Avoiding Penalties Under Making Tax Digital: A Practical Guide

Making Tax Digital (MTD) is a pivotal move by HMRC to modernise the UK tax system. Through the use of digital tools, it aims to simplify the tax process, reduce errors, and ensure more accurate tax returns. However, while MTD brings efficiency, it also introduces a risk of penalties. This guide explains everything UK businesses need to know about avoiding penalties under Making Tax Digital, ensuring full compliance and peace of mind.

Understanding Making Tax Digital (MTD)

Making Tax Digital is a government initiative aimed at transforming tax administration by making it more effective, efficient, and easier for taxpayers. MTD requires businesses and individuals to maintain digital records and submit updates to HMRC using functional compatible software.

Online sellers using digital platforms must stay compliant, and our Ecommerce Accountants UK team can help ensure you meet all MTD obligations.

This digital service began with VAT-registered businesses, but it's gradually expanding to cover income tax for self-employed individuals and property income recipients under MTD for ITSA (Income Tax Self Assessment).

Key elements of MTD include:

• Maintain electronic records

• Submit quarterly updates to HMRC

• Use MTD-compatible software

• Avoid manual data entry

Who Needs to Comply With MTD?

VAT Registered Businesses

All VAT-registered businesses must now follow MTD rules for VAT, regardless of turnover. The VAT registration threshold is currently £90,000 (increased from £85,000 in April 2024). You must keep VAT records digitally and file VAT returns via MTD-compatible software.

Self-Employed & Sole Traders

• April 2026: Self-employed individuals with business or property income over £50,000 will need to comply with MTD for ITSA

• April 2027: Those earning above £30,000 will follow

• April 2028: Those earning above £20,000 will need to comply

Property Income Earners

Landlords with qualifying income from rental properties will also fall under MTD rules. This includes those with joint property income and married couples allowance recipients.

Important Note on Partnerships

Partnerships are currently excluded from MTD for ITSA regulations. HMRC intends to extend MTD to partnerships in the future, but no date has been announced.

MTD Rules & Key Dates

To comply, businesses must meet all requirements by the relevant tax year and maintain their records accordingly.

Required Software for MTD

Functional Compatible Software

This is software that can:

• Record and store electronic records

• Submit data to HMRC via digital links

• Maintain adequate records

MTD Compatible Software Options

Popular options include:

• Xero

• QuickBooks

• FreeAgent

• Sage

All offer features such as automatic VAT calculations, bank statement imports, and support for quarterly submissions. Cloud-based MTD software is recommended for easy access and data security.

Keeping Electronic Records Accurately

Digital records must include:

• Business name, address, and National Insurance number

• VAT number (if applicable)

• Details of income and expenses

• Accounting period dates

• Invoices, bank statements, and receipts

Important: Quarterly updates are now cumulative, allowing errors to be corrected as part of the following update without needing to resubmit previous quarters.

Quarterly Submissions Explained

Instead of the traditional annual tax return, businesses under MTD must submit digital quarterly updates. This ensures HMRC receives real-time data and helps you stay on top of your tax affairs.

Submission Deadlines

The quarterly deadlines are the 7th of the month after the quarter end (changed from the 5th to align with VAT reporting deadlines):

• Jan-Mar: 7 May

• Apr-Jun: 7 August

• Jul-Sep: 7 November

• Oct-Dec: 7 February

Late or missed submissions attract penalty points and potential financial penalties.

Common Pitfalls and Errors

• Not using compatible software

• Missing a VAT return deadline

• Incomplete or inaccurate business records

• Forgetting to submit quarterly updates

• Using multiple platforms without digital links

Penalties for Non-Compliance

Late Submission Penalty Points

You get one penalty point per missed deadline. When you hit the threshold (e.g., four points for quarterly submissions), a £200 penalty applies. Points accrue separately for VAT and Income Tax.

Points thresholds:

• Monthly submissions: 5 points = £200 penalty

• Quarterly submissions: 4 points = £200 penalty

• Annual submissions: 2 points = £200 penalty

Points expire after 24 months if you remain below the threshold.

