Making Tax Digital (MTD) for VAT has applied to all VAT-registered businesses since April 2022, regardless of turnover. If you are still keeping VAT records in a spreadsheet that you re-key into the HMRC online portal, you are non-compliant and exposed to MTD penalty points. This guide covers what MTD requires, which software qualifies, the digital links rule that catches a lot of small businesses out, and how the new penalty system works.
What MTD for VAT requires
MTD has three core requirements:
- Digital record keeping: you must maintain your VAT records in a digital format (not paper, not as scans of paper).
- Functional compatible software: you must use HMRC-approved software to submit VAT returns. The old "log into the portal and type in nine boxes" route was switched off.
- Digital links: if you use multiple pieces of software in your VAT process, the data must move between them via digital links (CSV import, API, formula reference) and not via copy-paste or manual re-keying.
Who must comply?
All VAT-registered businesses, regardless of turnover. The previous £85,000 threshold was removed in April 2022. If you are voluntarily registered for VAT below the £90,000 threshold, MTD still applies to you.
The few exemptions are narrow: religious societies whose beliefs prevent computer use, businesses subject to insolvency procedures, or those who can demonstrate it is "not reasonably practicable" to comply due to age, disability or remoteness of location. You must apply for exemption; it is not automatic.
What counts as functional compatible software?
HMRC publishes an approved list at gov.uk. The main categories:
Full cloud accounting packages
- Xero
- QuickBooks Online
- Sage Business Cloud Accounting
- FreeAgent
- Zoho Books
- KashFlow
These keep your records and submit returns in one tool. Most cost £10-40 per month.
Bridging software
If you keep records in a spreadsheet and want to continue doing so, bridging software pulls the totals from your spreadsheet via API or formula and submits them to HMRC. Common options:
- VitalTax (free Excel add-in)
- Tax Optimiser
- Avalara MTD Filer
- 123 Sheets
Bridging software is a valid compliance route, but the spreadsheet itself must contain the digital records and the link from spreadsheet to bridge must be a genuine digital link, not a copy-paste.
The digital links rule (the one people get wrong)
If you use more than one piece of software in your VAT process (for example, an EPOS system feeding into a spreadsheet, then a bridging tool), the data must flow between them via a digital link. Manually retyping totals from one system into another is no longer compliant.
HMRC defines a digital link as any of:
- Linked cells in a spreadsheet (so a SUM formula referencing another sheet is fine)
- Importing data via CSV or XML
- API calls between systems
- Emailing a digital file from one system to another (the file itself, not a screenshot)
- Linked databases
A "soft landing" period that allowed manual re-keying ended in April 2021. There is no further grace period.
The new MTD penalty system
Since January 2023, MTD penalties operate on a points-based system. Late submission of a VAT return adds a penalty point. Once you reach a threshold, a £200 fixed penalty is charged, plus another £200 for each subsequent late submission until you regain a clean compliance period.
| VAT Return Frequency | Penalty Threshold | Compliance Period for Reset |
|---|---|---|
| Monthly | 5 points | 6 months on time |
| Quarterly | 4 points | 12 months on time |
| Annually | 2 points | 24 months on time |
Late payment penalties are separate. At HMRC's current rates, raised in 2025, there is no penalty if you pay within 15 days of the due date, then 3% of the unpaid VAT at day 15 and another 3% of what is still unpaid at day 30, with a daily charge at 10% a year from day 31. Interest accrues from the due date at the Bank of England base rate plus 4%.
What records must be digital?
The digital record-keeping rule covers:
- Your business name, principal address and VAT registration number
- VAT accounting scheme used
- For each supply made: time of supply, value of supply (excluding VAT), rate of VAT charged
- For each supply received: time of supply, value of supply, amount of input VAT to be reclaimed
- Daily gross takings if you use a retail scheme
- Adjustments and corrections
Receipts can still be paper, but the data extracted from them must be digital. You do not have to scan every receipt, but you do have to record its details digitally.
Practical setup checklist
- Pick functional compatible software (full package or bridging).
- Sign up to MTD for VAT in your HMRC online account (note: this is a separate sign-up from your VAT registration).
- Connect your software to HMRC via the MTD API. Most cloud packages handle this in their settings.
- If using bridging software with a spreadsheet, confirm the spreadsheet contains the actual digital records and the bridge connects via digital link.
- Submit your first MTD-compliant VAT return.
- Set a recurring reminder for the return deadline (one calendar month plus seven days after the period ends).
Need to calculate the VAT figures before they go into your software? Use the calculator.
Open the VAT Calculator