What Is Making Tax Digital for VAT?

Making Tax Digital (MTD) for VAT is HMRC’s requirement to keep digital records and submit VAT returns using compatible software. It is not optional. If your agency is VAT-registered, you must comply.

The old method of logging into the HMRC portal and typing in nine boxes of numbers manually is gone. From April 2022, MTD for VAT became mandatory for all VAT-registered businesses, regardless of turnover. That includes every agency from a sole trader web designer in Manchester Northern Quarter to a 50-person digital agency in Bristol Harbourside.

There are no exceptions for size, sector, or turnover once you are VAT-registered. If you have a VAT number, you need MTD-compatible software.

Why HMRC Introduced MTD for VAT

HMRC estimates that the UK tax gap, the difference between tax owed and tax paid, is around £35 billion per year. A significant portion comes from avoidable errors in VAT returns. Manual data entry, spreadsheet errors, and transposition mistakes all add up.

MTD aims to reduce those errors by forcing a digital link between your accounting records and your VAT submission. No more copying numbers from one spreadsheet to another. No more typing nine boxes of figures into a web portal by hand.

For agencies, the practical effect is straightforward. Your accounting software, Xero, QuickBooks, FreeAgent, Sage, or an MTD-bridging tool, sends the VAT return directly to HMRC. You review it, approve it, and submit it from within the software.

Does MTD for VAT Apply to Your Agency?

Yes, if you are VAT-registered. Here is the full breakdown.

  • Mandatory for all VAT-registered businesses since April 2022. No turnover threshold applies once you are registered.
  • Applies to both standard VAT accounting and flat rate VAT. If you use the flat rate scheme, you still need MTD-compatible software.
  • Applies to annual accounting and cash accounting schemes. The scheme you use for VAT does not exempt you from MTD.
  • Applies to partial exemption and the VAT margin scheme. If your agency buys and sells used goods or deals with mixed supplies, MTD still applies.

If you are not yet VAT-registered but your turnover is approaching the £90,000 threshold, you will need to register. At that point, MTD compliance becomes mandatory from your first VAT return.

What You Need to Do: The Practical Steps

Step 1: Check Your Software

Your accounting software must be MTD-compatible. Most modern cloud accounting platforms already are. Here is the status for the most common agency tools.

  • Xero: MTD-compatible. Submits VAT returns directly to HMRC. You do not need a separate bridging tool.
  • QuickBooks: MTD-compatible. Same process as Xero.
  • FreeAgent: MTD-compatible. Popular with agencies using FreeAgent for full accounting.
  • Sage: MTD-compatible if you are on a current version. Older desktop versions may need upgrading or a bridging tool.
  • Excel or Google Sheets: Not MTD-compatible on their own. You need a bridging tool like Dext or a direct API connection to HMRC.

If you are still using a desktop accounting package from 2019, you almost certainly need to upgrade. Check with your accountant before your next VAT return is due.

MTD requires a digital link between every stage of your VAT data flow. That means:

  • Your source data (sales invoices, purchase invoices, bank transactions) must be digital.
  • Your calculations (VAT totals, partial exemption calculations) must be performed in software.
  • Your submission to HMRC must come from that software.

The most common compliance failure for agencies is what HMRC calls "cut and paste", manually copying numbers from one system to another. If you export a CSV from your time tracking tool, paste it into a spreadsheet, adjust the VAT, then type the totals into your accounting software, you have broken the digital link.

Fix this by using integrations. Most agency tools, Harvest, Toggl, Float, Dext, connect directly to Xero or QuickBooks. Set those integrations up properly, and your digital link is intact.

Step 3: Authorise Your Software

You must authorise your software to send VAT returns to HMRC on your behalf. This is a one-time setup per software.

In Xero, go to the VAT section, click "Set up MTD," and follow the prompts to sign into your HMRC Government Gateway account. The same process applies in QuickBooks, FreeAgent, and Sage.

If you use an agent (your accountant), they can handle this authorisation for you. Many agencies prefer to have their accountant manage the MTD submission directly. That is fine, just make sure the authorisation is in place before your next return is due.

Step 4: File Your First MTD Return

Once your software is set up and authorised, your next VAT return will be filed through MTD. The process is:

  1. Your accounting software calculates the VAT figures from your digital records.
  2. You review the figures within the software.
  3. You approve the return.
  4. The software submits it to HMRC.

You no longer log into the HMRC portal to file VAT. If you do, you will get an error message telling you to use MTD-compatible software.

What Happens If You Don't Comply?

HMRC has been pragmatic about MTD enforcement, but that is changing. From 2024, HMRC began issuing penalties for non-compliance more consistently.

The penalty structure for late VAT returns under MTD is:

  • First late submission: No penalty if you file within 15 days of the due date. A £200 penalty if you file after 15 days.
  • Second late submission: £200 penalty regardless of how late.
  • Subsequent late submissions: £200 per return, plus a further £200 if you are more than 15 days late.

These penalties apply to each VAT return, not each quarter. If you miss four quarterly returns, you could face £800 in penalties before interest.