Late Payment Penalties (Updated Rates from April 2025)

No penalty for the first 15 days

After 15 days: 3% penalty on the outstanding tax amount

After 30 days: Additional 3% penalty on the outstanding tax amount (total 6%)

After 31+ days: 10% per annum daily interest on the outstanding amount

Interest Rate: HMRC charges interest at 8.5% from April 2025 (Bank of England base rate plus 4 percentage points).

Inaccuracy Penalties

Incorrect submissions due to negligence or deliberate errors incur penalties ranging from 15% to 100% of the tax due.

Tips to Avoid MTD Penalties

• Set calendar alerts for quarterly submissions

• Use MTD-compatible accounting software

• Keep digital copies of all business transactions

• Review submissions for accuracy

• Maintain bank statements and receipts digitally

• Consider setting up a Time to Pay arrangement if you cannot pay on time (this stops penalty accrual)

Appeals: What to Do If Penalised

If you believe you've been wrongly penalised, you can:

• Contact HMRC via their online service

• Request a review or make an appeal

• Provide supporting evidence of a reasonable excuse

• Refer to the First-tier Tribunal if unsatisfied

Special Cases and Exemptions

HMRC has announced various exemptions and deferrals, including:

Automatic Exemptions

• Foster carers (for qualifying care relief)

• Those without reliable internet access

• Individuals who do not hold a National Insurance number

• Taxpayers for whom HMRC "cannot provide a digital service"

Deferrals During Current Parliament

Certain groups will not have to comply with MTD during the current Parliament, including:

• Non-UK resident individuals (until April 2027)

• Those who submit residence/remittance basis pages (SA109) with their tax returns

Application-Based Exemptions

Some exemptions require application to HMRC, including those for digitally excluded individuals.

Important: The exemption application process is expected to be available from October 2025. While your application is being considered, you are not required to comply with MTD rules.

Role of Accounting Software

Accounting software simplifies:

• Tracking income and expenses

• Generating reports

• Automating quarterly updates

• Minimising data entry errors

• Ensuring digital links between systems

With the right software, compliance becomes significantly easier.

Why Compliance Matters

Staying compliant with Making Tax Digital is not just about avoiding financial penalties. It's about building a robust financial foundation. With digital tools and timely submissions, businesses can:

• Monitor cash flow more effectively

• Gain insights into tax liabilities early

• Avoid last-minute panic during tax season

• Reduce administrative burden over time

Frequently Asked Questions (FAQs)

What counts as qualifying income for MTD?
Qualifying income includes business or property income above HMRC's thresholds. This excludes savings or investment income.

What happens if I miss a quarterly update?
You'll receive a penalty point. Four missed quarterly updates led to a £200 financial penalty.

Can I use spreadsheets to keep digital records?
Yes, but only if you use digital links to submit data via MTD-compatible software.

How does MTD affect self-assessment tax returns?
You'll switch from annual returns to quarterly digital updates, plus an End of Period Statement and final tax return.

What if my business has seasonal income?
You must still submit quarterly, even if you've had no income during the period. A nil return is still necessary.

Are partnerships included in MTD?
No, partnerships are currently excluded from MTD for ITSA, with no confirmed date for inclusion.

What if I can't pay my tax on time?
Contact HMRC immediately to arrange a Time to Pay agreement. This stops penalty accrual and may prevent interest charges.

Conclusion

Adapting to Making Tax Digital can be challenging, but with proper preparation and the right guidance, it becomes a powerful tool for your business. Avoid penalties, keep your finances in order, and future-proof your tax process by:

1. Choosing appropriate MTD-compatible software

2. Setting up digital record-keeping systems

3. Understanding the penalty structure

4. Preparing for your relevant start date

5. Seeking professional advice when needed

The key to MTD success is early preparation and understanding the requirements before they become mandatory for your business.

Important Disclaimer

This guide is for general information only and should not be considered official tax advice. Tax regulations change frequently.

For official information, always consult:

• Gov.uk - Official HMRC guidance

• HMRC directly for specific queries

• Qualified tax advisors for personalised advice

Numbersmith accepts no responsibility for actions taken based solely on this guide. Always verify information with official sources and seek professional advice for your specific circumstances.