Understanding Making Tax Digital (MTD) for VAT

Introduction

Making Tax Digital (MTD) represents one of the most significant reforms to the UK tax system in recent decades. Introduced by HM Revenue & Customs, MTD is part of a long-term government strategy to modernise tax administration by replacing manual and paper-based processes with fully digital systems.

For many UK small businesses, the introduction of Making Tax Digital for VAT marked a major shift in how VAT is managed day to day. Tasks that were once handled through spreadsheets, handwritten records, or manual entry into HMRC’s online VAT portal are now subject to strict digital requirements. As a result, MTD has raised a wide range of practical and compliance-related questions for business owners, directors, and finance teams.

Common questions include:
What exactly is Making Tax Digital for VAT?
Which businesses are required to comply?
What software must be used?
Can spreadsheets still be used?
What penalties apply if the rules are not followed?

Under Making Tax Digital for VAT, VAT-registered businesses are required to keep their VAT records digitally and submit VAT returns using MTD-compatible software. Manual submissions through the old HMRC VAT portal are no longer permitted for most businesses. The intention is to reduce errors caused by manual data entry, improve the accuracy of VAT reporting, and create a clearer, more transparent audit trail between business records and VAT returns.

While the principles behind MTD are straightforward, the practical implementation can be challenging — particularly for small businesses with limited accounting resources. Understanding the rules, deadlines, software requirements, and compliance obligations is essential to avoid penalties and unnecessary HMRC scrutiny.

This guide explains everything UK small businesses need to know about Making Tax Digital for VAT. It covers what MTD is, who must comply, what digital records must be kept, how VAT returns are submitted under MTD, available exemptions, and how to stay compliant while minimising disruption to your business.

What Is Making Tax Digital (MTD) for VAT?

Making Tax Digital for VAT is a mandatory digital reporting system that changes how VAT information is recorded and submitted to HMRC. Under MTD, VAT-registered businesses must follow three core requirements:

• Keep VAT records digitally, rather than on paper or in non-digital formats
• Use MTD-compatible software to maintain VAT records and calculate VAT
• Submit VAT returns directly to HMRC through software, instead of using the old online VAT portal

In practical terms, this means that VAT data must be captured and stored in a digital format from the point of transaction through to the submission of the VAT return. The system must maintain a clear digital link between:

• Sales and purchase records
• VAT calculations
• The final VAT return submitted to HMRC

MTD replaces traditional manual VAT reporting methods with a structured digital process designed to reduce reliance on re-keying data, copying and pasting figures, or manually adjusting VAT totals at the point of submission.

The key objective of Making Tax Digital for VAT is to minimise human error, which HMRC has identified as one of the main causes of incorrect VAT returns. By requiring digital record keeping and software-based submission, MTD aims to improve overall compliance, reduce mistakes, and give HMRC greater confidence in the accuracy of VAT data submitted by businesses.

From HMRC’s perspective, MTD also enables more efficient access to VAT information, better risk assessment, and more targeted compliance activity. For businesses, however, this means that VAT processes must be more structured, consistent, and digitally compliant than ever before.

Who Must Comply with MTD for VAT?

VAT-Registered Businesses

Making Tax Digital for VAT applies to almost all VAT-registered businesses in the UK, regardless of their size, sector, or turnover. Once a business is registered for VAT, it is generally required to comply with MTD rules as part of its ongoing VAT obligations.

This includes the following business types:

• Sole traders registered for VAT
• Limited companies, including owner-managed companies
• Partnerships and LLPs
• Charities and non-profit organisations that are VAT registered

When MTD for VAT was first introduced, compliance was initially limited to businesses with taxable turnover above the VAT registration threshold. However, HMRC later expanded the scope of the rules. As a result, MTD for VAT now applies to nearly all VAT-registered businesses, including those with turnover below the VAT threshold.

In practice, this means that once a business is on the VAT register, it must:

• Keep VAT records digitally
• Use MTD-compatible software
• Submit VAT returns through software rather than manually

The obligation applies regardless of whether the business files quarterly, monthly, or annual VAT returns.

