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VAT is Turning Digital in the UK

January 9, 2023

In an effort to revolutionize tax reporting and administration, Her Majesty's Revenue and Customs (HMRC), the United Kingdom's taxation agency, is swiftly transitioning towards digitalization. The Value-Added Tax (VAT) has been chosen as the specific levy that will be digitized first.


As of 1 April 2022, all U.K. VAT registered companies, both big and small, must comply with the regulations outlined in MTD (Making Tax Digital Law). This includes not only local businesses but international ones too that hold a U.K. VAT number such as those run by American entrepreneurs; hence it is essential to be aware of these standards if you fall into one of these categories! To this end, firms will have to ensure compliance when recording transactions or filing and producing their respective Value-Added Tax returns from now on onwards.

Digitized Record Keeping


Although digital record-keeping may seem like a straightforward and uncomplicated need, U.S. corporations are required to document the following transaction-level information in their system:


  • The sales tax on products and services sold (VAT)

  • The value-added tax on products and services purchased (VAT)

  • Date of invoice of purchases

  • The VAT rate in effect (standard rate, reduced rate, zero rate, exempt, or outside the scope of U.K. VAT)

  • The invoice amount excluding VAT

  • Reverse charge transactions (i.e., if VAT needs to be self-accounted by the company)

  • Any modifications to the VAT return


Due to recent changes, it is no longer deemed acceptable to input invoices into the system without deducting any VAT while preparing the UK VAT return. Furthermore, all sales and purchase figures must be recorded in pound sterling (GBP) with corresponding conversion rates for VAT on sales as well as purchases from vendors. For this reason, we recommend that U.K. businesses record their sales and purchases using GBP along with applicable currency conversions for accuracy when filing a VAT return.


VAT on purchases may usually be recovered as a credit in the VAT return, thus it is important that this amount be accurately itemized on vendor invoices. When it comes to meeting these digital record-keeping standards, many U.S. organizations have come to the realization that they may need to establish new company structures in their ERP or accounting systems, as well as new tax codes and tax GL accounts.


Using API Software Applications for Submission of VAT Returns


It is no longer possible to manually enter and submit the VAT return data using the old HMRC system (nine boxes on the return). In the future, all VAT-registered firms in the United Kingdom will be required to sign up with HMRC for Making Tax Digital for VAT and then use either a suitable software package or bridging software to submit their U.K. VAT return through an API connection. HMRC will not get any new data at this time, contrary to the prevalent practice throughout Europe to transmit transaction-level information to the tax body.

Making VAT Submissions Online


The need that unambiguous "digital connections" exist between the underlying digital records of transactions and the final U.K. VAT return that is filed through an API link is the most important new requirement, and possibly the most problematic for firms. To put this into effect, the digital records including tax and transaction information must have an audit trail that demonstrates any changes made to the data.


  • Files may be imported and exported in XML and CSV formats, as well as downloaded and uploaded.

  • Data exchange and API transfer automation

  • Linked spreadsheet cells, like in the case of macros or formulae


Under Making Tax Digital, companies are prohibited from severing the VAT digital chain of custody, as stated by HMRC. Businesses in the United States should be aware that under Making Tax Digital, the practice of "cut and pasting" or "copying and pasting" data between reports and spreadsheets is no longer permissible, even if HMRC may accept other types of digital connectivity in the preparation of VAT returns. That's a major shift. Further, information entered during VAT return preparation cannot be reentered manually.


When filing a VAT return, HMRC also doesn't anticipate any modifications being made by hand. To make the necessary corrections to the VAT return, the underlying digital record in the accounting system should be updated. With this in mind, it's more crucial than ever to get VAT handling and input into accounts right the first time around. One such example is the practice of determining the "reverse charge" on purchases of services made to non-UK vendors by hand when preparing a VAT return by many UK enterprises. The Making Tax Digital initiative has changed this, with HMRC now expecting this to be handled automatically by the accounting software or enterprise resource planning system. This necessitates the creation of new tax codes by firms so that the appropriate value added tax may be applied.


What Should Companies Do Be Compliant?


To guarantee that the tax amounts recorded in their system are precise, reliable, and comprehensive enough to comply with the Making Tax Digital regulations, businesses can purchase software that is compatible with the VAT API. Furthermore, these companies should audit their current VAT processes, systems and data for better understanding of what changes need to be made to their accounting software or ERP system as well as automate its estimated value added tax (VAT) calculation process.


U.S. small companies may find it more convenient to use third-party service providers that use Making Tax Digital-compliant software to prepare and file their tax returns (although businesses still need to maintain digital links up to the point where they share the data with the compliance provider). Firms should be motivated to adopt Making Tax Digital by the promise of simplified VAT compliance procedures, greater quality of accounting and tax data, and fewer mistakes. However, there is also the stick: HMRC is establishing new fines for businesses that don't comply. Further, in cases of mistakes, HMRC will likely also take into account any noncompliance with regulations in determining whether an error is careless; disobedience will decrease the probability of having a penalty lightened.


Companies in the United States would do well to take note of the global digital tax revolution now underway. Making Tax Digital in the United Kingdom is only the beginning of a global trend toward electronic invoicing and reporting of transactions in near-real time.

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