MTD for ITSA and what it means for you

The big news in the accounting and bookkeeping world is the Treasury’s announcement yesterday that they’re pushing back MTD for ITSA (Making Tax Digital for Income Tax Self Assessment) and considerably increasing the threshold at which it starts to apply.

🎄 It’s your Christmas present from HMRC! 🎄

I haven’t talked much about MTD, so you may be wondering what it’s all about.

What is MTD?

There are lots of parts to Making Tax Digital, including keeping your records electronically and impacting how and when you file returns with HMRC.

• The most visible part of MTD is filing returns with HMRC electronically.
• The most visible part of MTD ITSA is filing quarterly returns plus an annual return, instead of only annual returns.

Until yesterday, this was going to apply to some 4.5 million sole traders and landlords – anyone with sales over £10k per year. That was a huge change for a lot of people!

With the changes now announced, it is estimated that 4.5 million will drop to 1.6 million – so nearly 3 million people should be spared. Happy Christmas!

Why is HMRC bringing in MTD?

The short version is: To boost tax revenue.

HMRC estimates that it lost £32 billion in tax revenue for 2020-2021, 5% of the total. Mistakes and negligence are a fairly large chunk of that, plus deliberate avoidance. These numbers haven’t changed much for several years.

Millions and billions are notoriously difficult to wrap our heads around. To put £32 billion into context:

• The extra spending for Covid-19 is 10-12 times that amount (so, excluding interest, we could theoretically pay off all our extra Covid support measures in 10-12 years of recovering all lost tax).
• We could build about 4,600 new primary schools with £32 billion.

​In order to combat some of this, HMRC has been updating its systems to talk to each other (they currently don’t) and obliging more and more taxpayers to report electronically so that HMRC can use computers to search for suspected fraud or mistakes. 

So the big idea behind Making Tax Digital is to keep your records in an electronic means from the beginning (not on paper), and from those electronic records file directly with HMRC. One big reason behind this is to reduce typos. Instead of typing numbers from a piece of paper to one Excel sheet, then from there to another Excel sheet, and then from there into whatever you’re submitting to HMRC for your taxes, where each step along that way you could mis-type the number, the idea is to make it all electronic as soon as possible and then keep it that way. Link spreadsheets using cell references, or use accounting software (Xero, QuickBooks, Sage, etc), in order to reduce those mistakes.

I have seen a great number of mistakes brought about by typos or mis-adding. The amount of time collectively wasted by businesses sorting out these issues, if anyone added it all up, would be breathtaking, I am sure.

So is MTD a good thing?

Like everything else in Entrepreneur Land, it depends on your business.

I am a huge advocate, of course, for knowing what’s going on in your business so you can spot opportunities to trim the fat and increase profitability. Most of all, I believe in reviewing your reports frequently so you can respond to what’s happening in your business now.

It’s easy to cost a new product or service, decide to launch it, and then you are aware that some of your costs are now higher, without knowing how that impacts your profitability. It’s easy to decide to ignore that for now and just carry on selling and sort out the paperwork later. And if you do this, it’s easy to later discover you’ve been making no or very little profit on each one you sold – no wonder you feel like you’re working nonstop and have little to show for it!

If you develop the habit of pulling your numbers together to report to HMRC quarterly, then you can see that problem earlier, if you choose to look.

However, these are still two separate things. Forced filing of quarterly tax returns does not mean that every sole trader will be interested in reviewing their numbers and using them to improve their business. There are lots of situations where reviewing your accounting numbers to look for improvement opportunities doesn’t make a great deal of sense.

• Looking for better prices on their supplies and
• Reviewing booking patterns – perhaps they can rent the chair for 4 days a week instead of 5 but still get the same traffic?

• Networking to find those who can pay them top rates for the kind of work they can do.
• Searching to find the most cost-effective options to free up more of their time (hire a cleaner, a gardener, find a good hand car wash and valet, etc) to increase their availability for sales.

So is MTD a bad thing?

Again, that depends. It definitely has some downsides, though.

The biggest downside is cost – both in time and money. Everyone obliged to make quarterly filings would need to pay for either accounting software or bridging software to work with spreadsheets. Those who use bookkeepers and accountants would pay for 5 returns to be filed each year instead of 1. Those who don’t would need to spend more time filing those returns themselves.

Another risk is, ironically, more errors. The number of bookkeepers and accountants in the UK has experienced slow and steady growth over the last decade. There is no glut of newly qualified bookkeepers and accountants available to help those 4.5 million people file their 4 extra returns each year.

Being a bookkeeper or accountant is first and foremost about knowing the laws and regulations you’re working under.

• It’s no good to neatly log all the expenses you aren’t allowed to claim tax relief on; you have to know to remove those from your accounts so you don’t accidentally underpay tax and end up with a fine.
• It’s also not helpful to forego claiming the expenses you can; you want to include those so you don’t pay more than your fair share of tax.

Much of the hair-splitting between what’s allowed and what’s not is quite illogical – remember, politicians usually decide the law, not logicians (or mathematicians).

It takes many years to learn the regulations and how they apply in practice, and it’s not why you went into business as a creative. You went into business to create!

Some Background

Originally, HMRC planned to start MTD with sole traders. After considerable pushback from industry, the accounting sector, and professional bodies, HMRC instead first implemented MTD for VAT returns. That began being compulsory for most VAT-registered businesses in April 2019. It is now compulsory for all VAT-registered businesses since April 2022.

The first announced start date for MTD ITSA was April 2018. Yesterday’s deferral was the fifth one for this scheme.

In spite of it being in the plans for some years, HMRC hasn’t been able to issue definitive rules or guidance about the details of how to implement MTD ITSA yet. The software providers aren’t able to finish writing their integrations because the rules haven’t been finalised.

Part of the promise and challenge of MTD is a joined-up HMRC. I’ve been very surprised to hear about how disjointed HMRC’s records are. Different departments currently use different systems, so part of the move to MTD has been getting HMRC using one cohesive system. If this is implemented, the promise is that we should have fewer errors made by HMRC because Department 1 knows something that Department 2 doesn’t, and so you get a letter that you wouldn’t have gotten had they both known that same bit of information. This happens much more often than you’d think.

However, HMRC is a massive organisation. Its workforce has over 69,000 people. HMRC has had notable issues implementing new IT systems in the past. Change must be slow in such a huge organisation that affects so many others.

There have been far too many self-employment situations brought up by industry bodies and now by the pilot testing that HMRC’s systems are still not yet ready to tackle.

The Bottom Line

I expect further delays in implementing MTD ITSA. At this time, I wouldn’t worry about it impacting you if your sales are less than £50k per year.

If your sales are over £50k per year, honestly, you have enough moving parts in your business to benefit greatly from digital records. Regardless of when or if you might be obliged to keep digital records by HMRC, you should make your accounting records digital now to help yourself.

Whether spreadsheets or accounting software is more suitable for you depends on your business and how you operate.