Businesses Below the VAT Threshold

Many small businesses voluntarily register for VAT even when their turnover is below the compulsory VAT registration threshold. Common reasons include reclaiming VAT on expenses, appearing more established to customers, or working with VAT-registered clients.

It is important to understand that voluntary VAT registration does not remove MTD obligations. If your business is VAT registered voluntarily, you are still required to comply fully with Making Tax Digital for VAT.

This means that voluntarily registered businesses must:

• Maintain digital VAT records
• Use MTD-compatible accounting or bridging software
• Submit VAT returns digitally under MTD rules

There is no distinction under MTD between mandatory and voluntary VAT registration. Once registered, the same digital requirements apply.

Are There Any Exemptions from MTD for VAT?

Although Making Tax Digital for VAT is mandatory for most businesses, a small number of limited exemptions do exist. These exemptions are tightly controlled and apply only in specific circumstances.

You may be exempt from MTD for VAT if one or more of the following applies:

• Digital exclusion, where it is not reasonably practicable to use digital tools due to disability, age, or location
• Insolvency procedures, such as bankruptcy or liquidation, where the business is no longer trading in the usual way
• Other exceptional circumstances, where HMRC accepts that digital compliance is not feasible

It is important to note that exemptions are not automatic. Businesses must apply directly to HM Revenue & Customs and receive written confirmation before continuing to submit VAT returns using non-digital methods.

Until an exemption is formally granted:

• The business remains legally required to comply with MTD
• Non-digital submissions may be treated as non-compliant
• Penalties may apply if VAT returns are not submitted correctly

HMRC generally expects businesses to make reasonable efforts to comply digitally. Exemptions are granted only where there is clear evidence that compliance is genuinely impractical.

MTD for VAT Record Keeping Requirements

One of the core pillars of Making Tax Digital for VAT is the requirement to keep specific VAT records in digital form. This requirement applies to all businesses within the scope of MTD, regardless of size.

Under MTD rules, businesses must keep the following VAT records digitally:

• Business details, including legal name, address, and VAT registration number
• VAT accounting schemes used, such as standard VAT accounting, cash accounting, or flat rate scheme
• VAT on sales (output VAT), showing VAT charged on taxable supplies
• VAT on purchases (input VAT), showing VAT paid on business expenses
• Time of supply (tax point) for each transaction
• VAT rate applied to each sale or purchase

These records must be maintained in a digital format from the point of entry through to VAT return submission. Businesses must also ensure that:

• Digital records are accurate and up to date
• Records are preserved without manual alteration
• A clear digital audit trail exists between transactions and VAT return figures

VAT records must be retained for at least six years, in line with HMRC record-keeping requirements.

Under MTD, paper records alone are no longer sufficient. While paper invoices may still be received, the relevant VAT data must be transferred into a compliant digital system. Failure to maintain proper digital records can result in non-compliance, penalties, or HMRC intervention.

What Does “Digital Links” Mean Under MTD?

One of the most misunderstood — and most frequently breached — requirements of Making Tax Digital for VAT is the concept of digital links. Many businesses assume that using accounting software alone is enough to comply, but MTD goes further than simply submitting VAT returns online.

Under MTD rules, a digital link means that VAT data must move between different parts of your accounting process electronically and automatically, without any manual re-entry or copying of figures.

What Counts as a Digital Link?

A digital link exists where information is transferred using an electronic connection between software systems or files. Common examples include:

• Data flowing from accounting software directly into VAT return submission software
• Spreadsheet totals being transferred via formulas or file imports into bridging software
• Sales data moving from a point-of-sale (POS) system into accounting software
• Imports from CSV files or API connections between systems

These methods preserve the integrity of the data and ensure that figures are not altered during transfer.

What Is Not Allowed Under MTD?

HMRC does not consider the following to be compliant digital links:

• Manually typing VAT figures into another system
• Copying and pasting totals from spreadsheets into software
• Re-keying figures from one system to another
• Manually adjusting totals outside a digital system without an audit trail

Even if the final VAT figures are correct, manual intervention breaks the digital audit trail and can result in non-compliance.

