Making Tax Digital for VAT: Compliance Guide (2026)

Making Tax Digital (MTD) for VAT is now mandatory for all VAT-registered businesses in the UK, regardless of turnover. Since April 2022, every business must keep digital records of sales and purchases, submit VAT returns through MTD-compatible software, and maintain digital links between systems—meaning you can't simply copy-paste figures from one spreadsheet to another. The rules require either bridging software (typically £20–£50 per year) or full accounting packages like Xero, QuickBooks or Sage. A points-based penalty system has applied since January 2023: accumulate four points for late submissions and you face a £200 fine, with further £200 penalties for each subsequent late return. This guide explains exactly what MTD for VAT means, who it affects, how to comply, and what happens if you get it wrong.

What is Making Tax Digital for VAT?

Making Tax Digital (MTD) is HMRC's programme to modernise the tax system by requiring digital record-keeping and online filing. The VAT element—MTD for VAT—was the first phase to become mandatory.

The core principle is straightforward: HMRC wants to eliminate paper records and manual data entry errors by requiring businesses to maintain digital records and submit returns electronically through approved software. This isn't simply about filing online (which has been possible for years), but about how you keep your records throughout the VAT period.

The three key requirements

1. Keep digital records
You must maintain your VAT records in digital form. This means recording all your sales (outputs) and purchases (inputs) using a computer, not in paper ledgers or handwritten books. A spreadsheet counts as digital, as does accounting software.

2. Use MTD-compatible software to submit returns
You cannot submit VAT returns through HMRC's old online portal anymore. You must use software that connects directly to HMRC's systems via their Application Programming Interface (API). This software pulls your figures and transmits them securely.

3. Maintain digital links
This is the requirement that catches people out. If you use multiple software programs or spreadsheets, they must be digitally linked—meaning data flows automatically between them via software, not because you've typed or copy-pasted figures from one to another. HMRC calls these "functional compatible software" links.

Who must comply with MTD for VAT?

Everyone who is VAT-registered. Since 1 April 2022, MTD for VAT has applied to all VAT-registered businesses, regardless of turnover.

Previously, only businesses with taxable turnover above the VAT registration threshold (£90,000 in 2026-27) had to comply. That changed. Even if your turnover is £10,000 and you voluntarily registered for VAT, you must follow MTD rules.

Exemptions

Very few exemptions exist:

• Practising members of religious societies who object to computers on religious grounds may apply for exemption
• Businesses prevented from using digital tools due to age, disability, remoteness or other reasons may apply for exemption on grounds of digital exclusion

HMRC reviews exemption applications individually. Simply finding the technology inconvenient or preferring paper records is not sufficient grounds.

What counts as "digital records"?

Digital records are any records maintained electronically. This includes:

• Spreadsheets (Excel, Google Sheets, LibreOffice Calc)
• Accounting software (Xero, QuickBooks, Sage, FreeAgent, etc.)
• Specialist VAT software
• Cash register systems that store data electronically

What doesn't count:

• Paper invoices filed in folders
• Handwritten ledgers
• Scanned images of paper records (unless the data is extracted and stored digitally)
• Word documents or PDFs where figures are typed but not structured as records

You must record the information HMRC requires for VAT purposes digitally. This includes:

• Time of supply (tax point)
• Value of supply
• Rate of VAT charged
• Details of supplier or customer (for certain transactions)
• Copies of VAT invoices issued and received

The digital links requirement explained

This is where many businesses trip up. HMRC requires "digital links" between different pieces of software or spreadsheets you use.

What is a digital link?

A digital link is a transfer or exchange of data between software programs, products or applications that happens automatically without manual intervention. The key word is automatic.