Separately, if your records are not digital or your software is not MTD-compatible, HMRC can issue a penalty for failing to keep proper records. That penalty is up to £3,000 per failure.

For agencies, the practical risk is lower if you are already using cloud accounting software. But if you are still on a desktop package or using spreadsheets, you are exposed.

MTD for VAT and Agency-Specific Issues

Flat Rate VAT and MTD

If your agency uses the flat rate VAT scheme, MTD still applies. Your accounting software will handle the flat rate calculation automatically. You just need to make sure your software knows your flat rate percentage.

One trap: if your agency is a limited cost trader (you spend less than 2% of your VAT-inclusive turnover on relevant goods), you must use the 16.5% flat rate. Your software needs that setting correct. If you are not sure whether you qualify as a limited cost trader, check with your accountant before your next return.

Partial Exemption

Some agencies make both taxable and exempt supplies. If you are partially exempt, your VAT recovery is restricted. MTD does not change the calculation, but it does require that your partial exemption method is applied digitally.

Most cloud accounting software handles partial exemption through manual adjustments. You will need to enter your exempt and taxable figures correctly to ensure the software calculates the right recovery percentage.

International Agencies and VAT

If your agency works with overseas clients, you may deal with reverse charge VAT, place of supply rules, or cross-border adjustments. MTD applies to all of these. Your software must handle the correct VAT treatment for each transaction type.

For agencies with clients in the UAE, for example, the VAT treatment is different from UK domestic sales. Your accounting software needs to be set up with the correct tax codes for each jurisdiction. If you are unsure, your accountant can help configure this.

What About MTD for Income Tax?

MTD for Income Tax Self Assessment (MTD for ITSA) is coming. It was originally scheduled for April 2024 but has been delayed twice.

The current timetable is:

  • From April 2026: Mandatory for self-employed individuals and landlords with qualifying income over £50,000.
  • From April 2027: Mandatory for those with qualifying income over £30,000.
  • Beyond 2027: Expected to extend to all self-employed and landlord taxpayers.

If your agency is structured as a limited company, MTD for ITSA does not apply to you directly. Corporation Tax MTD is on the horizon but has no confirmed date yet. For now, focus on VAT MTD compliance.

If you are a sole trader or partnership agency with turnover over £50,000, you should start preparing for MTD for ITSA now. The software requirements are similar, cloud accounting with digital record-keeping, so if you are already MTD-compliant for VAT, you are partly there.

How Your Accountant Can Help

As ICAEW qualified accountants working exclusively with agency founders, we handle MTD compliance for our clients as part of our standard service. Here is what that looks like in practice.

We check that your software is MTD-compatible before your first MTD return. We set up the HMRC authorisation on your behalf. We review each VAT return before it is submitted. And we handle any penalty notices or HMRC queries that arise.

If you are still using spreadsheets or a non-MTD-compatible package, we can recommend the right software for your agency size and structure. For most agencies, Xero or QuickBooks with Dext for receipt capture is the standard setup.

We also help with the digital links requirement. If you are using multiple tools, Harvest for time tracking, Dext for expenses, Xero for accounting, we make sure the data flows are properly integrated and compliant.

Common Mistakes Agencies Make

Here are the most frequent MTD compliance failures we see from agency clients.

  • Using an older version of desktop software. Sage 50 from 2018 is not MTD-compatible. You need the current version or a bridging tool.
  • Breaking the digital link with manual adjustments. If you adjust VAT figures in a spreadsheet and then type them into Xero, you have broken the chain. Make adjustments within the software.
  • Not authorising the software correctly. Your accountant cannot submit your VAT return if the authorisation is not in place. Check this before the return is due.
  • Filing through the HMRC portal instead of your software. This will give you an error. Always file from within your accounting software.
  • Ignoring flat rate or partial exemption settings. If your software has the wrong VAT scheme selected, your return will be wrong. Review your settings annually.

Your MTD Compliance Checklist

Use this checklist to confirm your agency is MTD-compliant for VAT.

  • Are you using MTD-compatible software? (Xero, QuickBooks, FreeAgent, Sage current version, or bridging tool)
  • Is your software authorised with HMRC to submit VAT returns?
  • Are all your VAT records kept digitally? (Sales invoices, purchase invoices, bank statements)
  • Are your digital links intact? (No manual copying between systems)
  • Are your VAT scheme settings correct? (Standard, flat rate, partial exemption)
  • Have you tested your first MTD submission?
  • Does your accountant have access to submit on your behalf?

If you answered no to any of these, you need to act before your next VAT return is due.

What to Do Next

MTD for VAT is not new. It has been mandatory for over three years. But many agencies are still not fully compliant, particularly around digital links and software authorisation.

If you are unsure whether your agency meets the requirements, ask your accountant to review your setup. The cost of getting it wrong, penalties of up to £3,000 plus late filing charges, far outweighs the cost of getting it right.

If you do not have an accountant who understands agency-specific VAT issues, we can help. We work with marketing agencies, digital agencies, creative agencies, PR agencies, advertising agencies, web design agencies, and recruitment agencies across the UK.

Contact us to review your MTD setup and make sure your next VAT return is compliant.