It would be a mistake for businesses to believe that Making Tax Digital for VAT is old news.
There’s a monster lurking in the shadows: the digital link.
And defeating the monster could involve significant additional adjustments for VAT accounting with businesses.
A ‘soft landing period’ was granted to businesses adopting Making Tax Digital (MTD) for VAT when it first came into operation in April 2019.
This gave 12 months to get systems 100% digitally linked, to comply with MTD’s requirements.
In 2020, this soft landing period was extended to April 2021 for every business making use of MTD for VAT. This was because of coronavirus disruption.
Initially until April 2020, and now until April 2021, HMRC considers the cutting or copying and pasting of data, for example, from one application to another, to be a kind of digital link. Ordinarily, this is prohibited.
If businesses continue doing this beyond April 2021 then it will incur the wrath of the VAT Inspector. Penalties could follow.
“Business is stressful enough without the extra pressure of MTD,” says Steve Bicknell, a certified management accountant and managing director of Bicknell Business Advisers Ltd. “Many businesses made incorrect assumptions about digital links.”
Are you one of the businesses doing digital linking the wrong way? And, if so, what can you do about it?
Read this article to find out. Here’s what it covers:
What is an MTD digital link?
To be compliant with Making Tax Digital for VAT, businesses needed to shift their accounting to “functional compatible software”, in the words of HMRC.
But what if you use more than one piece of software? Perhaps you use one for record keeping and one for submission. Or what if you use spreadsheets for part or all of your accounting – how do you make everything work together?
A digital link is the solution.
It occurs when the VAT data required for MTD is transferred between two digital places, such as software or computing devices.
A digital link also applies to recapturing or modifying the data when moving it between two digital places.
For example, a digital link exists when a business digitally transfers VAT accounting data to their accountant so a partial exemption can be calculated.
It also occurs when a business retains all transactions in a spreadsheet and uses a formula to calculate a total.
There are strict rules on what defines a digital link for MTD. According to HMRC, they have two characteristics:
- Data is transferred electronically between software programs, products or applications. This could include linked cells in a spreadsheet, such as a formula.
- The transfer is automated. It doesn’t need manual intervention such as copying over the data by hand or manually moving data between two or more pieces of software. But you can, of course, click a button to initiate the process.
HMRC accepts the following less obvious examples as digital links, although there are others too:
- Emailing a spreadsheet so it can be imported into software.
- Using a memory stick or pen drive, even if you physically hand this to somebody else who then imports the data into their software.
- CSV or XML import and export, including the downloading and uploading of files.
- API: This is the technology used when software or computers talk to each other to transfer data. It’s how accounting software talks to HMRC’s computers in order to submit your VAT return, for example.
“No one imagined a digital link would include putting something on a memory stick or sending an email to your accountant,” says Bicknell.
“It took a long time for HMRC to give details on what would count as a digital link, which created unnecessary worry for businesses.”
But HMRC is keen on digital links not because it wants to make things more difficult. It wants to reduce the potential for errors.
Fewer errors mean a reduced possibility of penalties for businesses and, of course, it means HMRC gets all the taxes it’s due.
By introducing digital links, HMRC was also pointing to how automation can help businesses.
The more of your accounting that’s automated, the more you can focus on building your business. In this way, HMRC hopes to address the productivity gap that businesses are struggling with.
What is not considered a digital link?
As mentioned, what is considered a digital link is perhaps surprisingly inclusive.
But HMRC says one thing is definitely not a digital link: ‘cut and paste’ or ‘copy and paste’ to select and move information, either within a software program or between software programs.
There are slightly different rules for making input/output adjustments, as we’ll explain in a minute.
But it’s otherwise correct to say that cut/copy and paste must never be used in the presence of the VAT accounting records required for MTD.
“Cut/copy and paste is seen by HMRC as risky and error-prone,” adds Bicknell. “It also means lots of manual intervention, which is inefficient and time-consuming.”
