Making Tax Digital For VAT (Costs And Benefits)
Updated: Oct 17
The Costs And Benefits of Making Tax Digital For VAT (experienced by small businesses)
The aim of Making Tax Digital (MTD) is to make it simpler for businesses to manage and submit their taxes. But the shift to MTD for VAT has not always been smooth sailing. MTD has sometimes been met with resistance, in some cases resulting in non-compliance.
The major factor behind this is concern over costs and lack of clarity about the benefits of MTD. Much research has been done into the issues surrounding MTD. One of these was a qualitative research study conducted by the HMRC.
In this article, we look at what MTD is and what it offers. We summarise the key findings of this research study, and how these affect smaller businesses. And we conclude what this means for small businesses now entering the world of Making Tax Digital for VAT.
Making Tax Digital For VAT
First, let’s look at the background of when and why MTD entered the UK tax system. In 2015, the UK government envisaged plans for the HMRC to become one of the most digitally advanced tax administrations worldwide.
What Is MTD?
The Making Tax Digital (MTD) rollout for UK businesses was a significant part of this. This entails a digital system that updates automatically, storing all financial information in one place. The aim is to simplify tax accounting.
As a part of the UK government’s new digital initiative, all businesses will have access to a digital tax account. They will now use this channel to submit their tax information to HMRC every quarter. Once signed up for Making Tax Digital, you will be able to submit your VAT returns using MTD-compatible software only.
In April 2019, the government introduced MTD for VAT-registered businesses with taxable turnover above the VAT threshold. MTD for businesses under the VAT threshold has followed in April 2022, and the Income Tax Self-Assessment phase starts in April 2024.
All VAT Registered Businesses Must Now Comply With MTD
Many businesses and individuals are already able to manage their financial affairs, including tax, digitally. MTD is in harmony with this trend. From April 1, 2022, all VAT-registered businesses are required to keep digital records of their finances and tax.
What Does MTD Offer?
MTD offers businesses a wide range of benefits and allows them to stay in control of their finances with access to real-time data. The tax authority, in turn, is better able to assess these taxpayers’ financial position and provide support against any future economic instability that was caused by the pandemic.
Fewer Errors, More Confidence And Greater Transparency
Making Tax Digital for VAT increases transparency but more importantly, eliminates the inevitable errors incurred with paper tax filing.
Businesses using MTD report that they are:
What Are The Costs Of MTD?
The costs of making the shift to MTD for VAT can be broken down into two main categories. Transitional costs and continuing costs. The main benefits can be categorised as digital fluency, greater efficiency and enhanced productivity. Let’s take a closer look at these.
MTD Transitional Costs
Transitional costs refer to the costs incurred by businesses while transitioning to MTD for VAT. For some businesses, this phase may take up to 3 years. Transitional costs may include:
The latter two will only be relevant in the minority of cases, more particularly for those small business owners falling within the scope of MTD ITSA. (More about that later.)
Some of these costs, however, can be offset against profits when calculating the tax due. And this reduces the net transitional cost for most businesses.
MTD Continuing Costs
Continuing cost estimates are based on what a business may incur once transitioned to MTD for VAT. These costs are in addition to the business’ usual costs of tax management.
Those businesses who previously used paper or spreadsheets, and now need MTD-compatible software, may incur costs of accounting software subscriptions.
In the case of businesses who prefer to continue using spreadsheets, continuing bridging software subscriptions may be necessary to be compatible with MTD for VAT.
While there may be marginal increases in existing software costs, several VAT subscription-based software packages have been updated for MTD for free.
Those businesses operating MTD VAT that use a tax agent to manage quarterly submissions or returns should not face higher continuing costs in this regard.
HMRC Estimated Transitional Costs Of MTD
For some small businesses, one of the continuing costs of submitting tax returns is the services of an accounting agency. If you currently outsource your tax return admin to a tax agent, you may wish to continue doing so.
For businesses operating MTD VAT without MTD ITSA (such as a Limited Company), these continuing quarterly costs are not expected to increase. These costs will remain stable irrespective of MTD compliance.
HMRC Estimated Continuing Costs Of MTD
HMRC estimates that businesses that are mandated to use MTD for Income Tax Self Assessment (ITSA) may incur total transitional costs of around £1,383 million.
This works out to an average transitional cost of £330 and an annual continuing cost of £35 per business within that sector. These costs were estimated based on the assumption of a certain number of hours of tax agent support, software setup, and training in MTD record keeping.
Thankfully, HMRC has ensured that there are free MTD ITSA software products available for smaller businesses with simpler financial affairs.
What Are The Benefits Of MTD?
