What Is Making Tax Digital and How Should Small Businesses Prepare?

If you run a small business in the UK, you've probably heard about Making Tax Digital (MTD) from your accountant, software provider, or HMRC. MTD is the UK government's initiative to modernise how tax is recorded and filed—and unlike most government initiatives, this one isn't optional. It's a legal requirement rolling out in phases, and understanding where your business fits in that timeline is essential to staying compliant.

The core idea is straightforward: HMRC wants digital records and direct software submissions instead of manual record-keeping and annual paper returns. But the execution matters. Get it right, and MTD actually improves how you manage your finances. Get it wrong, and you're facing penalties—points-based, designed to be "proportionate," which is corporate-speak for "more consistent and less surprising" (not more forgiving).

Let's break down what MTD actually requires, who it affects, and how to prepare without losing your mind.

What Making Tax Digital actually requires

At its heart, MTD mandates two things:

1. Digital record-keeping. You must keep your business records in a digital format. Spreadsheets count—but only if they're linked to compatible software through what HMRC calls "digital links." (Copy-pasting figures from Excel into your filing tool does not constitute a digital link. If you're doing that, HMRC would like a word.)

2. Software-based submissions. You must use MTD-compatible software to submit your tax returns directly to HMRC. You cannot log into the HMRC website, type in your figures manually, and call it a day. The submissions have to come from the software.

The stated goal: reduce errors, close the tax gap, and keep you on top of your obligations throughout the year instead of panic-filing in January. The practical goal: HMRC gets better real-time visibility into the tax system. For you, that's either a feature (clearer picture of your own finances, fewer mistakes) or a bug (more frequent reporting, less time between submission and feedback). Usually both.

The MTD timeline: where you are now

MTD has been rolling out in stages since 2019. Here's where we stand:

MTD for VAT (mandatory since 2019–2022)

All VAT-registered businesses must file their VAT returns through MTD-compatible software. This became mandatory for most businesses around 2019–2022, depending on your turnover threshold at the time.

If you're VAT-registered and still filing through the manual HMRC portal, you're non-compliant. Full stop. This phase is already live and has been for years. If you haven't switched yet, your accountant probably knows about it.

MTD for Income Tax Self-Assessment (ITSA) — coming soon

This is the next major rollout. Sole traders and landlords will need to:

Keep digital records of income and expenses
Submit quarterly updates to HMRC (four times a year, not once)
Provide an end-of-period statement and final declaration

The current timeline targets sole traders and landlords earning above £50,000 first, with lower thresholds following in subsequent years. The exact dates have shifted before and will probably shift again, so check HMRC's official guidance before making long-term plans.

MTD for Corporation Tax — future phase

Limited companies are not yet required to comply. MTD for Corporation Tax is still being consulted on and is expected to follow a similar pattern once the self-assessment rollout stabilises. If you run a limited company, start thinking about digitising your records now.

Who MTD affects (and when)

If you fall into any of these categories, MTD is relevant:

VAT-registered businesses — Already required
Sole traders earning above the threshold — Coming soon
Landlords with rental income — Same timeline as sole traders
Partnerships — Expected to follow
Limited companies — Future phase, not yet confirmed

Even if you're currently below the threshold, start preparing now. Thresholds tend to decrease over time. Read The Complete Guide to VAT Registration for Small Businesses to understand when registration becomes mandatory. Building good habits before MTD applies to you means you won't be scrambling when the next phase hits.

How to prepare for Making Tax Digital

1. Get MTD-compatible software

This is the single most important step. You need accounting software that can:

Store your records digitally
Generate and submit VAT returns directly to HMRC (if applicable)
Submit quarterly updates and final declarations (when ITSA goes live)
Maintain digital links and integrate with HMRC

Not all accounting software is MTD-compatible. Some older or free tools let you keep records digitally but cannot submit to HMRC. Check the vendor's MTD status before assuming you're covered.

You'll want software with direct HMRC integration, automated VAT calculations, and the ability to generate the nine-box VAT return without manual re-entry. If you're evaluating options, the Complete Guide to MTD for VAT walks through software selection and bridging solutions in detail.

2. Digitise your records

If you're still keeping records on paper, in unlinked spreadsheets, or in a literal shoebox, now is the time to change. Start by:

Setting up a digital chart of accounts
Entering your opening balances
Recording all income and expenses digitally going forward
Scanning and attaching receipts where possible

You don't need to backdate your entire history, but you do need a clean starting point from which all future records are digital.

3. Understand the quarterly reporting rhythm

Under MTD for ITSA, you'll submit updates to HMRC every three months. This is a significant change from the annual self-assessment return you might be used to.

Each quarterly update summarises income and expenses for that quarter. At year end, you submit a final declaration confirming your total figures. This means keeping your books current throughout the year, not just in January. If you currently do all your bookkeeping in a single caffeine-fueled weekend, you'll need to build new habits.

