How to set up MTD-compatible digital records from scratch

Introduction

For sole traders and landlords with earnings over £50,000, Making Tax Digital for Income Tax Self Assessment (MTD ITSA) is set to begin on 6 April 2026. It's important to prepare in advance by establishing digital records that align with HMRC guidelines to avoid any last-minute rush. The transition to digital record-keeping is not just about compliance; it also streamlines your financial management processes, making it a valuable step for your business operations.

Understanding digital records

Under MTD ITSA, HMRC mandates that all income and expenses be recorded digitally. This requirement means using approved software to capture data accurately and efficiently, ensuring that information is transmitted to HMRC without manual re-keying. This not only reduces errors but also saves time in the long run.

Essential digital records

To comply with MTD ITSA, you need to maintain digital records of the following:

• Sales and income: Every transaction contributing to your earnings must be recorded, providing a clear picture of your income streams.
• Expenses: Documenting all business-related expenses is crucial for accurate tax calculations.
• VAT: If you're VAT registered, maintaining accurate VAT records is mandatory. This includes details of VAT charged on sales and paid on purchases.
• Bank transactions: Keep a digital trail of all business-related bank movements to ensure complete financial transparency.

Setting up your MTD-compatible system

1) Choose HMRC-recognised software

Selecting the right software is a critical step in setting up your MTD-compatible system. Look for software that is recognised by HMRC for MTD ITSA. Evaluate features such as direct submission capabilities, ease of use, and costs involved. It’s worth investing in software that can submit data directly to HMRC, as this will simplify the submission process significantly.

2) Link your bank account

Connecting your bank account to the software automates the importing of transactions. This feature reduces the need for manual data entry and enhances accuracy, ensuring that all financial activities are captured in real-time. Many software options offer real-time bank feeds, which can be a major asset in maintaining up-to-date records.

3) Categorise your transactions

Proper categorisation of your transactions is key to maintaining clear and accurate records. Use categories that are specific to your trade. For example, a builder might need categories for materials, fuel, tools, subcontractors, insurance, and PPE. This allows you to track where your money is going and aids in accurate financial reporting.

4) Set up quarterly submission reminders

Scheduling reminders for your quarterly submissions is essential. MTD requires four updates annually in addition to a final end-of-period statement. Setting up reminders ensures you meet these deadlines, helping to avoid penalties and keeping your tax affairs in order.

Choosing the right software

When selecting HMRC-recognised software, consider the following features:

• Direct submission capabilities: This feature allows you to send information directly to HMRC, streamlining the submission process.
• Real-time bank feeds: These feeds automatically update your financial records, reducing manual effort and ensuring accuracy.
• Trade-specific categorisation options: Make sure the software can handle categories specific to your business needs.
• User-friendly interface: A straightforward interface will make it easier to manage your digital records without specialised training.

Bridging software for spreadsheet users

If you're still relying on spreadsheets to manage your records, bridging software can serve as an interim solution. This software allows your spreadsheets to communicate with HMRC systems, providing a transitional step towards fully digital records. While this may not offer all the benefits of a complete digital accounting system, it can help you stay compliant as you adjust to new requirements.

Setting up categories for trades

Ensure that your software supports categories that are relevant to your trade. This includes:

• Materials: Track all purchases related to the materials you use in your trade.
• Fuel: Record expenses related to travel and transportation.
• Tools: Keep tabs on purchases and maintenance of tools necessary for your work.
• Subcontractors: Document payments to any subcontractors you hire.
• Insurance: Include costs related to business insurance policies.
• PPE: Record expenses for personal protective equipment required for safety compliance.

Understanding quarterly submissions

With MTD ITSA, you are required to update HMRC four times a year, plus submit a final declaration. Each update includes your income and expenses, which simplifies your end-of-year tax process by spreading the workload throughout the year. This approach also provides you with a consistent view of your financial situation, helping you make informed business decisions.

Using tools like the Self-assessment calculator and mileage calculator can assist with accurate estimations, helping you prepare for each submission with confidence. InvoiceAdept is another tool that ensures your records remain submission-ready, keeping you compliant with MTD ITSA requirements.

Records checklist

To help you stay on top of your digital record-keeping, here’s a handy checklist:

Practical examples

Consider a typical scenario for a self-employed electrician named John:

1. John purchases materials for a job. He logs these expenses digitally using his HMRC-approved software, categorising them as 'Materials'.
2. After completing the job, he issues an invoice using an invoice generator, which automatically updates his digital records with the income earned.
3. Once payment is received, it is automatically logged through the linked bank feed, ensuring no transaction is missed.
4. At the end of the quarter, John uses his software to review and categorise all transactions, verifying that everything aligns with HMRC requirements.
5. He submits his quarterly update directly through the software, maintaining compliance with MTD ITSA.

Step-by-step guide to MTD ITSA compliance

Here’s a detailed guide to ensure your business complies with MTD ITSA:

1. Research and choose an HMRC-recognised software package that meets your business requirements. Consider the features, usability, and cost-effectiveness.
2. Install and set up your chosen software, linking it with your bank account to facilitate automatic transaction logging.
3. Regularly review and categorise your transactions to maintain accurate and up-to-date records, which will aid in smooth HMRC submissions.
4. Utilise tools like the VAT calculator for precise tax calculations, ensuring you are prepared for each quarterly update.
5. Schedule quarterly submissions, setting reminders to avoid missing deadlines. Ensure updates to HMRC are timely and accurate.

Additional tips for compliance

To further assist with MTD ITSA compliance, consider these additional tips:

• Stay informed: Keep up to date with any changes in tax regulations or MTD requirements by regularly checking the HMRC website.
• Seek professional advice: If you're uncertain about any aspect of MTD ITSA, consult with an accountant or tax advisor who specialises in digital tax systems.
• Utilise training resources: Many software providers offer tutorials and training sessions to help you make the most of their features, ensuring you’re using the software effectively.

Further guidance

For more detailed information, refer to the HMRC MTD ITSA guidance. This resource provides comprehensive insights into the requirements and processes involved in Making Tax Digital for Income Tax Self Assessment.

FAQ

What happens if I miss a quarterly submission?

If you miss a quarterly submission, you may face penalties from HMRC. It's vital to set reminders and use software that alerts you to upcoming deadlines. Penalties can vary depending on the circumstances and the number of late submissions, so staying organised is key.

Can I still use spreadsheets for MTD ITSA?

Yes, you can continue using spreadsheets, but you'll need bridging software to connect them with HMRC systems. This solution is temporary and helps as you transition to fully digital records. Bridging software may not be as efficient as a comprehensive digital system, but it ensures compliance in the interim.

How do I choose the right software for my trade?

When choosing software, look for options that offer trade-specific categorisation, direct submission capabilities, and a user-friendly interface. Consider the cost and any additional features that might benefit your business. Reading reviews and seeking recommendations from fellow tradespeople can also be helpful in making an informed decision.

What records do I need to keep digitally?

You must keep records of all sales, income, expenses, VAT (if applicable), and bank transactions. This ensures a comprehensive digital log for HMRC submissions and helps you maintain accurate financial records for your business operations, providing clarity and ease of access.

Where can I find more information on MTD ITSA?

Further information is available on the HMRC website, which offers detailed guidance on MTD ITSA requirements. This resource is invaluable for understanding the intricacies of the system and staying compliant with ongoing obligations.