Since the Covid pandemic of 2020, businesses are becoming more reliant on digital tools to communicate and work remotely. This has spread to banking, invoices, and also filing tax returns online.
Making Tax Digital in the UK was already planned before the pandemic but is the perfect complement to this digital movement.
MTD Digital Benefits
MTD eliminates the need for paper-based manual tax records. Not only is this kinder to the environment, but it saves business owners time and money too.
Through the use of software and a new approach to finances and tax, you will greatly reduce the time spent on administration. Going digital will always streamline your financial affairs.
You will have a continuous and real-time handle on your tax liabilities. No more surprises at the end of the year. This will help you plan to allocate enough money to pay your taxes.
MTD Productivity Benefits
Digital record-keeping, due to the time saved by not doing everything manually, leads to an increase in productivity. Because less admin means more time to get other business tasks done.
It can also be the catalyst for greater changes within the business. As confidence in digital record keeping soars, other changes will not seem as difficult.
MTD Efficiency Benefits
Web-based accounting software was found to improve business efficiency.
MTD requires you to submit your tax data every quarter. Because you no longer have to collate 12 months' worth of data at the end of each year, the risk of errors is greatly reduced.
The Phases Of MTD
These are the 3 phases of MTD and their expected commencement dates.
MTD For VAT Registered Businesses
At first, only VAT-registered businesses with a taxable turnover of £85,000 or more, had to abide by the rules for MDT for VAT. VAT-registered businesses with lower turnovers could choose to use the MDT voluntarily.
But all VAT-registered businesses are now required to abide by the MTD rules for their first VAT return from April 2022. This includes those businesses that are below the VAT threshold. This will pave the way for the next phases of the MTD rollout timeline.
Next Phase - MTD For Income Tax Self Assessment
Making Tax Digital for Income Tax Self Assessment (MTD ITSA) will be introduced in April 2024. It will apply to the income tax returns of self-employed business owners, freelancers and landlords earning income from property, of more than £10,000
Instead of the traditional annual income tax return, taxpayers will be expected to keep digital tax records and submit updates throughout the year.
Last Phase - MTD For Corporation Tax
Your corporation’s tax information is reported using UK GAAP principles, and your VAT accounting may be cash-based. Making Tax Digital has thus far only applied to businesses for VAT purposes. But Making Tax Digital for corporation tax (MTD CT) is the last phase, that will be introduced in 2026.
Are unsure if your software can operate on both bases concurrently? Or concerned that your VAT periods won't coincide with your tax reporting quarters? It would be wise to consult the HMRC’s Making Tax Digital For CT document before the implementation of MTD for corporation tax.
Costs and Benefits of Making Tax Digital For VAT Research
To measure the impact of Making Tax Digital on small businesses, the HMCR commissioned qualitative research exploring how these new regulations for VAT have affected them.
The research entailed 31 in-depth telephonic interviews with small businesses. These businesses surveyed have an annual turnover of under £10 million and less than 30 employees.
The Research Sample
The sample included 11 nano businesses with no employees, 11 micro-businesses employing under 10 employees and 9 small businesses with 10-30 employees. They included sole traders, partnerships, and limited/not limited businesses across the UK. Before MTD, they relied on software, paper and spreadsheets.
The Aim Of This Research
This research study aimed to discover what the costs and benefits of implementing MTD for VAT are, both direct and indirect, financial and non-financial. It also aimed to learn how business owners perceived these costs and benefits.
Key Research Findings
Certain costs are inevitable when making the shift to MTD for VAT. But for some businesses, these may differ depending on how digitally prepared they were, to begin with. There are also many benefits to implementing MTD, but once again, this differs depending on certain factors.
Like all qualitative research, this study primarily focused on the underlying reasons, opinions, perceptions and motivations surrounding the topic. As this particular sample was limited, these findings should not be used to make general assumptions for all who use MTD for VAT.
But they do give us valuable insight into how the costs and benefits of making MTD for VAT can be perceived by different businesses, and why.
The four main findings to come out of this research are as follows:
1. Costs Outweigh The Benefits For Those Who Lack Digital Confidence
Older participants who lacked digital expertise and confidence felt that the costs of MTD for VAT outweighed the benefits.
Their financial practices had remained unchanged for years, and they were not particularly looking to grow their businesses. But it is important to note that the fieldwork for this research was completed in Feb-March 2020 before the Covid-19 lockdown.
As such, the majority of businesses surveyed were satisfied to maintain the status quo. And although they saw the benefits of MTD, they did not believe it to be worth the transitional costs involved.
2. Balance Of Costs and Benefits For The Digitally Fluent
A large majority of the businesses surveyed did not experience greater costs or benefits from switching to MTD for VAT. Therefore, they were neutral regarding the costs and benefits of MTD for VAT.
