Reducing the tax gap: Adam Bernstein explores ‘making tax digital for income tax’, and how to get ready for the changes.
The difference between how much tax should be paid and how much is actually collected is called the ‘tax gap’. A 2024 HM Revenue and Customs (HMRC) report estimated it at almost £40 billion.
Making tax digital (MTD) for income tax is part of the government’s strategy to reduce this gap. It introduces requirements for businesses to keep digital records and submit information to HMRC in closer to real-time.
Who MTD will affect
According to David Wright, a technical officer at the Association of Taxation Technicians (ATT), MTD for income tax applies to unincorporated businesses – sole traders and the self-employed – and landlords and will be introduced in phases. Self-employed dentists and locums are squarely in the firing line of the regime.
Wright explains that the date from which a taxpayer might have to join MTD for income tax will depend on their combined level of income from trading and property, before expenses. HMRC calls this ‘qualifying income’.
According to Wright: ‘From April 2026, taxpayers with qualifying income of more than £50,000 will need to comply with MTD. From April 2027 that will drop to income over £30,000, and from April 2028 MTD will extend to those with qualifying income over £20,000. While we’re only referring to businesses here, if the owner is also a landlord, they will need to look at their total income (before expenses) from both sources.’
As an example, someone who is self-employed whose business has an annual turnover of £48,000 will have to comply with MTD for income tax from April 2027. However, if they also have a rental property generating gross rent of £15,000 per year, both sources of business income would need to be combined, meaning they would be in scope of MTD for income tax from April 2026 as the combined qualifying income is over £50,000.
Tax will still be due by 31 January after the end of the tax year. The due dates for paying tax won’t change.
For now, taxpayers with qualifying income under £20,000 can continue without change. However, Wright notes: ‘The the government intends to extend MTD to cover partnerships and limited companies at some point, but there’s no indication of when this might happen.’
What MTD will involve
Wright explains that MTD for income tax has four key components:
- Digital records
- Quarterly updates
- A year-end tex return
- Digital links.
Under digital records, taxpayers will have to use software to keep digital records of the amount, category and date of income and expenses relating to their business.
Then there are quarterly updates where ‘a summary will have to be submitted to HMRC of the income and expenses of the business every quarter, based on the digital records kept.’
Wright continues: ‘The quarterly updates won’t be as detailed as the annual tax return, but a separate quarterly update will be needed for each trade or property business.’
He warns here that if a person also rents out a property, they will have eight quarterly submissions to make each year. Next comes the year-end declaration. As Wright details, after the fourth quarterly update has been submitted, the taxpayer will need to file a ‘digital tax return’.
This is similar to the current self-assessment return and ‘will pre-populate income and expenses from the quarterly updates already filed; the entries will need to be adjusted for accounting and tax purposes.’ Wright adds that any non-business income sources – bank interest, salaries or pensions – will need to be reported too while also claiming relevant tax reliefs.
Lastly are digital links. ‘This,’ as Wright says, means that ‘all transfers of data will have to be sent digitally. This includes submitting quarterly updates, making any corrections, and filing the year-end declaration.’ It also includes transfers of business records, for instance between the taxpayer and their bookkeeper or accountant.
Getting ready for the change
The exact date from which taxpayers have to comply with MTD for income tax will depend on the qualifying income reported on their most recent tax return.
For instance, tax returns for the year ended 5 April 2025 will be due for submission by 31 January 2026. If that tax return reports gross qualifying income of more than £50,000, that individual will have to join MTD from April 2026. Here, Wright warns that if business owners don’t plan in advance, they could only have two months to prepare for MTD after filing their 2024/25 tax return.
And if someone has set up in business since April 2024, they’ll need to scale their income. Wright says: ‘Take a business that started on 1 January 2025 and has earned gross income of £10,000 per month.
The 2024/25 tax return will show £30,000 of income, which is below the MTD threshold for April 2026. But they’ll need to adjust that to estimate a full year’s worth of income – £120,000.’ Therefore, they’ll need to comply with MTD for income tax from April 2026.
Helpfully, HMRC has an online tool that can help check when to start using MTD for income tax – find it via www.gov.uk/guidance/check-if-youre-eligible-for-making-tax-digital-for-income-tax.
Another issue for Wright is record-keeping. Here he says that: ‘If a taxpayer keeps paper receipts and tends to work out the accounts and tax position after the end of the year, they’ll need to start using software and keep records on a timelier basis.’
For small, straightforward businesses, a spreadsheet will help. ‘Bridging software’ is already available to feed the data from spreadsheets into other software products that can support MTD filing obligations.
HMRC’s software choices webpage (www.gov.uk/guidance/find-software-thats-compatible-with-making-tax-digital-for-income-tax) shows what compatible software is available. HMRC won’t be offering an online filing service for the digital tax return in MTD – instead, taxpayers will need to find software that supports this.
Even so, the demands of record-keeping and administration will increase for most of the businesses affected by MTD. Therefore, it could be worthwhile to find an adviser or qualified professional to advise and support the business with MTD.
Finally, while HMRC will be writing to taxpayers it believes needs to comply with MTD for income tax, anyone in scope of MTD will need to register; HMRC won’t do it automatically. Whether taxpayers like it or not, change is coming. It makes sense, therefore, to seek advice sooner rather than later about how to comply.
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