Why Digital Links Matter

HMRC expects businesses to maintain a clear digital audit trail that shows:

• Where each VAT figure originated
• How it was calculated
• How it flowed from transaction level to VAT return

This audit trail allows HM Revenue & Customs to verify VAT returns more efficiently and reduces the risk of errors, manipulation, or accidental misreporting.

Failure to maintain digital links can lead to:

• MTD non-compliance
• VAT return rejection
• Penalties under HMRC’s compliance framework

MTD-Compatible Software: What Are Your Options?

To comply with Making Tax Digital for VAT, businesses must use HMRC-approved (MTD-compatible) software. The right solution depends on business size, complexity, and existing systems.

Cloud Accounting Software

For many UK small businesses, cloud accounting software is the simplest and most robust way to comply with MTD.

Popular MTD-compatible platforms include:

• Xero
• QuickBooks Online
• Sage Business Cloud

These systems are designed specifically to meet HMRC requirements and typically provide:

• Fully digital VAT record keeping
• Automatic VAT calculations
• Built-in VAT return preparation
• Direct submission of VAT returns to HMRC
• Secure digital audit trails
• Ongoing updates to reflect VAT rule changes

Cloud accounting software is particularly well-suited to:

• Small and medium-sized businesses
• Start-ups
• Service-based companies
• Businesses with regular VAT reporting

It also reduces the risk of human error and makes HMRC compliance significantly easier to manage.

Bridging Software

Bridging software is an alternative solution for businesses that prefer — or need — to continue using spreadsheets.

Rather than replacing spreadsheets, bridging software:

• Digitally links spreadsheet data to HMRC
• Pulls VAT totals directly from spreadsheets
• Submits VAT returns without manual data entry

This approach is commonly used by:

• Very small businesses
• Property businesses
• Landlords
• Businesses with bespoke or complex spreadsheet models

However, to remain compliant:

• Spreadsheets must still be maintained digitally
• Formulas must be used to calculate VAT totals
• No manual copying or re-keying is allowed between files

Bridging software can be compliant, but it requires discipline and careful spreadsheet management to avoid accidental breaches of MTD rules.

How to Sign Up for MTD for VAT

Using MTD-compatible software alone is not enough. Businesses must also formally sign up for MTD for VAT with HMRC before submitting returns digitally.

Step-by-Step MTD Sign-Up Process

The process typically involves the following steps:

1. Confirm you have MTD-compatible software
   Ensure your chosen accounting or bridging software is approved by HMRC and ready to submit VAT returns.
2. Access your HMRC online account
   Log in using your Government Gateway credentials.
3. Sign up for Making Tax Digital for VAT
   Follow the MTD registration process and provide required business details.
4. Authorise your software
   Grant permission for your software to communicate directly with HMRC on your behalf.

Once authorised, your software will be able to submit VAT returns under MTD rules.

Timing: When Should You Sign Up?

Timing is critical. Businesses should sign up for MTD at least 7–14 days before their VAT return deadline.

Signing up too late can result in:

• Inability to submit the VAT return on time
• Missed filing deadlines
• Late submission penalties

You should not sign up:

• Too early, while a VAT return is still pending under the old system
• On or immediately before the VAT return deadline

Planning the transition properly helps avoid unnecessary disruption or compliance issues.

Submitting VAT Returns Under MTD

Once a business has successfully signed up for Making Tax Digital for VAT, all future VAT returns must be submitted under MTD rules. This represents a permanent change in how VAT reporting works, not a one-off adjustment.

Under MTD, VAT returns must be submitted:

• Through HMRC-approved (MTD-compatible) software
• Using digital VAT records, maintained throughout the accounting period
• By the usual VAT deadlines, which remain unchanged

It is important to note that MTD does not change how VAT is calculated. The underlying VAT rules, rates, and reporting periods stay exactly the same. What changes is how VAT data is recorded, transferred, and submitted.

