Making Tax Digital for Income Tax Self-Assessment becomes law on 6 April 2023 and aims to make tax accounting easier for businesses and individuals such as sole traders by legislating the digitalisation of tax data and submission.
I currently submit tax returns online with HMRC – will I need to do more?
Yes, if you are a sole trader IF your income is £10,000 (this also affects landlords so make sure you speak with your accountant for more information).
If your income is £10,000 or below then you will continue using the existing Self Assessment system.
MTD for income tax will require the use of software for your accounting, which will end the need to submit annual tax returns.
There are benefits of digitalising taxes:
Improved cash flow as you have a better understanding of how much tax you owe throughout the year.
Does MTD for Income Tax affect all sole traders?
If your income is £10,000 then yes. It also affects landlords (unless your total income is £10,000 or below then you will continue using the existing Self Assessment system.
Am I a sole trader?
If you working for yourself, not using a limited company, then you are a sole trader.
When what you make through your sole trader business exceeds the trading allowance of £1,000 then you should anticipate having to pay taxes and National Insurance and you should register with HMRC so you can use the Self Assessment tax system and then file an annual Self Assessment tax return. It is here where, amongst other things, you tell HMRC how much you’ve earned and how much you’re claiming as allowable expenses. You are now considered a sole trader.
Making Tax Digital for Income Tax replacing the Self Assessment system for sole traders who fall within its scope
MTD for Income Tax – what are the rules for sole traders?
To date MTD for Income Tax Self Assessment requirements are pending legislation being published by the government – this is what we know so far.
From 6th April 2023: If your sole trade income is above £10,000 you will need to use compatible software for your income tax accounting for the first full accounting period starting on or after 6 April 2023 (this threshold applies to the individual and might be generated from one business or multiple entries (including rental income too).
Examples: If you owned and operated three businesses, each with an income of £4,000, you need to register for MTD for Income Tax and then follow its rules for all of them
Example: The same applies if for example you received £4,000 income from your sole trader business and £6,000 from rental income on property you own, you will again be required to use MTD for Income Tax
Changes to Self Assessment
There will no longer be any requirement to send a a Self Assessment tax return IF you submit details using MTD for Income Tax and you report all income and allowable expenses.
For each of your businesses, you will will be required to submit updates at least quarterly, but this can be done more frequently if you prefer), and an end of period statement (EOPS). Plus on 31 January every year you will need to submit a single final declaration for all your income. This is where the accounting software comes into its own, it will automate the above (providing it is compatible software)
QUARTERLY UPDATES INFORMATION
Quarterly updates for each business you own has to be sent to HMRC via software (or more frequently if you prefer).
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.
An up-to-date estimate of how much tax you owe will now be available (only based on the information you provide, so will not take into account any adjustments that you make at the year-end for assets or reliefs)
You could interpret that there is no legal requirement for your quarterly updates to be accurate – if they are;
END OF PERIOD STATEMENT (EOPS)
You will need to make an EOPS for every business you own at the end of each accounting period (sometimes known as the basis period). Plus an EOPS for income from property (if you have any) that includes any adjustments that are required.
If you are familiar with the current process for the SA103 and SA105 schedules, the EOPS is similar.
One thing to take into consideration, the EOPS applies to each business you run, rather than the individual, so you may find yourself submitting several. This is where engagement with an accountant or tax adviser will help and they can advise you to take advantage of any allowances and tax reliefs that can be claimed. Plus they can support you with any complex calculations such as accounting for assets, R&D, leases for example.
Final declaration each year
You will use your software after the end of your accounting period to view the final income tax estimate (calculated by HMRC) which should include details of all income, expenses and allowances you’ve told it about.
Corrections or adjustments can be made by your accountant or tax adviser at the time too.
Now you are ready to legally declare (through your final declaration) that HMRC have been provided with all information required and that you are in agreement it the income tax calculation.
The final declaration applies to individuals, and not to individual businesses and/or property income, so you’ll only submit one Final Declaration each tax year.
When does MTD for Income Tax start for sole traders?
This date that MTD for Income Tax starts for sole traders will be the same date as the start of your first full accounting period following 6 April 2023. Sole traders will have an MTD for Income Tax ‘digital start date’ for their business.
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.
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.
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.
Will a sole trader still be able to file paper Self Assessment returns under MTD for Income Tax?
Is your income below £10,000? If yes then MTD for Income Tax regulations will not apply to you. It’s likely you’ll be able to continue filing your self-assessment return in the same way as usual.
Most businesses will be required to follow the MTD for Income Tax rules and will have to use software which is compatible HOWEVER, some can apply to be digitally excluded. This will be allowed because it is either impossible or impractical for them to use technology in the way MTD requires – examples could include those who don’t have internet access because of their remote location or if a disability makes 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 and it is likely those wishing to become digitally exempt will be required to apply to HMRC directly and explain why.
What software does a sole trader need for MTD for Income Tax?
We anticipate that most cloud-based small business accounting software will be updated in time for MTD for Income Tax and 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 will 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.
If you are using old software you may discover that it won’t be updated, so you will need to change to a newer package or software provider – allow time for this to take place well ahead of the 6 April 2023 implementation date.
Can a sole trader use spreadsheets for MTD for Income Tax?
When MTD for VAT came into force in 2019, it was allowable to use bridging software (essentially an add-in) to use with your spreadsheet, to comply with the requirement to digitally file VAT Returns. However, as we have discussed above, MTD for Income tax requires you to do much more work, ie quarterly updates, EOPS and a final declaration all need to be made digitally. It isn’t obvious how this can be achieved in a user-friendly way with a spreadsheet. However, it’s possible there will be examples of spreadsheets that are compatible with MTD for Income Tax.
Spreadsheets are definitely a handy tool for businesses and can be used for all kinds of tasks, but they have limitations.
MTD for Income Tax accounting records must be kept for at least five years. It’s too easy to accidentally delete a spreadsheet file, or overwrite the contents of a cell through human error. You could be liable for a fine if you do this with a spreadsheet containing your historic MTD for Income Tax accounting and HMRC found out.
Digital linking could also be problematic.
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 could result in a penalty if HMRC finds out, so 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.
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.
Can my accountant sign my sole trader business up for MTD for Income Tax?
Yes. You should speak to your accountant or tax adviser about this well ahead of time.
An accountant will also be able to submit quarterly updates, EOPS and a final declaration on your behalf (and would usually discuss with you to ensure all the details are correct).
Can a sole trader still handwrite or print invoices under MTD for Income Tax?
Yes you can create paperwork BUT the data will either have to already be in your digital accounting records or you’ll need to transfer the details to your digital accounting records asap.
By using compatible accounting software, you will ensure your accounting records are being kept digitally, even if you or your clients/customers still want a paper invoice.
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. Likewise, it is unknown if sole traders will be able to voluntarily make use of MTD for Income Tax if their income is below £10,000.
Plan ahead, give yourself time and 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?
As we have touched on, spreadsheets might be problematic 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.
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