MTD Phase 2: How To Prepare For The Next Stage
Making Tax Digital (MTD) was introduced in 2019 to simplify tax paying. The UK government hopes to reduce human error and increase productivity by making a digital system so that it’s simpler to pay taxes.
This system will affect both businesses and sole traders. Sole traders include any self-employed person who keeps all the profits of their work after tax.
Currently, anyone who voluntarily registered for VAT must participate in Making Tax Digital. However, the UK government plans to introduce MTD for income tax and corporate tax returns.
- MTD makes tax paying a digital system. Business owners and sole traders must file their returns digitally and maintain digital records.
- In phases 1 and 2, MTD only applies to VAT. Only businesses within the current VAT registration threshold are subject to these standards.
- Every business must use MTD-compatible software to file returns.
- Failing to submit data to the HMRC digitally will lead to fines. The HMRC started enforcing penalties in phase 2.
- Corporate, property, and income tax will follow MTD in 2026.
- Sole traders and landlords with an income <£50,000 must follow MTD in 2026. Those with an income <£30,000 must do the same in 2027.
This article will recap phase 1 and explore MTD phase 2. We will cover the following:
Recap of Making Tax Digital Phase 1
What is Making Tax Digital Phase 2
What are the MTD Requirements?
Recap Of Making Tax Digital Phase 1
Making Tax Digital (MTD) phase 1 was the initiative’s soft landing. During the first wave, VAT-registered businesses were required to add MTD-compatible digital software into their accounting system. However, they were still allowed to submit some returns manually.
Phase 1 was filled with tight deadlines. As a result, many accountants and taxpayers focused on compliance and chose MTD software providers quickly.
Now as accountants prepare for phase 2, many wonder what to expect. While the standards for digital links remain the same, there are some anticipated compliance changes.
What Is Making Tax Digital Phase 2?
MTD phase 2 officially went live in April 2021 after a series of COVID-19-induced Making Tax Digital delays. Phase 1 was a “soft launch” to help taxpayers adjust to the changes. Phase 2 will introduce tighter restrictions and stricter standards.
MTD compliance requirements remain mostly the same in phase 2. The biggest change is enforcement. Throughout phase 1, the HMRC did not issue penalties for non-compliance because they understood that businesses needed time to adjust to the new regime.
Here is a list of what else accountants can expect from phase 2:
- Penalty enforcement
- Digital links are required for all systems
- Bridging software may not be acceptable
- Digital audit trails must be apparent
- Businesses and sole traders must keep records digitally
- All VAT-registered businesses must date, value, and VAT charged for each sale and purchase, retail businesses are exempt.
What Are The MTD Requirements?
For now, the main requirement of MTD is that all VAT-registered taxpayers within the current VAT threshold must submit VAT returns with a digital link. Small businesses are not exempt from this requirement based on their size.
Any business or sole trader who voluntarily registered for VAT must also meet the following standards:
- Every VAT return must be filed using functional compatible software
- Business owners must store VAT documents electronically — digital record keeping must include a summary of the business’s VAT data for each VAT quarter
- Paper records are not acceptable for submission
- Each VAT return must be filed as a 9-box summary and submitted via a digital link to the HMRC’s JSON API software
- Multiple digital software tools are allowed as long as they meet MTD standards
FreshBooks helps ease the transition to MTD. Our user-friendly software lets you keep digital records of your income and expenses per HMRC requirements. Gain peace of mind knowing that your accounting tool is perfectly compliant. Click here to try it today.
Making Tax Digital Penalties
Phase 2 means the HMRC will get stricter with Making Tax Digital penalties. So, it’s important for taxpayers to understand what can happen if they are not MTD compliant.
- Improperly submitting a VAT return may incur a £400 fine per file
- All companies must use digital links or they may receive a £5 to £15 fine for each day they don’t
- If a VAT return includes errors, the taxpayer will have to pay the amount of VAT owed up to 100%
- If a taxpayer underestimates the amount of VAT owed, they may have to pay 30% of their assessment if they don’t inform the HMRC within 30 days of the return
What is Next For MTD
The next phase of MTD will roll out between 2026 and 2027. This phase will expand requirements beyond MTD for VAT. This is what you can expect from MTD in the future.
- April 2026
- Sole traders and landlords with an annual income above £50,000 will need to keep digital records and give the HMRC quarterly updates through MTD software.
- Corporation tax, income tax, and property tax will be subject to MTD. This includes Income Tax Self Assessment (ITSA).
- April 2027
- Sole traders and landlords with an annual income between £30,000 and £50,000 will be subject to the same requirements as those with an income above £50,000.
Please see FreshBooks’ Making Tax Digital timeline for a detailed overview of the MTD roll-out.
In 2023, MTD phases 1 and 2 are both past. Now, all VAT-registered businesses must comply with MTD. If you haven’t already, please sign-up quickly to avoid HMRC penalties. Any business intending to register for VAT must also remember this requirement.
FAQs On Making Tax Digital Phase 2
Can I opt out of Making Tax Digital?
You may request an exemption from MTD if there is a just cause. Simply finding MTD standards too difficult or time-consuming does not qualify as a just cause. Exemptions may apply to:
- People who cannot reasonably access a secure internet connection
- People who cannot use a computer, tablet, or smartphone long enough to file their returns due to a disability (age may qualify under this exemption in some cases)
- People who cannot use electronic devices due to their religious affiliation
Who is affected by Making Tax Digital?
Business owners, landlords, and sole proprietors must follow Making Tax Digital (MTD). As of 2021, this applies to VAT but in 2026, it will apply to ITSA, property tax, and corporation tax.
How long does it take to register for Making Take Digital?
After you sign up, the HMRC may take up to 72 hours to confirm your registration. Please register at least 5-7 days before any of your returns are due. You must have functional-compatible software in place prior to registration.
What are digital links?
Digital links are data transfers between software programs or electronic devices. However, not every electronic data transfer qualifies as a digital link to the HMRC. Consult this guide on MTD Digital Links for more information.
Do I need to hire an accountant or tax advisor to comply with MTD phase 2 requirements?
Hiring an accountant or tax advisor is not mandatory. However, it is a good idea because they can help you navigate phase 2 changes.
Balil Warraich, ACCA
About the author
Balil Warraich is an ACCA and CPA with over ten years of experience in the financial space. He specializes in accounting, assurance, and taxation services. Balil currently resides in British Columbia, Canada, where you’ll find him at https://www.notioncpa.com/