Quarterly reporting also gives you a much clearer picture of your business finances mid-year. You can spot problems earlier and make better decisions—which beats discovering in April that you've had a cash-flow problem since October.

4. Set up bank feeds

One of the easiest ways to stay on top of your records is to connect your bank account to your accounting software. Bank feeds automatically import your transactions, which you then categorise and reconcile.

This dramatically reduces manual data entry and makes quarterly reporting far less painful. It's also more accurate than typing in transactions by hand.

5. Align with your accountant

If you use an accountant, make sure they're ready for MTD too. Many are already set up with MTD-compatible software and can handle submissions on your behalf. Discuss:

Who will be responsible for quarterly submissions (you or them)
What software you'll both use (and whether it integrates)
How you'll share records throughout the year
What the fee implications are for more frequent reporting

See How to Use Accounting Software to Prepare for Your Accountant for guidance on structuring records they can actually use.

Common MTD mistakes to avoid

Assuming your current software is compliant. Not all accounting tools support MTD. Some older or free options let you keep records digitally but cannot submit to HMRC. Check your vendor's MTD status.

Relying on spreadsheets as your primary system. HMRC allows spreadsheets as part of your digital records, but they must be connected via digital links. Copy-pasting from Excel into your filing tool does not count.

Waiting until the deadline. Every MTD phase sees a surge of businesses scrambling to comply at the last minute. Software migrations take time, data needs cleaning, and there's a learning curve. Start preparing at least six months before any deadline.

Ignoring the penalty regime. HMRC uses a points-based penalty system for late submissions. Each late submission earns a point; hit the threshold and you receive a financial penalty. It's designed to be proportionate, but that doesn't mean it's cheap.

What to look for in MTD software

When evaluating tools for MTD, consider:

HMRC recognition — Is it on the official list of MTD-compatible software?
VAT filing — Can it generate and submit the nine-box VAT return directly?
Quarterly updates — Is it ready for MTD for ITSA when it launches?
Bank feeds — Does it support automatic transaction imports?
Ease of use — Can you actually use it without an accounting degree?
Accountant integration — Can your accountant log in and review your records?
Reporting — Does it give you insights into your business finances, or just compliance data?
Pricing — Does the cost scale fairly as your business grows?

The best MTD software is the one you'll actually use consistently. A powerful platform sitting unused because it's too complicated defeats the entire purpose.

Frequently asked questions

Q: Do I have to use MTD software if I'm not VAT-registered yet?

A: Not yet. If you're a sole trader or landlord earning below the current threshold, you can continue using standard accounting software or spreadsheets. But if you're expecting to cross the threshold soon, starting now will save you stress later.

Q: Can my accountant file MTD returns on my behalf?

A: Yes. Many accountants are set up to submit MTD returns directly to HMRC on behalf of their clients. You'll still need MTD-compatible software to keep your records, but your accountant can handle the actual filing. Clarify this with your accountant's firm before assuming.

Q: What happens if I miss an MTD deadline?

A: HMRC applies points under their penalty regime. The first late submission earns you a point. Once you hit the threshold (typically three points), you receive a financial penalty. The penalty increases incrementally, not all at once.

Q: How long do quarterly returns take to file?

A: If your records are clean and up to date, a quarterly MTD return takes 15–30 minutes. If your records are a mess, you're looking at a few hours while you track down receipts and fix categorisations. This is another reason to keep records current throughout the year.

Q: Can I use spreadsheets for MTD?

A: Spreadsheets can be part of your digital records if they're linked to your MTD software via a digital link. But spreadsheets alone don't satisfy MTD requirements. You need the software-to-HMRC submission part, which spreadsheets can't do independently.

Q: Will MTD apply to my limited company?

A: Not yet. MTD for Corporation Tax is still being consulted on. But it's coming eventually. If you run a limited company, start thinking about digitising your records now—you'll be required to eventually.

Q: What if I change accountants?

A: Your new accountant will need access to your MTD software and records. Modern platforms allow accountant access at no extra cost, which makes handovers much simpler. If your current software charges extra per accountant, that's a sign to explore alternatives.

Moving forward with MTD

Making Tax Digital is here to stay, and its scope will only expand. Whether you're already compliant for VAT or preparing for the next phase, the key is to start now, choose the right tools, and build habits around regular digital record-keeping.

The businesses that treat MTD as an opportunity—to get clearer visibility into their finances, to catch problems earlier, to automate away manual data entry—benefit most. The businesses that treat it as just another compliance box to tick will still be compliant, but they'll be missing the real upside.

Check our Year-End Accounting Checklist to make sure your records are MTD-ready before the next deadline. If you'd like to see how Relentify's accounting platform handles MTD compliance out of the box—with direct HMRC integration, bank feeds, and accountant collaboration built in—try it free for 14 days. No credit card, no sales call, just a working platform designed for how small businesses actually keep their books.