These respondents typically fell into 2 categories:
Businesses that already used software for their financial and tax records and needed only minor adjustments to become MTD compatible. They were already digitally fluent and knew how to use the new software to their benefit.
Businesses for whom the costs of MTD-compatible software were balanced with the benefits of reduced errors, automatic calculations, and faster tax returns.
These businesses experienced a balanced view of costs and benefits. However, they expected the benefits of MTD for VAT to outweigh the costs with continued use.
3. Benefits Slightly Outweigh Costs When There Is Ambition For Growth
These were businesses that had previously been using spreadsheets to manage their finances and taxes, before switching to MTD for VAT. And having outgrown that system, they were ready for a more digital approach.
They indicated that despite the transitional costs of MTD, the long-term benefits of the new software would offset these costs. But the perceived ease with which this transition to MTD was made, was a major factor driving this.
4. Benefits Greatly Outweigh Costs For High Volumes Of Invoices
Participants who had a high volume of invoices, but also the necessary digital skills, experienced clear benefits from switching to MTD for VAT.
Improved receipt capture and error spotting were major benefits. MTD-compatible software made it easier for them to issue and track invoices and payments.
The respondents who fell into this group were satisfied with the current processes but were open to trying new technologies and software.
Take Away Thoughts From Findings OF MTD Costs And Benefits Research
While some transitional costs of Making Tax Digital are unavoidable, calculated at a per-business rate, these are relatively minor. In the long term, the benefits of Making Tax Digital do seem to outweigh these initial costs.
Changes that increase your efficiency can only be conducive to the growth of your business. But with any great change, there will always be a measure of hesitation and sometimes, resistance. This is especially true of smaller businesses.
Looking at the findings of this study, the experience that each small business has with MTD depends largely on the following factors.
Costs vs Benefits
The findings indicated that, in general, costs were seen as more transitional and tangible, by most small businesses. The transitional costs incurred at the outset of MTD for VAT were greater for those who were not already digitally competent.
However, the benefits of MTD for VAT were more far-reaching and ongoing. Although these benefits were only starting to be realised later in the process. The costs were immediately felt and had the biggest impact.
In a large number of cases, the anxiety surrounding the change to MTD for VAT was of greater impact than the actual financial cost.
What Does It Mean For You?
Changing to MTD does not cause anxiety for those who are digitally confident and prepared.
Ambitions For Growth
The businesses surveyed not only varied in size, structure, products, and business outlook but especially in their ambitions for growth. Most businesses appeared to see the switch to MTD for VAT more as a matter of compliance than an opportunity to grow their businesses and improve their financial operations.
Older business owners who were not as tech-savvy were the most resistant to MTD for VAT. They were not as concerned with business growth and technological progress as the newer start-ups and younger entrepreneurs.
They did, however, acknowledge that the new software helped streamline the tax process. With encouragement and technical support, they may change their views on the issue of transitional costs.
This is evident from what is seen in those business owners focused on growing. They tend to be more proactive about implementing changes like Making Tax Digital for VAT.
What Does It Mean For You?
Business owners with ambitions for growth are more inclined to appreciate the change to MTD.
How businesses manage their finances varies due to several factors. Financial expertise, time available for financial management, the complexity of VAT obligations, and bespoke financial practices are some of the most relevant factors.
This ties in with the first point. There needs to be a move away from “maintaining the status quo” seen in some smaller businesses. Not only tech skills, but also wider financial skills are needed here.
What Does It Mean For You?
Financially savvy and technically competent people are more accepting of the changes that MTD for VAT brings.
VAT is usually considered to be a straightforward and relatively minor factor in running a business. However, any change to the process can trigger latent anxieties about making mistakes. Digital confidence affects how easily businesses can adapt to MTD financial requirements.
Although all respondents felt that the introduction of MTD had been well-publicised, those relying on paper and spreadsheets delayed the switch due to fears of the transitional costs involved with going digital.
Those businesses who reported that the benefits of MTD for VAT far outweighed any costs were usually quite digitally competent, to begin with. Naturally, their transitional costs were, therefore, lower, and quite possibly their running costs as well.
What Does It Mean For You?
Digital confidence lowers transitional and also possibly the continual costs of MTD.
Simply put, the aim of the Making Tax Digital (MTD) movement is to create efficiencies for small businesses and make it simpler for them to manage and submit their taxes.
Given the outcomes of the qualitative research study conducted by the HMRC on the costs and benefits of MTD for Vat, it is clear that the most prevalent findings suggest that digital confidence and preparedness, ambitions for growth, and general financial skills are the most prominent points of feedback reported.