Making Tax Digital Guide for Small Businesses | London Accountant

What Is Making Tax Digital?

Making Tax Digital (MTD) is HMRC's programme to modernise the UK tax system by requiring businesses and individuals to keep digital records and submit tax information to HMRC using compatible software. The goal is to reduce errors, make it easier for taxpayers to get their tax right, and bring the UK's tax administration into the digital age. MTD has been rolling out in phases since 2019, starting with VAT, and is now expanding to Income Tax Self Assessment (ITSA).

MTD for VAT: Already in Effect

MTD for VAT has been mandatory for all VAT-registered businesses since April 2022, regardless of turnover. If you are VAT-registered, you must already be keeping your VAT records digitally using MTD-compatible software and submitting your VAT returns through that software (not through the old HMRC portal). If you have not yet made the switch, you are already non-compliant and could face penalties.

The key requirements are straightforward: you must maintain digital records of your supplies and purchases, and there must be a "digital link" between your records and the software you use to submit your return. This means you cannot simply type figures from a spreadsheet into your submission software — the data must flow digitally.

MTD for Income Tax: What Is Changing

MTD for Income Tax Self Assessment (MTD for ITSA) is the next major phase. From April 2026, self-employed individuals and landlords with a gross income above £50,000 will be required to keep digital records and submit quarterly updates to HMRC. From April 2027, the threshold drops to £30,000. HMRC has indicated that further reductions to the threshold are planned, potentially bringing those earning above £20,000 into scope in future years.

Under MTD for ITSA, instead of filing one annual Self Assessment return, you will need to submit quarterly summaries of your income and expenses using compatible software, followed by a final declaration (which replaces the traditional Self Assessment return). This is a significant change in how self-employed individuals and landlords interact with the tax system.

Who Is Affected?

You will need to comply with MTD for ITSA if you are self-employed or a landlord with qualifying income above the threshold. Qualifying income means gross income from self-employment or property before deducting any expenses. If you have both self-employment and property income, these are combined to determine whether you exceed the threshold. Limited companies are not directly affected by MTD for ITSA — Corporation Tax is expected to be brought into MTD at a later stage, though no date has been confirmed.

Software Requirements

You will need MTD-compatible software to keep your digital records and submit updates to HMRC. HMRC maintains a list of compatible software on GOV.UK. Popular options include Xero, QuickBooks, FreeAgent, and Sage. Many of these offer plans specifically designed for small businesses and sole traders. If you already use cloud accounting software for your bookkeeping, there is a good chance it is already MTD-compatible or will be by the time the requirements apply to you.

If you currently use spreadsheets, you will need either to switch to dedicated software or use "bridging software" that can take data from your spreadsheet and submit it to HMRC digitally. However, HMRC expects most businesses to move to proper accounting software over time.

Quarterly Updates: What You Need to Submit

Under MTD for ITSA, you will submit four quarterly updates per year. Each update summarises your income and expenses for that quarter. The quarterly periods are fixed: 6 April to 5 July, 6 July to 5 October, 6 October to 5 January, and 6 January to 5 April. Each update must be submitted by the last day of the month following the end of the quarter. After the fourth quarter, you will submit a final declaration by 31 January following the end of the tax year — this is where you can make adjustments, claim reliefs, and confirm your overall tax position.

Penalties Under the New System

HMRC has introduced a new points-based penalty system for late submissions, which already applies to MTD for VAT and will apply to MTD for ITSA. Under this system, you receive a penalty point for each late submission. Once you reach the penalty threshold (which depends on your submission frequency — 4 points for quarterly submissions), you receive a £200 penalty for that late submission and for every subsequent late submission. Points expire after a period of compliance.

For late payments, there is a separate regime: a penalty of 2% of the tax outstanding if payment is 15 days late, rising to an additional 2% at 30 days, and then a daily penalty of 4% per annum from day 31 onwards. Interest also accrues on late payments from the due date.

How to Prepare for MTD

Start early. If you are not already using digital accounting software, now is the time to research your options and begin the transition. Many accountants (including ourselves at London Accountant) can help you choose the right software, set it up, and migrate your existing records. Getting comfortable with the software before MTD becomes mandatory for you will reduce stress and the risk of errors.

Here are practical steps you can take today:

Review your current record-keeping — are you already digital, or still using paper and spreadsheets?
Check whether your existing software is MTD-compatible
Set up bank feeds so transactions are imported automatically
Speak to your accountant about a transition plan
Start keeping your records in the quarterly format to get used to the rhythm

How London Accountant Can Help

We have helped hundreds of small businesses and sole traders prepare for Making Tax Digital. Whether you need advice on choosing the right software, help setting up Xero or QuickBooks, or want us to handle your quarterly submissions for you, our team is here to support you through the transition. We offer fixed-fee MTD packages so you know exactly what you are paying, with no hidden costs. Get in touch for a free initial consultation to discuss your MTD readiness.