time racking. It’s also a cloud accounting software package so accessed via your web browser. FreeAgent claim they were pre- Making Tax Digital-ready – and have been able to submit digital VAT returns to HMRC since 2010.
Xero is another big player in cloud accounting software, offering easy-to-use functional modules for invoicing, payroll, inventory, and expense claims. You can use it to import banking, credit card, and PayPal data. Xero also offers a mobile app for iPhone and Android that allows you to access your accounts and make new entries on the move.