Making sense of Making Tax Digital

Many businesses are using MTD as an opportunity to revamp outdated compliance processes and seek out opportunities to automate time-consuming processes.

Making Tax Digital (MTD) was introduced on 1 April 2019 in the United Kingdom (UK) with a six-month deferral in place for a small cohort of taxpayers. The aim of MTD is to transform and modernise how tax is reported and managed, and the first stage of MTD is to bring VAT into the digital domain.

For VAT periods commencing on or after 1 April 2019, all VAT-registered businesses with a turnover in excess of the VAT registration threshold (taxable supplies of £85,000 per annum) will be required to maintain digital records for VAT and submit their VAT returns digitally. There will be some limited exceptions, which are in line with the current exceptions for businesses that are unable to submit returns electronically (due to lack of internet access, insolvency or religious beliefs, for example). Once a business is covered by MTD, it will remain within the regime even if its turnover later goes below the threshold, while businesses for which MTD is not mandatory can opt into the regime if they so wish.

The UK is one of many jurisdictions taking measures to modernise the tax reporting process. MTD is unique in its design and, unlike measures taken in mainland Europe, doesn’t require the provision of additional data to the tax authorities. However, the need to maintain quality data to support the tax reporting process is critical for businesses to build the robust electronic audit trail that is now required.

MTD requirements

There are three principal requirements in relation to MTD for VAT. Each requirement is outlined below.

Digital records 

(effective from 1 April 2019)
Details of the business transactions that directly lead to the creation of the summarised VAT return figures due for periodic submission to HMRC must be maintained in digital form within ‘functional compatible software’.

The time of supply, value of supply and the amount of input VAT to be claimed must be recorded digitally in respect of all individual purchase transactions. For sales, it is necessary to record the time of sale, value of sale and the applicable VAT rate.
This requirement may be straightforward for larger businesses, which already record granular data in enterprise resource planning (ERP) systems. While standard accounts payable or accounts receivable transactions will contain the required data, however, exceptional items recorded by journal entry or manual workarounds are presenting challenges to businesses in meeting their MTD obligations. It should be noted that where improvements can be made to the raw data and system tax logic supporting VAT compliance, this will help streamline the tax compliance process and help businesses meet MTD’s other requirements – in particular, the need to build “digital links”.

Digital links 

(soft landing up to 1 April 2020)
It will be necessary to demonstrate that “digital links” are used throughout the end-to-end VAT return preparation process to transmit data between systems used to produce data relevant to the VAT return. Re-keying data and the use of ‘cut and paste’ are specifically prohibited. Information flows between systems must therefore be automated.

It should be noted that links between various Excel documents are permitted. However, businesses will be challenged by the manual adjustments and various journal entries that typically form part of the VAT reporting process.

While this requirement has the force of law from 1 April 2019, HMRC has confirmed that a “soft landing” period will apply, whereby penalties will not be imposed for non-compliance prior to 1 April 2020 (or 1 October 2020 where the deferral applies). However, the soft landing applies only in respect of the digital links requirement.

Digital submission of VAT returns

(effective from 1 April 2019)
For VAT periods commencing on or after 1 April 2019, VAT return information can only be submitted to HMRC via an application programme interface (API). It will no longer be permitted to manually complete the nine-box UK VAT return via HMRC’s portal. HMRC has issued a list of compatible software packages that will support this requirement.

For some of the larger businesses that already keep digital records and have automated VAT compliance processes which comply with the first two requirements mentioned above, MTD may simply require investment in bridging software to allow the business’s software package(s) to ‘talk’ to HMRC’s systems and achieve compliance with the third requirement. For others, more action may be needed depending on how the business arrives at its VAT return figures at present and the extent to which records are currently maintained digitally.

Deferral

A six-month deferral is available for certain categories of taxpayer including public bodies, members of VAT groups and foreign non-established businesses with a UK VAT registration.

It should be noted that a specific direction from HMRC is required in order for the deferral to apply. We understand that HMRC has written to the taxpayers they believe to be in this category. Where the deferral applies, the requirements in respect of digital records and the digital submission will apply from 1 October 2019, while the requirement to maintain ‘digital links’ will not apply until October 2020. Businesses that believe they should be entitled to the deferral, but have not received a notice from HMRC, should contact their case manager as a priority.

What’s next?

It is expected that MTD will eventually be extended to income tax and corporation tax. An exact timeline for implementation has not been confirmed, but HMRC has stated that it will not be before April 2020. MTD for income tax and corporation tax will likely require periodic disclosure of income, expenditure and profit data, which is not currently disclosed until annual tax returns are filed. Many commentators view this as signalling the beginning of the end of the tax return as we know it.

There has been a clear shift in recent years towards real-time reporting and greater collection of data by tax authorities. This is perhaps most evident in Spain, where the 2017 introduction of Immediate Supply of Information requires detailed invoice data to be filed with the Spanish tax authorities within four days of the transaction.

This prompts the question: when will such measures be introduced in Ireland? Revenue’s first step into the world of real-time reporting, PAYE Modernisation, is now up and running. Changes to the administration of VAT and other operational taxes may be a logical next step as Revenue continues to modernise Ireland’s tax system.

Conclusion

As tax authorities’ analytics capabilities become more sophisticated, businesses will have to deploy significant resources to react to tax authority changes. While the exact requirements may vary across jurisdictions, the principle of ‘garbage in, garbage out’ holds true across the board. Many businesses, especially those with operations in multiple jurisdictions, are using MTD as an opportunity to revamp outdated compliance processes and seek out opportunities to automate time-consuming processes before the compliance burden gets even larger.

As businesses seek to future-proof their tax reporting process, the starting point for tax and finance teams is typically a data cleansing exercise and a review of tax functionality in finance systems to eliminate the root cause of existing inefficiencies and workarounds.

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Key steps in preparation for Making Tax Digital

Businesses should assess the impact of MTD on their UK VAT reporting process to ensure that they are compliant from 1 April 2019. This assessment should include: 

• Reviewing the existing end-to-end process to ensure it is efficient and accurate;
• Securing confirmation from HMRC where entities are eligible for deferral;
• Verifying that the business is capable of submitting VAT returns digitally via an API for the first VAT return period commencing on or after 1 April 2019;
• Reviewing existing records to confirm that they meet the MTD digital record-keeping requirements and are retained in functional compatible software;
• Putting a plan in place to ensure that the journey of information, from source to VAT return, will be compliant with the digital link requirement from 1 April 2020. As this may involve changes to finance systems and business processes, early engagement with IT is key; and
• Where the deferral applies, ensuring that correspondence has been received from HMRC to this effect.