Acceptable digital links:

• API connections between software programs
• XML or CSV file imports that happen automatically
• Emailed data files that are automatically imported
• Copy-paste using software macros or scripts
• Cloud-based software where modules share the same database

Not acceptable:

• Manually typing figures from one spreadsheet into another
• Copy-pasting figures by hand from one Excel file to another
• Reading a figure on screen and typing it into different software
• Printing a report and manually entering the totals elsewhere

Example: Sarah's flower shop

Sarah runs a small florist. She records all her sales in a simple Excel spreadsheet throughout each VAT quarter. At the end of the quarter, she used to add up the totals, open HMRC's website, and type the figures into the online VAT return form.

Under MTD, Sarah cannot do this. She has two compliant options:

Option 1: Use bridging software. Sarah continues using her Excel spreadsheet but purchases bridging software (around £25/year). The bridging software connects to her spreadsheet via a digital link, reads the figures automatically, and submits them to HMRC through the API.

Option 2: Switch to accounting software. Sarah moves to cloud accounting software like QuickBooks or Xero (typically £10–30/month). She records sales and purchases directly in the software, which has built-in MTD submission capability.

Sarah chooses Option 1 because her business is simple and she's comfortable with her spreadsheet.

MTD-compatible software: your options

You need software that can submit VAT returns via HMRC's API. HMRC maintains a list of compatible software on GOV.UK.

Bridging software

Bridging software is designed for businesses that want to keep using spreadsheets. It acts as a bridge between your Excel or Google Sheets records and HMRC's systems.

Cost: Typically £20–£50 per year

Popular options include:

• Taxfiler
• Absolute Topup
• Capium
• Gosimpletax

Bridging software usually works by connecting to your spreadsheet (you may need to format it in a specific way), reading the VAT figures, and transmitting them to HMRC. Some products also store your submission history.

Full accounting software

Full accounting packages handle invoicing, bookkeeping, and VAT returns in one system.

Cost: £10–£50+ per month, depending on features

Popular options include:

• Xero
• QuickBooks Online
• Sage Business Cloud
• FreeAgent
• Kashflow

These systems maintain your records digitally, calculate VAT automatically, and submit returns via MTD. They're more expensive than bridging software but offer comprehensive business management features.

Free options

HMRC provides basic free software for very simple businesses through its "HMRC VAT online account" but functionality is limited. Some accounting software providers offer free tiers for sole traders or micro-businesses with minimal transactions.

How to submit a VAT return under MTD

The process varies slightly depending on your software, but the general steps are:

1. Record transactions digitally throughout the VAT period (usually quarterly)
2. Reconcile your records at the end of the period—ensure all sales and purchases are recorded
3. Open your MTD-compatible software and navigate to the VAT return section
4. Review the figures the software has calculated (total sales, VAT on sales, total purchases, VAT on purchases, net VAT due)
5. Submit electronically through the software—it connects to HMRC's API and transmits the return
6. Receive confirmation from HMRC (usually instant)
7. Pay any VAT due by the deadline (usually one calendar month and seven days after the period end)

You cannot submit via HMRC's old online portal. You must use compatible software.

Penalties for non-compliance

HMRC introduced a new points-based penalty system for VAT returns in January 2023.

How the points system works

Late submission penalties:

• Each late VAT return earns you one penalty point
• When you reach your penalty point threshold, you receive a £200 fine
• Each subsequent late submission after reaching the threshold triggers another £200 penalty
• Your threshold depends on how often you submit returns:
  • Quarterly filers: 4 points trigger the first penalty
  • Monthly filers: 5 points trigger the first penalty
  • Annual filers: 2 points trigger the first penalty

Example: James submits VAT returns quarterly

• Q1 2026: Submitted on time (0 points)
• Q2 2026: Submitted 5 days late (1 point)
• Q3 2026: Submitted on time (0 points remain—see below)
• Q4 2026: Submitted 2 days late (1 point)
• Q1 2027: Submitted 10 days late (2 points)
• Q2 2027: Submitted 1 day late (3 points)
• Q3 2027: Submitted 3 days late (4 points—threshold reached, £200 penalty)
• Q4 2027: Submitted 1 day late (£200 penalty)

Points expiry: If you submit on time for a full compliance period (24 months for quarterly filers), your points reset to zero.

