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MTD for VAT: establishing your digital links

12 March 2019

Making Tax Digital (MTD) introduces important digital record keeping requirements, as we highlighted in our previous blogs in this series. The next step is to understand the need for ‘digital links’.

A digital link is an electronic or digital transfer or exchange of data between software programs, products or applications. To comply with MTD, you will need to have digital links between the software programs, products or applications you use during the process of calculating your VAT liability and filing your VAT return.

As HMRC explains, every piece of software must be digitally linked to other pieces of software to create a ‘digital journey’. There should be a clear digital audit trail from the transactional data recorded in your accounting systems, all the way through to the VAT return numbers submitted to HMRC.

By removing the need for manual intervention, HMRC anticipates fewer errors in accounting and tax information. Creating digital links is an essential requirement for creating a digital audit trail and reducing the risk of error. It could also be paving the way for the introduction of real time reporting at some future date – a move that would clearly require strong digital links to be in place.

In the meantime, under MTD, it is important to understand what will and will not constitute a digital link. Let’s start with what won’t meet the requirements. Transferring data manually within or between different sets of software programs that the business uses for MTD compliance will not be acceptable. This includes copying and pasting and HMRC emphasises this point, stating that it has the force of law. HMRC also gives the example of noting down details from an invoice in one ledger and using that handwritten information to update manually another part of the accounting system – an approach that again fails to satisfy the digital link requirements of MTD.

HMRC also gives some examples of what will be acceptable as a digital link. This includes emailing a spreadsheet containing digital records to a tax agent who will then import the data into their own software. Transferring a set of digital records onto a portable device – such as a pen drive, memory stick or flash drive – and physically giving this to the tax agent will also be acceptable. Similarly, the use of XML or CSV import and export, and download and upload of files would constitute a digital link. Automated data transfer, for example, where a VAT calculation spreadsheet is directly linked to the accounting software and accesses figures directly every quarter, would also be acceptable.

Consider the example of a VAT group involving multiple companies, each of which is using a different accounting system. The consolidated VAT liability is calculated using a spreadsheet containing relevant information from each company. Under MTD, that spreadsheet must be digitally linked to each of the group company accounting systems. Manual data entry based on information from PDF reports, for example, will not be acceptable. However, an Excel-type format that enables the direct transfer of data (e.g. through linking cells in different spreadsheets) would be acceptable under MTD with onward submission through bridging software.

These requirements may sound daunting, but HMRC is allowing a ‘soft landing’ in relation to digital links. Although MTD comes into force from 1 April 2019 (or 1 October 2019 depending on your business – see Making Tax Digital for VAT – do you know your start date?), HMRC will take a light touch approach to the regulation of digital links during the first year. This means that businesses should not be penalised if they have not managed to establish and embed all the necessary digital links by the date they start filing under MTD.

However, this does not mean businesses have an extra year to comply with the other requirements of MTD. The soft landing only applies to digital links. It will still be necessary to maintain digital records and submit VAT returns by compatible software once MTD is in force.

One added wrinkle is that HMRC recognises that there may be points during the preparation of a VAT return when calculations need to be made outside of any software used to keep digital records. This would be the case, for example, for organisations that have partially exempt supplies.

If you have any questions relating to the issues discussed here, please get in touch.