However, HMRC knew some businesses still relied upon multiple pieces of software for their accounting, not all of which had easy tools to share data. Some businesses just didn’t have their systems fully linked together in time for the original April 2019 introduction of MTD.
So, it initially granted a one-year grace period – known as the soft-landing period – during which cut/copy and paste were considered to be a way of digital linking.
And it has now extended this soft-landing period to April 2021.
The extension applies to all businesses that use MTD for VAT – those that began doing so in April 2019, and also those who had a deferred MTD start date of October 2019.
However, you should not forget that when April 2021 rolls around, cut/copy and paste when it comes to your MTD for VAT records will break the law for all MTD for VAT businesses.
HMRC will understandably take a very dim view.
Speaking as an accountant, Bicknell’s advice is simple: “Why not just bite the bullet and find a complete MTD for VAT compatible accounting solution? It will make your life and your accounting much easier.”
As mentioned earlier, adjustments to the input or output tax are treated differently in MTD (notably, the specific adjustments are outlined in section 4.4 of the official VAT Notice).
The total of the adjustment must be kept as a digital record but the calculation you use to create it in a spreadsheet does not need to be digitally linked (although it should be retained for your VAT record keeping).
Adjustments can be manually journaled into your VAT accounting.
In other words, this is the one instance in the world of MTD for VAT where it’s OK to manually type figures or cut/copy and paste (provided the data isn’t pasted directly into one of the nine boxes of the actual VAT return, which isn’t allowed under the MTD rules).
Read more about Making Tax Digital
- How to submit a Making Tax Digital for VAT return
- Making Tax Digital and its future: 10 answers from HMRC
MTD digital link misunderstandings and myths
Perhaps understandably, there’s been some confusion about the upcoming digital linking requirements. Let’s clear up some misunderstandings, as follows.
Put simply, the end of the soft landing period does not mean the end of spreadsheets in your VAT accounting.
Spreadsheets can be used alone if they’re MTD API-enabled so they can record and submit digital transactions.
Or they can be used as part of a larger software suite, assuming there are digital links in place between all the software used.
However, using spreadsheets for all of your VAT accounting can be problematic, as explained below – see “Digital linking for MTD and spreadsheets”.
As mentioned earlier, the end of the soft landing does not mean the end of manual adjustments for things like the capital goods scheme, partial exemption and so on.
Manual adjustments prior to submission are completely acceptable as long as digital links are in place.
Here’s a basic example.
Based on the underlying transactions, my software records VAT box 1 as £1,000.
I then make a manual adjustment in my accounting for £100 (for which I have supporting evidence/calculations), and the software automatically calculates that the revised box 1 figure is £1,100.
This is acceptable.
What would not be acceptable is if, based on the underlying transactions, my software records VAT box 1 as £1,000 and I then manually overwrite this figure with £1,100.
Many people think that the end the soft landing period means bridging software can no longer be used.
This is not correct.
As long as bridging software is used in the appropriate way and digital links are in place then it is fine to keep using it. This will the case for the foreseeable future.
However, it can be problematic to use – again, see “Digital linking for MTD and spreadsheets” below.
What to do if your digital links aren’t legal
“While most businesses have met their obligations and complied with MTD, it could have been so much simpler,” says Bicknell. “Confusion has led to unnecessary costs particularly consultancy around gap analysis.”
But what do you do right now if you’re using cut/copy and paste for your VAT accounting?
The answer might not be as drastic as simply avoiding the good old cut and paste.
First, check if the data you’re cut/copying and pasting is that specified as a digital record in the MTD for VAT regulations (specifically, VAT Notice 700/22).
Your VAT records are likely to be extensive but the MTD for VAT rules encompass only certain parts of it (albeit the important parts).
For example, retail schemes only need to keep a digital record of their daily gross takings (DGT). The supplies that make up the DGT are outside the scope of MTD’s record-keeping requirements.
In other words, if you cut/copy and paste data relating to these supplies then you can continue to do so.
If you’re using the Flat Rate Scheme, you don’t need to keep digital records of your purchases (unless they’re capital expenditure goods on which the input tax can be claimed). So, you can happily cut/copy and paste data relating to these purchases.
