Making Tax Digital (MTD) is the UK government’s flagship programme to make tax accounting easier for businesses and individuals such as sole traders.
As you might guess from the name, it does this by legislating the digitalisation of tax data and submission.
Making Tax Digital for Income Tax Self Assessment becomes law on 6 April 2023.
You might already use HMRC’s online services to complete tasks such as submitting your tax returns. But MTD for Income Tax, as it’s commonly known, goes further than that. It requires the use of software for your accounting. It even ends the need to submit annual tax returns.
There are an incredible number of benefits for businesses and individuals when it comes to digitalising taxes. For example, cash flow is improved because you have a good idea throughout the year how much tax you owe.
And using software for accounting means you spend much less time on admin, and more time doing what you love.
MTD for Income Tax will affect millions of sole traders and will change how they handle their taxes. It also affects landlords as well as the individuals within certain kinds of partnerships – but in this blog we focus on sole traders.
Notably, it only affects those who have a personal income above £10,000 across their businesses or properties.
If your income is £10,000 or below then you will continue using the existing Self Assessment system.
Here’s what we cover in this article:
1. Am I a sole trader?
Sole trader is simply a description of one of three business types for tax purposes. The other two are partnerships and incorporated businesses.
If you work for yourself, you’re considered to be in business. You own your business and are entitled to keep all its profits after tax.
You should anticipate having to pay taxes and National Insurance contributions once what you make through your sole trader business gets past the trading allowance of £1,000.
To do this, you have to register with HMRC so you can use the Self Assessment tax system. And then file an annual Self Assessment tax return where, among other things, you tell HMRC how much you’ve earned, and how much you’re claiming as allowable expenses.
Once you do this, you’re considered a sole trader.
All kinds of people and businesses are sole traders – from freelancers, to construction workers such as builders or plumbers, to those who provide services.
As described below, Making Tax Digital for Income Tax will replace the Self Assessment system for many of the above sole traders who fall within its scope.
2. What are the MTD for Income Tax rules for sole traders?
This is what we know so far about the MTD for Income Tax Self Assessment requirements, pending legislation being published by the government.
This is based on what the government has announced so far, as well as the rules for the MTD for Income Tax pilot scheme.
MTD for Income Tax scope
The majority of sole traders whose business income is above £10,000 will be required to use compatible software for their income tax accounting for the first full accounting period starting on or after 6 April 2023.
This income threshold applies to the individual. It might come from just one business, or multiple entities.
Rental income from property you own contributes to this £10,000 threshold, too.
If you owned and operated four businesses, each with an income of £3,000, for example, you’d need to register for MTD for Income Tax and then follow its rules for all of them.
Similarly, if you received £5,000 income from your sole trader business and £6,000 from rental income on property you own, you’ll need to use MTD for Income Tax.
Self Assessment changes
For taxpayers who submit details via the MTD for Income Tax route and report all their income and allowable expenses, there will no longer be any need to send a Self Assessment tax return (outside of a minority of circumstances where other types of income or deductions need to be declared, in which case a Self Assessment return may be required in addition to following MTD for Income Tax’s rules).
For each of their businesses, individuals will need to submit updates at least quarterly (or more frequently if desired), and an end of period statement (EOPS).
On 31 January each year, they will need to submit a single final declaration for all their income (see below).
See below for more information about each of these.
While this may sound like a lot of documentation, if you’re using compatible accounting software, it will automate the tasks. Most taxpayers will find they do less admin work than under the traditional Self Assessment process.
Under the MTD for Income Tax rules, an update about for each business you own has to be sent to HMRC via software every three months (or more frequently if you choose to).
You’ll also need to send a quarterly update for any rental income from property that you own.
You’ll then see a more up-to-date estimate of how much tax you owe.
But this will only be based on the information you provide, so won’t take into account any adjustments that you make at the year-end for assets or reliefs.
In other words, there’s no legal requirement for quarterly updates to be accurate – if they are.
End of period statement (EOPS)
At the end of each accounting period (sometimes known as the basis period), you’ll need to make an EOPS for each business that you own, and also an EOPS for income from property (if you have any) that includes any adjustments that are needed.
This is similar to the current process for the SA103 and SA105 schedules.
Notably, the EOPS applies to each business you run, rather than the individual, so you may find yourself submitting several.
It’s likely that if you use an accountant or tax adviser, they’ll help with this to help take advantage of any allowances and tax reliefs that can be claimed.
They’ll also support you with any complex calculations such as accounting for leases, assets, R&D, etc.
Final declaration each year
After the end of your accounting period, you need to ‘crystallise’ your income tax.
This means you’ll need to use software to view the final income tax estimate calculated by HMRC, which includes details of all the income, expenses and allowances you’ve told it about.
Your accountant might make corrections or adjustments at this point too.
You’ll then need to legally declare – via the final declaration – that you’ve provided HMRC with all the information it requested and that you agree with its income tax calculation.
The final declaration applies to individuals, and not to individual businesses and/or property income, so you’ll only submit one each tax year.
3. When does MTD for Income Tax start for sole traders?
Sole traders will have an MTD for Income Tax ‘digital start date’ for their business. This will be the same date as the start of their first full accounting period following 6 April 2023.
