MTD VAT: Crunch time for micro businesses

The Making Tax Digital (MTD) for VAT crunch has arrived. Small businesses who are voluntarily VAT registered, because their turnover has not exceeded £85,000, now have to face reality and sign up for MTD in order to submit their next VAT return using MTD-compatible software. 

Annual returns

Smaller businesses (turnover not exceeding £1.35m) can opt to submit an annual VAT return, under the VAT annual accounting scheme. These traders must pay their VAT liability in monthly or quarterly instalments, plus a final balancing payment within two months of the end of the year.  

Having an annual VAT return will effectively delay the mandation date for MTD for up to nine months. For example, a trader with an annual return period that runs from 1 April 2022 to 31 March 2023, has to submit their first VAT return under MTD by 31 May 2023.     

Monthly returns

Those businesses who submit monthly VAT returns had to submit their first MTD return for the period to 30 April 2022, by 7 June 2022. HMRC only permits businesses to submit monthly VAT returns if they regularly claim a VAT repayment, or if it is required for “protection of the revenue” (HMRC VAT Accounting manual VATAC1100). Monthly VAT returns are thus relatively rare.

Quarterly returns

The majority of VAT-registered businesses submit quarterly VAT returns in one of these three possible staggers:

1. Quarters to end: June, September, December, March
2. Quarters to end: July, October, January, April
3. Quarters to end: August, November, February, May.

Stagger 1 is the most popular pattern of quarterly returns as it aligns with the commonly used accounting periods ending on 31 March and 31 December. 

The ideal window during which the business should sign up to MTD VAT will vary according to the stagger period used and whether the business pays its VAT due via direct debit, as I explained in March 2022. 

Businesses on the stagger 1 pattern need to submit their first MTD return by 7 August 2022, which means they should sign up for MTD between 13 May and 31 July 2022, or by 4 August if they don’t pay by direct debit. 

How many have signed up?

According to HMRC’s latest figures around 40% of VAT-registered businesses that are trading below the VAT registration threshold had signed up to MTD VAT by 16 May 2022. This is quite a reasonable percentage as stagger 1 businesses have until 31 July or 4 August to sign up to MTD. 

Early adopters 

Some voluntarily registered businesses signed up to MTD for VAT much earlier than they were required to. The reasons for such voluntary sign-up were explored in qualitative research for HMRC published in late 2020, and can be summarised as:

• Not aware there was a choice 
• Excepted to shortly exceed VAT registration turnover threshold
• Wanted to get the switch done to avoid later hassle
• Already using MTD software, so it was an easy switch 
• New business that used MTD software from the start 
• Wanted to improve record keeping and reduce errors.

Further research conducted

In 2021 HMRC commissioned research into the awareness of MTD among smaller VAT-registered businesses, mostly those with turnover under £50,000. The research was conducted in two waves with 551 business owners interviewed by phone in June 2021, and another 556 interviewed during December 2021 to January 2022. 

The sample was also chosen to include a spread of businesses across all regions of the UK and in a variety of different industry sectors. 

Do businesses understand MTD?

Although there was high awareness of the term or concept of MTD (for example, 93% in wave 2), some 28% of businesses in the second wave did not think MTD applied to them. 

There is clearly some misunderstanding about how MTD for VAT differs from the current electronic VAT return filing requirements. In both interview groups over 30% of businesses thought they had already signed up to MTD, when in fact they had not. The entire sample of 1,107 businesses was drawn from the HMRC’s database of VAT-registered businesses that had not signed up to MTD. However, 4% of the sample had signed up for MTD by the conclusion of the interview period.

Those businesses that were already using software to keep their business records were more likely to say they were already fully complying with the MTD requirements. Even after these requirements were spelled out, 26% of businesses thought that they were fully compliant, when in fact they were not, as their software had not been linked to HMRC in order to submit VAT returns.

Around 20% of the sample were still using paper to record business transactions. This percentage was much higher in Scotland (39%), Wales (36%) and Northern Ireland (40%). The industry sectors more likely to use paper-based record-keeping methods were the agriculture, forestry and fishing sectors.

When will they take action?

The sample was asked when they would take action to prepare for MTD. Although all the businesses should have received a letter or email from HMRC on the topic, 37% in wave 2 did not know when they would take action and 19% were waiting for their accountant to advise them. Also 13% said they needed more information.

It is clear that businesses that are still using paper methods of record keeping will need greater support to transition to MTD. These businesses also had significant concerns over the security of keeping records digitally.

What benefits?

HMRC has not sold the benefits of MTD to this small business community, as 38% in the first wave, and 46% in the second wave, could see no benefits associated with implementing the changes related to MTD. 

The threat of penalties for non-compliance may convince some to convert to MTD for VAT, but in the end when HMRC closes the old portal businesses will have no choice, other then to claim exemption.