Late payment penalties

Separate penalties apply if you pay VAT late:

• First late payment in 12 months: 2% of the VAT owed if unpaid 15 days after the deadline
• Second late payment in 12 months: 2% of the VAT owed if unpaid 15 days after the deadline
• Further interest: 4% per annum on outstanding amounts after 30 days

Reasonable excuse defence

You can appeal penalties if you have a "reasonable excuse" for late submission or payment. HMRC accepts:

• Serious illness or bereavement
• Computer or software failure beyond your control
• Fire, flood or theft affecting your records
• Postal delays you couldn't have anticipated

What HMRC typically doesn't accept:

• Pressure of work
• Lack of funds to pay VAT
• Reliance on another person without checking they'd done the work
• Ignorance of the law

Common mistakes to avoid

1. Copying and pasting between spreadsheets manually
Many businesses use multiple Excel files and manually copy totals from one to another. This breaks the digital links requirement. Use bridging software or macros to automate the transfer.

2. Leaving MTD compliance to the last minute
Setting up software and learning a new system takes time. Don't wait until your VAT return is due. Give yourself at least one full VAT period to implement MTD properly.

3. Assuming your accountant handles everything
Even if an accountant prepares your VAT return, you are responsible for keeping digital records and ensuring MTD compliance. Discuss with your accountant who does what.

4. Using non-compatible software
Some older accounting packages or custom-built systems aren't MTD-compatible. Check HMRC's list of approved software. If your current system isn't listed, you'll need to upgrade or add bridging software.

5. Forgetting to keep digital copies of invoices
You must retain digital records for at least six years. If you receive paper invoices, you should scan them or photograph them and store them digitally (though the data must also be entered into your digital records system).

6. Not testing your software before the deadline
Submit a test return or practice with your software before your actual deadline. Technical problems do occur, and HMRC expects you to allow time for troubleshooting.

Record-keeping requirements

Under MTD, you must keep digital records for six years. These records must include:

• Business name, address, VAT registration number
• VAT account showing calculations
• Copies of all sales invoices issued
• Copies of all purchase invoices received
• Details of goods/services imported or exported
• Credit notes and debit notes
• Adjustments and corrections

You can store these records in accounting software, on cloud storage, or on your own computer systems, provided they remain accessible and readable.

What if you're struggling with MTD?

If you genuinely cannot comply with MTD requirements due to age, disability, remoteness, or other reasons, you can apply for an exemption. Contact HMRC and explain your circumstances. They assess applications individually.

If cost is a concern, remember that basic bridging software costs around £20–£50 per year—less than £5 per month. HMRC also offers free basic software for very simple businesses.

If you're unsure how to set up your systems, consider:

• Asking your accountant for help implementing MTD
• Attending HMRC webinars (they run regular MTD guidance sessions)
• Using software provider support—most offer tutorials and helplines
• Joining business forums where others share their MTD experiences

What to do next

If you're already VAT-registered and haven't implemented MTD: You're technically non-compliant. Act immediately. Choose bridging software or accounting software, set it up, and ensure your next VAT return is submitted via MTD-compatible software. If you've been submitting late or via the old portal, you may already have penalty points.

If you're about to register for VAT: Build MTD compliance into your setup from day one. Choose accounting software that handles MTD, or plan to use bridging software with your spreadsheets. Don't set up paper-based systems.

If you're unsure whether your current setup is compliant: Check whether your software appears on HMRC's list of compatible products. Review how data moves between your systems—is it automatic or manual? If you're copy-pasting figures by hand, you need to fix that.

For specific questions about your situation: Use the AI Tax chat at myaitax.info to ask detailed questions about your particular circumstances, software choices, or compliance concerns.

For full support with VAT, MTD implementation, and ongoing compliance: Consider AI Accountant for end-to-end handling of your VAT obligations, software setup, and return submissions. Professional support ensures you stay compliant and avoid penalties while focusing on running your business.