If you use the tax year for your accounting period (6 April to 5 April), you’ll need to use MTD for Income Tax once the new tax year starts.
As of this digital start date, sole traders will need to follow the MTD for Income Tax rules if their income is above £10,000.
Remember that this £10,000 threshold income can be from multiple businesses and should include any rental income on properties you own.
However, if your accounting period ends after 6 April 2023, your digital start date will be later.
It’s even possible your digital start date could be almost a whole year after 6 April 2023 if your accounting period ends at the end of March 2023.
Even if you start to use MTD for Income Tax as of 6 April 2023, there will be an overlap with the existing Self Assessment system.
For example, you’ll still need to submit a Self Assessment tax return for the 2022/23 tax year by 31 January 2024 (or 30 December 2023, if you want HMRC to collect taxes due from wages and pensions via PAYE).
The exception to this is if you’re already part of the MTD for Income Tax pilot and have submitted quarterly updates, EOPS, and a final declaration.
4. Which sole traders are affected by MTD for Income Tax?
Any sole traders that have a taxable income over £10,000 are impacted by MTD for Income Tax. This can be from any businesses they own or rental on property they own (or a combination of them).
Those whose business income is below this threshold or those who complete Self Assessment for other reasons – such as for state benefits, pension income or savings interest – will probably see no changes.
5. Will a sole trader still be able to file paper Self Assessment returns under MTD for Income Tax?
If your income is below £10,000, the MTD for Income Tax regulations won’t apply to you. It’s likely you’ll be able to continue filing your Self Assessment return in the same way as usual.
While most businesses required to follow the MTD for Income Tax rules will have to use compatible software, some can apply to be digitally excluded.
This is allowed because it’s either impossible or impractical for them to use technology in the way MTD requires.
Examples include those who don’t have internet access because of their remote location. Some disabilities make using technology difficult or impossible.
Some religions prohibit the use of technology in the way MTD demands. HMRC considers these valid reasons for exemption, and there are other circumstances too.
However, these really are exceptions and will apply to only a few.
Additionally, it’s likely those wishing to become digitally exempt for what HMRC considers legitimate reasons will have to apply to HMRC directly and explain why.
6. Can a sole trader opt-out of MTD for Income Tax?
MTD for Income Tax is not optional if you fall within its scope (that is, you’re a sole trader and/or landlord with an income over £10,000).
In other words, you can’t simply choose not to take part.
But it’s possible to apply to be digitally excluded if you have a good reason – see “Will a sole trader still be able to file paper Self Assessment returns under MTD for Income Tax?” above.
7. What software does a sole trader need for MTD for Income Tax?
You’ll need to use MTD for Income Tax-compatible software to store your digital records for any business you run, send the required information to HMRC, view HMRC’s estimate of the final tax bill and send a final declaration to ‘crystallise’ your income tax.
According to TechRadar: “The best route to take for making the whole tax filing process even easier is to select a comprehensive accounting solution” – and it’s chosen Sage Accounting as the ideal choice to fit that criteria.
You can expect that most cloud-based small business accounting software will be updated in time for MTD for Income Tax.
If you use traditional desktop software, you’ll need to ensure it’s updated in time for MTD for Income Tax or investigate how to integrate it with bridging software, so any gaps in the digital journey are covered.
You may find some older software simply won’t be updated, so you might need to change to a newer package or software provider.
You should allow time for this to take place well ahead of the 6 April 2023 implementation date.
If you use a spreadsheet for your accounting, see “Can a sole trader use spreadsheets for MTD for Income Tax?” below.
8. What will the MTD for Income Tax deadlines be for sole traders?
You’ll need to submit quarterly updates and EOPS based on your accounting year.
But the EOPS for a business’ given accounting year will need to be submitted by 31 January following the tax year, as with Self Assessment. This date is the deadline, and it’s advised to submit this sooner.
The final declaration always has a deadline of 31 January.
You’ll still need to pay your income tax by 31 January of the following year. If you’re required to make a payment on account for the current year, this will need to be made by the following 31 July, as per existing rules.
9. If a sole trader has already registered for MTD for VAT, do they need to register for MTD for Income Tax?
Yes. The two schemes are separate, requiring their own sign ups and differing in their approaches and requirements.
For example, with MTD for VAT, you still need to submit periodic VAT Returns. With MTD for Income Tax, you no longer need to submit a return.
To avoid additional admin work, if you’re already registered for MTD for VAT, you might opt to adjust your accounting period so that the requirement for MTD for Income Tax’s quarterly updates align with the requirement for submitting VAT Returns.
This change will need to be done ahead of time because the request to adjust your accounting period must be made via a Self Assessment tax return – but it’s not yet clear how such a change will be achieved under MTD for Income Tax.
Speak to an accountant if required.
10. Can my accountant sign my sole trader business up for MTD for Income Tax?
Yes. You should speak to them about this well ahead of time.
An accountant will also be able to submit quarterly updates, EOPS and a final declaration on your behalf – although they will probably consult with you to ensure all the details are correct.
