Making Tax Digital: MTD for Sole Traders

Introduction to Making Tax Digital

Making Tax Digital (MTD) is a UK government initiative designed to digitalise the tax system. Starting with VAT, it now also covers income tax. Why? This will hopefully simplify the tax filing process, reduce errors, and improve tax compliance through better digital record keeping and regular updates.¹

What does this mean for you? From April 2026, MTD for income tax will become compulsory for sole traders and landlords with a gross income over £50,000. This income tax threshold will decrease to £30,000 in April 2027 and £20,000 in April 2028.² As a result, an increasing number of small businesses and self-employed individuals will be required to comply.

MTD aims to make managing business or property income easier by replacing traditional paper-based systems with digital tools. This shift will help reduce the tax gap by improving both accuracy and efficiency.

Understanding Income Tax Self Assessment Process

The Income Tax Self Assessment (ITSA) process requires individuals to report their taxable income to HMRC. This will be digitalised under MTD. Sole traders must now maintain digital records of their business income, expenses, and any other taxable income such as savings interest or rental income.

Instead of submitting a single self assessment tax return annually, businesses will need to submit quarterly updates of their tax data. These updates will be followed by a final declaration after the end of the tax year. This new system replaces the traditional assessment tax return and aims to provide a clearer, more up-to-date picture of a business’s financial position.³

The Importance of Digital Records and Accounting Software

To comply with MTD, sole traders must use compatible accounting software to maintain digital records. This software simplifies the tax compliance process by reducing costly administrative errors and the need for manual data entry.⁵

MTD-compatible software offers real-time insights into business finances, enabling better tax planning and cash flow management. Popular options include cloud-based solutions that allow secure access to digital accounting records anywhere at any time.

Additionally, sole traders can take advantage of digital tools and free software products to meet the digital record keeping requirements without facing high monthly fees.

MTD Requirements and Compliance for Sole Traders

Sole traders must meet several key MTD requirements:

• Maintain digital records of all business income and expenses.
• Submit quarterly updates to HMRC on specified deadlines.
• File a final declaration by 31 January following the end of the accounting period.

Failure to comply can lead to penalties, so understanding these obligations is crucial. Using compatible software ensures that digital record keeping is accurate and secure, helping sole traders meet their tax obligations efficiently.⁵

Business Bank Account and Internet Access

While not mandatory, having a business bank account is highly recommended, especially for sole traders with multiple income sources or a property business.⁶ It helps separate business finances from personal funds, making it easier to track qualifying income and expenses digitally. Maintaining clear tax records is crucial for compliance, particularly when managing self-employment income or staying below the VAT threshold.

Reliable internet access is essential for accessing MTD-compatible software, submitting digital tax returns, and communicating with HMRC through electronic communications. A stable connection reduces the risk of disruptions in the tax filing process and supports keeping electronic records efficiently.

Income Tax Rules and Digital for Income Tax

It’s important to note that income tax rules have changed for individuals with income above £50,000. They will need to move to the new way of reporting tax — moving from paper-based to digital submissions, using MTD compatible software.⁷

This tax digital for income approach allows sole traders to better understand their tax position throughout the year. This includes how much tax they owe based on their only income or combined income sources. This improves tax planning and reducing surprises at tax time and helps those with a national insurance number to stay on top of contributions related to self-employment.

Sole traders should be aware of the turnover threshold that determines MTD eligibility and keep accurate tax records to comply. Updates from the Autumn Budget may also impact reporting requirements, especially for those running a property business or approaching the VAT threshold.⁸

Preparing for MTD

Sole traders should start preparing for MTD by:

1. Reviewing current record keeping methods.
2. Selecting MTD-compatible software that fits their business needs.
3. Beginning to maintain digital records early to ensure a smooth transition.

Early preparation helps avoid last-minute issues and potential penalties. It also offers a chance to improve overall financial management.

Benefits of MTD for Sole Traders

MTD offers several advantages:

• Improved accuracy and fewer errors in tax reporting
• Reduced administrative burden through automation.
• Better tax planning with regular updates.
• Enhanced visibility of business profits and taxable income.
• More efficient management of tax affairs.

These benefits free up time for sole traders to focus on growing their business.

Challenges and Exemptions

Some sole traders may face challenges such as:

• Transitioning from paper records to digital record keeping.
• Accessing or affording compatible software.
• Being digitally excluded due to a lack of internet or skills.

Exemptions exist for those who cannot comply for valid reasons. It’s advisable to consult an accountant or HMRC for guidance on exemptions and/or support.⁹

Monitoring and Evaluation by HMRC

HMRC will continuously monitor MTD’s impact on the tax system, focusing on compliance rates, error reduction and efficiency gains. Feedback from sole traders will help improve the system and address any issues promptly.

Further Advice and Support

Sole traders can access support through:

• HMRC’s official guidance¹⁰ and webinars.¹¹
• Professional advice from accountants or tax advisors.
• Online forums and communities for peer support.

These resources are vital for navigating MTD successfully.

Operational Impact of MTD

Implementing MTD requires investment in new digital tools, training and reliable internet access. While this may pose initial challenges, the long-term operational benefits include smoother tax processes and fewer errors.

Economic Impact of MTD

MTD is expected to reduce the tax gap and increase tax revenues by improving compliance. Although some sole traders may face upfront costs for software and training, these are outweighed by the efficiency and accuracy gains over time.

Conclusion

Making Tax Digital represents a major shift for sole traders in the UK. The transition involves challenges such as adopting new digital record keeping and software. However the benefits of improved accuracy, reduced errors and better tax planning are significant.

Sole traders should prepare early by choosing compatible accounting software, maintaining digital records and seeking advice from professionals or HMRC. Embracing MTD will help ensure compliance and unlock opportunities for better financial management in the evolving tax system.

Sources

1. att.org.uk/making-tax-digital-frequently-asked-questions
2. gov.uk/making-tax-digital-for-income-tax-self-assessment-for-sole-traders-and-landlords
3. sage.com/self-assessment-ending-making-tax-digital-sole-traders
4. breezeaccountants.co.uk/making-tax-digital-mtd-for-small-businesses – remove
5. sage.com/making-tax-digital
6. thecompanywarehouse.co.uk//sole-trader-need-business-bank-account
7. One year until Making Tax Digital for Income Tax launches - GOV.UK
8. contractoruk.com/reeves_raise_vat_registration_threshold_ps100000
9. icaew.com/digitally-excluded-can-now-apply-for-mtd-exemption
10. gov.uk/use-making-tax-digital-for-income-tax
11. gov.uk/help-and-support-for-making-tax-digital