Penalty Regime for Making Tax Digital for VAT

INTRODUCTION

Making Tax Digital (MTD) is HMRC's grand plan to have the majority of routine tax submissions made via digital systems operated by taxpayers ('customers', to use HMRC's terminology) and linked to HMRC's own computer systems. The two sides will share information, with HMRC's system telling the taxpayer's system what reports are due, and the taxpayer's system being used to send submissions direct to HMRC.

VAT has been the testing ground for MTD, and while implementation was delayed a number of times we are now in a situation where all but a small handful of exempt VAT registered entities should be submitting VAT returns electronically via MTD. Income tax and corporation tax will follow, at the moment being scheduled for 2024 and 2026 respectively.

This article concentrates on the record-keeping aspects of MTD for VAT and HMRC's newly published penalty regime which is due to come into effect on 1 January 2023. Note that this regime is separate to but will run alongside the penalty regime for late VAT returns and late payments (see our separate article on this HERE).

REQUIREMENTS OF DIGITAL RECORDS

As well as submitting returns digitally, MTD for VAT requires registered entities to maintain their records via 'functional compatible software'. This means a software program, or set of software programs, products or applications (apps) that can:

• record and store digital records;
• provide HMRC with information and VAT returns from the data held in those digital records; and
• receive information from HMRC.

Within this software certain records need to be maintained digitally within what's called your 'electronic account'. This must contain the following:

• your business name, address and VAT registration number;
• any adjustments from calculations you make outside your functional compatible software for any VAT accounting schemes you use;
• the VAT on goods and services you supplied, meaning everything you sold, leased, rented or hired (supplies made);
• the VAT on goods and services you received, meaning everything you bought, leased, rented or hired (supplies received);
• any adjustments you make to a return;
• the ‘time of supply’ and ‘value of supply’ (value excluding VAT) for everything you bought and sold;
• the rate of VAT you charged on goods and services;
• your reverse charge transactions, where you record the VAT on the sale price and the purchase price of the goods and services you buy; and
• copies of documents that cover multiple transactions made on behalf of your business like those made by volunteers for charity fundraising, a third party business or employees for expenses in petty cash.

All transactions must be contained in your electronic account. You are not required to scan paper records like invoices and receipts, but you may choose to do so.

WHAT THIS MEANS IN PRACTICE

The list of records above is best managed using dedicated accounting software such as Xero, Sage or Quickbooks. However merely using the software isn't enough by itself, as the quality of the records is only as good as the data entry.

We have increasingly been introducing automation into data entry for our clients, both to speed up the process and to improve accuracy. Short cuts can be tempting when catching up on large volumes of data just before a deadline but it's much better to keep things up to date as you go along. One common shortcut which would not meet the record keeping standards listed above is entering a monthly supplier statement as if it was a single invoice, rather than entering the individual invoices themselves.

Generally however these systems will take you most of the way to complying with MTD. It's much more difficult where you rely on spreadsheets, or on disparate software systems for different parts of your accounting. Where this is the case HMRC have a set of standards as to the 'digital links' that must be in place. Their guidance expressly states that 'use of ‘cut and paste’ or ‘copy and paste’ to select and move information is not a digital link'.

The guidance also states that you must use the checking functions within your software to make sure your returns are correct before you file them, and that if you can, you should also download a copy of the return before you file it.

THE PENALTIES

There are 4 separate penalties within this regime:

1. Not using functional compatible software to file VAT returns - penalty of up to £400 for every return you file.
2. Not maintaining digital records - between £5 and £15 for every day that this requirement is not met.
3. Not using digital links to transfer data between pieces of software - between £5 and £15 for every day that this requirement is not met.
4. Filing VAT returns that contain errors - potential penalties of up to 100% of any VAT owed as a result of the errors.

These penalties can obviously rack up very quickly, particularly if HMRC only discover non-compliance several months (or years) down the line.

If you are in any doubt as to whether your system is compliant or not please get in touch.