Even though the accountant handles these for you, you must use software for your accounting, and keep your accounting relating to sole trader income digitally.
11. Can a sole trader use spreadsheets for MTD for Income Tax?
With the MTD for VAT scheme, introduced in 2019, it’s permissible to use an add-in known as bridging software alongside a spreadsheet to comply with the requirement to file VAT Returns digitally.
However, with MTD for Income Tax, you need to do much more than this. Quarterly updates, EOPS and a final declaration all need to be made digitally.
It’s hard to see how this can be achieved in a user-friendly way with a spreadsheet.
Nonetheless, it’s likely there will be some examples of spreadsheets that are compatible with MTD for Income Tax.
None of this means spreadsheets should be avoided entirely. They’re definitely a handy tool for businesses and can be used for all kinds of tasks.
But they have limitations.
For example, you must keep your MTD for Income Tax accounting records for at least five years.
It’s incredibly easy to accidentally delete a spreadsheet file, or overwrite the contents of a cell through mistyping.
If you do this with a spreadsheet containing your historic MTD for Income Tax accounting, then you could be liable for a fine if HMRC found out.
There are also issues around what HMRC calls digital linking.
This means all your accounting data must be digitally linked so the information is transferred between systems in a way that’s automated.
Manually copying and pasting data from one place to another isn’t allowed, and could result in a penalty if HMRC finds out.
If you keep your accounting in a spreadsheet and then copy and paste it across to you accounting software to make a quarterly update/EOPS/final declaration, for example, this could attract a penalty from HMRC.
12. Can a sole trader still handwrite or print invoices under MTD for Income Tax?
There’s no issue with creating paperwork in your business under MTD for Income Tax’s rules.
The proviso is that the data will either have to already be in your digital accounting records (e.g. you’re printing an invoice for posting out from within your accounting software), or you’ll need to transfer the details to your digital accounting records as soon as possible.
One thing is certain: using a modern accounting software solution will ensure your accounting records are being kept digitally in any event, even if you or your clients/customers still have a need for paperwork.
13. Can a sole trader deregister from MTD for Income Tax?
It’s not yet known if sole traders will be able to remove themselves from MTD for Income Tax should their income fall below £10,000.
Nor is it known if sole traders will be able to voluntarily make use of MTD for Income Tax if their income is below £10,000.
Final thoughts (and bonus steps) on MTD for Income Tax for sole traders
Although MTD for Income Tax might seem a distance away, you need to start planning now.
Consider the following steps:
1. Are you mandated for MTD for Income Tax?
It’s simple to work out, as mentioned above: take your income from any sole trader business(es), plus any rental income from property you own. If this is above £10,000, you’ll need to register for and use MTD for Income Tax.
It’s not yet clear how HMRC will require sole traders to work out whether their income is above £10,000 but it’ll probably be based on the previous Self Assessment return.
Similarly, a sole trader or landlord won’t need to use MTD for Income Tax until they pass the £10,000 threshold within a Self Assessment return they submit.
2. Work out your digital start date(s) for MTD for Income Tax
This will be the same as your first accounting period that begins on or after 6 April 2023. If you follow the tax year for your business, as many sole traders do, your digital start date will be 6 April 2023.
3. If you have more than one business, adjust the accounting periods so they all align
This will mean you can submit updates in one fell swoop, rather than having to cope with the admin load of having to do so individually across the months for each business.
Speak to your accountant if you need help doing this.
4. Plan to register for MTD for Income Tax well ahead of this date
It’s not yet clear if there will be limitations on how soon before your digital start date you’ll be able to apply. We should know more closer to the time.
You can register for the MTD for Income Tax pilot right now but software support is currently limited and registration is just for those who have a single sole trader business.
5. Look at your business admin. How much of it is compatible with MTD for Income Tax’s requirements?
For example, how much paperwork do you continue to rely upon?
Even spreadsheets might present issues when it comes to MTD for Income Tax – think deleting entries accidentally, mistyping, overwriting the contents of a cell, plus the need to make those quarterly updates, EOPS and final declarations.
6. Start your digitisation process as soon as possible
To avoid admin overload, you shouldn’t aim to introduce a new accounting system at the same time as MTD for Income Tax is mandated for your business(es). Instead, aim to be up and running with your new accounting solution well ahead of time.
Doing so as soon as possible will put you in the best position and give you a chance to firmly establish new working practices.
In addition, you should speak to your accountant, if you have one, to get advice and see what changes they’re planning and implementing.
If you use cloud accounting software, the good news is you almost certainly already meet the required criteria for digital record-keeping – and feature updates for EOPS and the final declaration are likely to arrive well in time for the MTD for Income Tax mandation date.
If so, it’s possible all you’ll need to do for the 2023/24 tax year is use the features that exist within your accounting software.
However, if you use spreadsheets, paper or a desktop accounting software package for your accounting, you’ll need to start making preparations earlier.
Switching to a cloud accounting package should be done sooner rather than later because that’ll give you time to become at ease with improved accounting processes ahead of the MTD for Income Tax start date.
Editor’s note: This article was first published in August 2020 and has been updated for relevance.
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