Making Tax Digital for VAT

Rules introduced under the Making Tax Digital initiative mean VAT registered businesses with taxable turnover above the VAT registration threshold need to keep digital records and submit VAT Returns to HMRC using functional compatible software from 1^st April 2019.

This blog explains:

the digital records businesses must keep, and ways to record transactions digitally in certain special circumstances
what counts as ‘functional compatible software’, and when software programs do and do not need to be digitally linked where a combination of programs is used

It is increasingly common for business records and accounts to be kept digitally, in a software program on a computer or tablet, or in a smartphone application, or maintained through such a device and stored using a cloud-based application.

Read our 13 reasons why you should use cloud accounting software.

The difference under Making Tax Digital is that the software which businesses use must be capable of keeping and maintaining the records specified in the regulations, preparing their VAT Returns using the information maintained in those digital records and communicating with HMRC digitally via our Application Programming Interface (API) platform.

If your digital records are up to date, software will be able to collate and prepare your return for you. It will then show the return to you and ask you to declare that it is correct and confirm that you want to submit it to HMRC. Once you have submitted your return you will receive confirmation through your software that it has been received.

Digital record-keeping

All VAT registered businesses must keep and preserve certain records and accounts. Under Making Tax Digital, some of these records must be kept digitally within functional compatible software.

Some software will record all your VAT records and accounts information. However, there are some records that by law must be kept and preserved in their original form either for VAT purposes or other tax purposes. For example you must still keep a C79 (import VAT certificate) in its original form.

Example 1

A business receives an invoice and types selected data contained in the invoice into functional compatible software. They must still keep the invoice in its original form as the data in the functional compatible software is not a copy of the invoice.

Example 2

A business has functional compatible software that scans the invoices received and puts the information in its ledger. If the image is retained and contains all the detail required for VAT purposes then the business does not need to keep the original invoice unless it is required for another purpose.

A great example of this is Receipt Bank which helps you spend less time bookkeeping and more time growing your business.

Functional compatible software

Functional compatible software is a software program, or set of software programs, products or applications, that must be able to:

record and preserve digital records
provide to HMRC information and returns from data held in those digital records by using the API platform
receive information from HMRC via the API platform

HMRC expects that there will be software products available that will perform all of the functions listed above. Below is a selection of the current software products that have tested their products in HMRC’s test environment and already demonstrated a prototype of their software to HMRC:

Clear Books
QuickBooks
Sage
Iris
Xero

The full list of functional compatible software can be found on HMRC’s website.

Some software programs will not be able to perform all of these functions by themselves. For example, a spreadsheet or other software product that is capable of recording and preserving digital records may not be able to perform the other two functions listed above, but can still be a component of functional compatible software if it is used in conjunction with one or more programs that do perform those functions.

The complete set of digital records to meet Making Tax Digital requirements does not all have to be held in one place or in one program. Digital records can be kept in a range of compatible digital formats. Taken together, these form the digital records for the VAT registered entity. This is however a more complicated, long winded and potentially costly route.

Digital links

Data transfer or exchange within and between software programs, applications or products that make up functional compatible software must be digital where the information continues to form part of the digital records. Once data has been entered into software used to keep and maintain digital records, any further transfer, recapture or modification of that data must be done using digital links. Each piece of software must be digitally linked to other pieces of software to create the digital journey.

It follows that transferring data manually within or between different parts of a set of software programs, products or applications that make up functional compatible software is not acceptable under Making Tax Digital. For example, noting down details from an invoice in one ledger and then using that handwritten information to manually update another part of the business functional compatible software system.

A ‘digital link’ is one where a transfer or exchange of data is made, or can be made, electronically between software programs, products or applications. That is without the involvement or need for manual intervention such as the copying over of information by hand or the manual transposition of data between two or more pieces of software.

A digital link includes linked cells in spreadsheets, for example, if you have a formula in one sheet that mirrors the source’s value in another cell, then the cells are linked.

HMRC will also accept digital links as:

emailing a spreadsheet containing digital records to a tax agent so that the agent can import the data into their software to carry out a calculation (for instance, a Partial Exemption calculation)
transferring a set of digital records onto a portable device (for example, a pen drive, memory stick, flash drive) and physically giving this to an agent to import that data into their software
XML, CSV import and export, and download and upload of files
automated data transfer
API transfer

This list is not exhaustive.

HMRC does not consider the use of ‘cut and paste’ to select and move information, either within a software program or between software programs, to be a digital link.

Records that must be kept digitally

The records listed in the following paragraphs must be kept, maintained and preserved in digital form. The regulations refer to this information as your “electronic account”. The exact way you must enter the information will depend on the software package you have. Contact your software provider if you are unsure how to enter information into your software. If you don’t have a software provider please contact us. HMRC can only provide advice on the legal requirements of Making Tax Digital.

You will need to keep additional records, such as invoices. You do not have to keep these digitally but you may choose to do so. For more information on the additional records that must be kept for VAT purposes, see VAT Notice 700/21: keeping VAT records.

Designatory data

You must have a digital record of:

your business name
the address of your principal place of business
your VAT registration number
any VAT accounting schemes that you use

Supplies made

For each supply you make you must record the:

time of supply (tax point)
value of the supply (net value excluding VAT)
rate of VAT charged

This only includes supplies recorded as part of your VAT Return. Supplies that do not go on the VAT Return do not need to be recorded in functional compatible software. For example intra-group supplies for a VAT group are not covered by these rules.

The time of supply is the date that you must declare output tax on. Typically this is when you send a VAT invoice or, if you are on cash accounting, when you receive payment for the supply.

Where more than one supply is recorded on an invoice and those supplies are within the same VAT period and are charged at the same rate of VAT you can record these as a single entry.

Supplies received

For each supply you receive you must record the:

time of supply (tax point)
value of the supply
amount of input tax that you will claim

This only includes supplies recorded as part of your VAT Return, supplies that do not go on the VAT Return do not need to be recorded in functional compatible software. For example, wages paid to an employee would not be covered by these rules.

There is no requirement under the regulations to record inputs for the period split by VAT rate.

The time of supply is typically the date on the VAT invoice or, if you are on cash accounting, when you pay for the supply. However you must also hold the associated evidence to claim deduction of input tax.

If more than one supply is on an invoice you can record the totals from the invoice. Where the amount of input tax that you will claim is not known at the time you record the supply you have received, you can record:

the total amount of VAT and adjust for any irrecoverable VAT once calculated
no VAT and adjust for any recoverable VAT once calculated
VAT recoverable based on an estimated percentage and adjust for any VAT once calculated

Where an invoice includes supplies with different times of supply that are within the same VAT period, you may record all supplies on the invoice as being at the same date.

Summary data

To support each VAT Return you make, your functional compatible software must contain:

the total output tax you owe on sales
the total tax you owe on acquisitions from other EU member states
the total tax you are required to pay on behalf of your supplier under a reverse charge procedure
the total input tax you are entitled to claim on business purchases
the total input tax allowable on acquisitions from other EU member states
the total tax that needs to be paid or you are entitled to reclaim following a correction or error adjustment, and
any other adjustment allowed or required by VAT rules

A total of each type of adjustment must be recorded as a separate line. This information is no different to what would be supplied to HMRC in boxes one through nine of your current VAT return.

Below is an example of the journey required using a modern online accounting system versus using spreadsheets.

Final Thoughts

If you are ready to make the switch to a single API enabled software package and need help and support with a migration then call us today. If you are going to take your chances with spreadsheets, bridging software we wish you all the best.

We are one of the UK’s leading Xero migration experts and help businesses every year make a seamless transition.

Click here to find out more.