Businesses can no longer:

• Log into the old HMRC VAT portal to type figures manually
• Submit VAT returns using spreadsheets alone
• Re-key VAT figures without digital links

Instead, VAT returns must be generated directly from digital records and transmitted electronically to HM Revenue & Customs via approved software.

This creates a continuous digital audit trail from the original transaction through to the final VAT return, which is central to HMRC’s compliance strategy.

Penalties for Non-Compliance with MTD for VAT

HMRC treats MTD compliance seriously, and failure to follow the rules can result in financial penalties and increased scrutiny.

Non-compliance with MTD for VAT may lead to:

• Late submission penalties, where VAT returns are not filed on time
• Penalty points or default surcharges, depending on the applicable HMRC penalty regime
• Increased HMRC monitoring, including compliance reviews
• Formal VAT compliance checks or audits, especially where errors persist

HMRC takes a particularly strict view where businesses:

• Continue submitting VAT returns manually without an approved exemption
• Break digital link requirements
• Use non-compliant software knowingly
• Ignore MTD sign-up obligations

Even where VAT is paid correctly and on time, using the wrong submission method can still trigger penalties. HMRC’s position is that MTD is not optional once a business is within scope.

Repeated non-compliance can also damage a business’s compliance history, increasing the likelihood of future checks and delays — especially around VAT refunds.

Common MTD for VAT Mistakes Small Businesses Make

Despite clear guidance, many small businesses struggle with MTD compliance in practice. The most common mistakes include:

• Failing to sign up to MTD in time, resulting in missed VAT return deadlines
• Using software that is not fully MTD-compatible, particularly older or unsupported systems
• Breaking digital links, often by copying and pasting figures manually
• Relying on spreadsheets without compliant bridging software
• Assuming the accountant “handles everything automatically”

One of the biggest misunderstandings is responsibility. Even if an accountant or bookkeeper prepares VAT returns, legal responsibility for MTD compliance always remains with the business.

If a business:

• Uses non-compliant processes
• Provides incomplete digital records
• Breaks audit trails

HMRC will hold the business — not the adviser — accountable.

Clear communication with advisers and regular reviews of systems are essential to avoid accidental non-compliance.

How MTD for VAT Affects Small Business Cash Flow

While Making Tax Digital for VAT introduces additional administrative requirements, it can also deliver tangible financial and operational benefits when implemented correctly.

For many small businesses, MTD results in:

• Improved VAT accuracy, reducing costly errors
• Earlier identification of VAT repayment positions, improving cash flow
• Better financial visibility, through real-time digital records
• Reduced long-term compliance risk, lowering the likelihood of HMRC disputes

Businesses that embrace MTD early often find that:

• VAT returns take less time to prepare
• Records are more organised and accessible
• VAT refund processing becomes smoother
• HMRC interactions are less frequent and less stressful

Although there may be initial setup costs or learning curves, these are often offset by improved efficiency and reduced risk over time.

Frequently Asked Questions (FAQ): Making Tax Digital for VAT

What is Making Tax Digital (MTD) for VAT?

Making Tax Digital for VAT is a UK government initiative introduced by HM Revenue & Customs that requires VAT-registered businesses to keep VAT records digitally and submit VAT returns using MTD-compatible software. Manual submissions through the old HMRC VAT portal are no longer allowed for most businesses.

Who needs to comply with MTD for VAT?

Almost all VAT-registered businesses must comply with MTD for VAT, including:

• Sole traders
• Limited companies
• Partnerships
• Charities that are VAT registered

This applies even if your turnover is below the VAT registration threshold, as long as you are VAT registered.

Does MTD for VAT apply to small businesses?

Yes. MTD for VAT applies to small businesses of all sizes if they are VAT registered. There is no minimum turnover exemption once a business is registered for VAT.

Are there any exemptions from MTD for VAT?

Yes, but exemptions are limited. You may be exempt if:

• You are digitally excluded due to age, disability, or location
• Your business is subject to insolvency procedures
• HMRC has granted you a specific exemption

You must apply to HMRC and receive approval — exemptions are not automatic.