A rule of thumb is that MTD record-keeping requirements cease at the invoice level. For example, you can handwrite invoices, if you like, provided the transactional data is transferred to your digital VAT accounting solution as soon as possible.
You need to transfer the tax point date, the value of the sale, the VAT rate applied, and the VAT element from the invoice.
However, you should seek expert advice from an accountant or HMRC if you’re uncertain about what constitutes MTD for VAT digital records in your business and the VAT scheme you’re using. Remember, you could get fined if you get it wrong.
Of course, the simple solution is to use MTD for VAT-compatible accounting software. If you issue invoices from the software or log your supplies using it, then you don’t even have to think about record keeping.
Somebody else has sweated the details for you.
When the time comes for your VAT return to be submitted, you can simply click a button and, in most cases, everything will be filled in and ready to go.
Digital linking for MTD and spreadsheets
Spreadsheets are computing’s greatest gift to the world of accounting. But their use for VAT accounting has obviously become problematic since the introduction of MTD.
Some businesses have attempted to get around this by using bridging software that hooks into the spreadsheet and is able to submit a final VAT return to HMRC digitally.
“Bridging software has a limited life even though HMRC says it can be used indefinitely,” says Bicknell.
“Most bridging software is basic and designed only for VAT. Many are just spreadsheet formulas. If HMRC wants the full data, the businesses won’t be capable of supplying it.”
Here’s an example. Let’s say you track your invoices using one spreadsheet and calculate your VAT using another spreadsheet. Getting data from one spreadsheet to the other is problematic if you can’t use cut/copy and paste.
Spreadsheet formulas are considered digital links for MTD, so you could build one to take the data from the invoice sheet automatically.
But any experienced spreadsheet user will know this is a recipe for frustration. This kind of formula can break too easily.
“I’ve seen businesses with very complicated methods of preparing a return,” says Bicknell. “One of them used 20 spreadsheets splitting out reverse charge, EC sales, fuel scale charges, and other factors. It’s time-consuming.
“Surely finding a new accounting system that can cope with this analysis would be a better long-term solution.”
Can I get a digital link extension for MTD for VAT?
Because of coronavirus disruption, and despite the extension to April 2021, some larger businesses might continue to have problems converting their legacy IT systems to get ready for the end of the soft landing period.
HMRC is allowing some businesses to apply to extend the soft-landing period beyond April 2021. See section 188.8.131.52 of VAT Notice 700/22 for specifics, but the summary details are as follows.
To be eligible, your business will need to tick one of the following boxes:
- Your business uses complex or legacy IT systems that mean 100% digital linking genuinely isn’t possible by April 2021. This will typically be for reasons outside of your direct control.
- You’ve recently acquired another business and it’s impossible to get everything digitally linked by April 2021.
Note that cost alone is not considered a good reason, and is likely to be rejected.
To apply for the extension, email [email protected] to request a form, and then set out your case about why your systems can’t be 100% digitally linked in time, including explaining why your current setup isn’t good enough, and why you can’t simply purchase better software.
You will need to provide details of your current MTD for VAT accounting solution, including a “map of your existing VAT systems, highlighting the exact areas that cannot be digitally linked”.
And finally, you will need to provide a timetable for getting 100% digital linking in place.
Conclusion on digital links
If you’ve read this article and discovered you’ll need to amend your processes to comply with the law as of April 2021, begin the process now.
If you need expert advice, consult an accountant, VAT specialist or HMRC sooner rather than later.
Penalties for incorrect accounting are very real and could end up costing your business. Any expense you might resent spending upfront should be considered alongside this.
Is it really worth the risk of thousands of pounds, or even more, when you can not only fix things right now with a full accounting solution but also transform the way you work and make life so much easier?
Editor’s note: This article was first published in December 2019 and has been updated for relevance.
The ultimate guide to Making Tax Digital
Is your business ready for Making Tax Digital? Download this free guide to find out what it means for your business and the steps required to submit VAT returns.