Making Tax Digital: What it means for your business

Published Wednesday 17 December 2025

Table of contents

• What is Making Tax Digital
• Who needs to use Making Tax Digital and when
• Making Tax Digital thresholds
• Who is exempt from Making Tax Digital
• How Making Tax Digital works
• What software do you need for Making Tax Digital
• How to comply with MTD legislation
• What happens if you don't comply with MTD legislation
• FAQs on Making Tax Digital

Key takeaways

• If you're VAT-registered, you must use MTD-compatible software now. If you're self-employed or a landlord, check when you need to comply based on your annual income: £50,000+ by April 2026, £30,000+ by April 2027, £20,000+ by April 2028.
• The legislation requires you to keep digital records of all business income and expenses using HMRC-recognised software, and submit quarterly updates instead of annual tax returns.
• HMRC operates a penalty point system for late submissions. You receive one point for each missed deadline, and once you reach the threshold for your submission frequency, you'll face a £200 fine.

What is the Making Tax Digital legislation

Making Tax Digital (MTD) is government legislation that modernises how businesses and individuals report tax to HMRC. The law requires you to keep digital records and use MTD-compatible software to submit tax returns. The legislation aims to reduce errors and make tax administration more straightforward.

Who needs to use Making Tax Digital and when

The legislation is being introduced in stages. MTD for VAT is already mandatory for all VAT-registered businesses. MTD for Income Tax (IT) will become mandatory for sole traders and landlords from different dates, depending on annual income levels. Check the thresholds below to see when the legislation applies to you.

Making Tax Digital thresholds

Current requirements:

• VAT: All VAT-registered businesses must comply now

Future Income Tax requirements:

• £50,000+ qualified annual income: April 2026
• £30,000+ qualified annual income: April 2027
• £20,000+ qualified annual income: April 2028

Who is exempt from Making Tax Digital

The legislation includes exemptions for certain businesses and individuals. You may be exempt if you're 'digitally excluded' – this means you cannot use digital tools due to age, disability, location, or religious beliefs. Certain types of organisations, such as religious societies, may also be exempt. If you think you qualify for an exemption, you need to apply through HMRC.

How Making Tax Digital works

The legislation changes how you report tax to HMRC. Instead of one annual tax return, you must send regular updates through software. For MTD for Income Tax, the law requires you to:

• Keep digital records of your business income and expenses
• Send quarterly summaries to HMRC using approved software
• Submit a final declaration at the end of the tax year

What software do you need for Making Tax Digital

To comply with MTD, you need to use software that is recognised by HMRC. This is often called 'functional compatible software'. The software must connect to HMRC's systems to send your tax information digitally. You cannot submit returns manually or by post if you're required to follow MTD rules.

How to comply with MTD legislation

Legal requirements:

• Use MTD-compatible software for all record keeping
• Submit returns digitally through approved software
• Maintain digital linksbetween different software systems
• Keep all business records in digital format

MTD for VAT requirements:

Your digital records must include:

• Business name, address, and VAT registration number
• VAT accounting schemes used
• VAT on goods and services supplied and received
• VAT rates charged on all services

You must submit VAT returns using HMRC-recognised software to comply with Making Tax Digital for VAT rules.

MTD for Income Tax requirements:

• Keep digital records of all business income and expenditure
• File quarterly updates using HMRC-recognised software
• Submit your final declaration by 31 January following the tax year

For more guidance, read the comprehensive guide to digital record keeping for MTD.

What happens if you don't comply with MTD legislation

If you don't comply with the legislation, HMRC will issue penalties. The penalty system includes fines and penalty points for late submissions.

In January 2023, HMRC introduced a points-based penalty system for late submissions. Each time you miss a deadline, you receive one penalty point. Once you reach the points threshold (which depends on how often you submit returns), you'll receive a £200 fine.

Late payments are also subject to penalties. If you don't pay tax within 15 days of the deadline, you'll pay a penalty of 3% on the outstanding amount. If the tax remains unpaid after 30 days, you'll pay an additional 3% penalty. After 31 days, you'll pay a daily penalty of 10% per annum on the outstanding amount.

This penalty system currently applies to MTD for VAT, and will apply to MTD for Income Tax when the legislation comes into effect.

Inaccuracy penalties for VAT and Income Tax remain unchanged under the legislation. These penalties work separately from the points-based system, so check HMRC's guidance to understand your obligations.

FAQs on Making Tax Digital legislation

Here are answers to common questions about the legislation.

Is it a legal requirement to use accounting software?

Yes. The legislation requires you to use MTD-compatible software to submit returns. This applies to both MTD for VAT and MTD for Income Tax. Without approved software, you cannot submit compliant returns. If you don't submit returns through MTD-compatible software, HMRC will issue penalties under the penalty point system.

Who needs to follow Making Tax Digital for Income Tax, and when?

The legislation will apply to sole traders and landlords based on their qualified annual income:

• £50,000+ annual income: from April 2026
• £30,000+ annual income: from April 2027
• £20,000+ annual income: from April 2028

To work out your qualified income, you need to add together your total business income and property income. Read HMRC's guidance on calculating qualified income for more information.

HMRC has not yet confirmed when the legislation will apply to general partnerships.

What are the penalties for not complying with Making Tax Digital?

The legislation sets out a penalty points system for late submissions. You receive one penalty point for each missed deadline. Once you reach the points threshold (which depends on whether you submit annually, quarterly, or monthly), you'll receive a £200 fine. Read Xero's guide on penalties for more information.

Late payment penalties work as follows:

• After 15 days: 3% penalty on the outstanding amount
• After 30 days: additional 3% penalty on the outstanding amount
• After 31 days: daily penalty of 10% per annum on the outstanding amount