What records must be kept digitally under MTD for VAT?

Businesses must keep the following VAT records digitally:

• VAT registration number
• Business name and address
• VAT accounting scheme used
• VAT charged on sales (output VAT)
• VAT paid on purchases (input VAT)
• VAT rates applied
• Tax point (time of supply)

Records must be retained for at least six years.

Can I still use spreadsheets for MTD for VAT?

Yes, but only with bridging software.

Spreadsheets alone are not compliant. Bridging software creates a digital link between your spreadsheet and HMRC, allowing VAT returns to be submitted digitally without manual re-entry.

What are “digital links” in MTD for VAT?

A digital link means VAT data must be transferred between systems electronically, without copying and pasting.

Examples of compliant digital links include:

• Spreadsheet → bridging software
• Accounting software → VAT return submission

Manual copying or re-typing VAT figures breaks MTD compliance rules.

What software is MTD-compatible?

MTD-compatible software includes:

• Cloud accounting software (e.g. Xero, QuickBooks, Sage)
• Bridging software for spreadsheet users

The software must be approved by HMRC and capable of submitting VAT returns directly.

Do I need to sign up separately for MTD for VAT?

Yes. Being VAT registered does not automatically enroll you in MTD.

You must:

1. Choose MTD-compatible software
2. Sign up for MTD through your HMRC online account
3. Authorise your software to interact with HMRC

You should sign up at least 7–14 days before your VAT return deadline.

How do I submit VAT returns under MTD?

VAT returns must be submitted:

• Through MTD-compatible software
• Using digital VAT records
• By the usual VAT deadlines

The VAT calculation itself remains the same — only the submission method changes.

What happens if I don’t comply with MTD for VAT?

Non-compliance may result in:

• Late submission penalties
• Penalty points under HMRC’s VAT penalty system
• Increased HMRC scrutiny
• Compliance checks or audits

Continuing to submit VAT returns manually without exemption is a common compliance breach.

Does MTD for VAT change how much VAT I pay?

No. MTD does not change VAT rates, thresholds, or calculations. It only changes how VAT records are kept and how returns are submitted.

Can my accountant handle MTD for VAT for me?

Your accountant can:

• Set up MTD-compatible systems
• Submit VAT returns on your behalf
• Maintain digital links

However, legal responsibility remains with the business, not the accountant. You are still responsible for ensuring compliance.

How does MTD for VAT affect VAT refunds?

MTD can actually improve VAT refunds by:

• Reducing calculation errors
• Creating clearer audit trails
• Speeding up HMRC processing

However, poor digital records or broken links may delay refunds or trigger HMRC queries.

Is Making Tax Digital expanding beyond VAT?

Yes. MTD is being rolled out in stages:

• MTD for VAT is already live
• MTD for Income Tax is being introduced gradually
• Corporation Tax may follow in future

MTD is a long-term digital transformation of the UK tax system.

Do I need professional help with MTD for VAT?

Many small businesses manage MTD themselves, but professional help is strongly recommended if:

• You use complex spreadsheets
• You have multiple VAT rates
• You regularly claim VAT refunds
• You’ve received HMRC warnings or penalties
• You’re unsure whether your setup is compliant

How Audit Consulting Group Can Help with MTD for VAT

Making Tax Digital for VAT can feel overwhelming, especially for small businesses without dedicated finance teams.

Audit Consulting Group helps UK businesses:

• Understand MTD for VAT requirements
• Choose the right MTD-compatible software
• Set up digital record-keeping systems
• Maintain digital links and audit trails
• Submit VAT returns compliantly
• Deal with HMRC queries or penalties

+44 7386 212550
info@auditconsultinggroup.co.uk

Final Thoughts

Making Tax Digital for VAT is not optional for most UK businesses — it is now a core part of VAT compliance. While the transition may seem complex at first, the right systems, processes, and professional support can turn MTD into a manageable and even beneficial change.

Understanding the rules today helps avoid penalties tomorrow.