This article explains what Making Tax Digital (MTD) for Income Tax is and how to prepare for it in FreeAgent.
Please note that FreeAgent’s MTD for Income Tax functionality is currently in pilot. Therefore, you’ll only have access to the functionality if you work with an accountant who is a FreeAgent partner and your business is eligible for HMRC’s pilot scheme. The functionality currently won’t be available if you have an unincorporated landlord account.
An introduction to MTD for Income Tax
Making Tax Digital (MTD) is a government initiative aiming to digitise the UK tax system.
MTD for Income Tax, also known as Making Tax Digital for Income Tax Self Assessment (MTD for ITSA), will apply from 6th April 2024 for unincorporated businesses and landlords with income from their business/property above £10,000 per year. HMRC requires anyone registered for MTD for Income Tax to keep digital records and send quarterly updates about their business income and expenses to HMRC. They will also have to submit an end of period statement and final declaration.
Partnerships with individuals as partners will have to follow the MTD for Income Tax rules from April 2025. Limited liability partnerships (LLPs) and partnerships with corporate partners will be required to join at a future date yet to be announced.
For more details about how MTD for Income Tax will work, please see the government’s Income Tax (Digital Requirements) Regulations 2021.
Preparing your accounts in FreeAgent
Before you connect FreeAgent to HMRC for MTD for Income Tax and send quarterly updates to HMRC using FreeAgent, there are a number of things you will need to check to ensure that FreeAgent creates an accurate quarterly report for your business.
1. Check your accounting dates
Your FreeAgent start date is the date from which you started keeping your books in FreeAgent. Find out more about the FreeAgent start date for new businesses and existing businesses.
To view or change your FreeAgent start date, select ‘Settings’ from the drop-down menu at the top-right of the screen and then select ‘Accounting Dates’ in the ‘Accounting, Tax & VAT’ section.
2. Ensure that all your transactions are recorded correctly in FreeAgent
In order to create your quarterly reports, FreeAgent needs to have the details of your bank transactions, invoices, bills and out-of-pocket expenses.
We recommend that you import your bank transactions into FreeAgent automatically by enabling a bank feed. If a bank feed isn't available for your bank, or you need to import historical transactions that are outside the scope of your bank feed, you will need to either upload bank statements or enter transactions manually. If you have a bank feed enabled to import transactions automatically, be careful not to duplicate any of these transactions with a manual import as this will cause transactions to be recorded twice.
After your bank transactions have been imported or uploaded, you will need to explain them. Once you’ve started explaining transactions, FreeAgent’s Guess feature will attempt to explain your transactions automatically. Find out more about how to manage Guess.
To record your income, you can create invoices or explain the money you receive into your bank account as ‘Type - Sales’ if you’re not sending invoices. If you receive cash payments, you’ll need to follow these steps to record cash transactions in FreeAgent.
FreeAgent will automatically populate your total income for the quarter in the ‘Income’ section.
To record your costs, you can create supplier bills, add out-of-pocket expenses or explain the money out of your bank account as ‘Type - Payment’ and select the relevant cost category. Before entering this data, it’s a good idea to familiarise yourself with the difference between an expense, a bill and a bank payment in FreeAgent.
FreeAgent will automatically populate your total costs for the quarter in the ‘Expenses’ section.
Other important things to remember
By enabling bank feeds and regularly explaining your imported bank transactions, your bank balance in FreeAgent should match the balance in your online bank account. If the figures don't match, follow our guidance for addressing discrepancies.
If any of your transactions have been explained incorrectly, you’ll need to either edit or remove the bank transaction explanations. If you need to create a credit note, make sure that you correctly net it off with the invoice.
How to send quarterly updates to HMRC via MTD for Income Tax
Once you’ve completed the steps above, you’ll be ready to connect FreeAgent to HMRC for MTD for Income Tax and send quarterly updates to HMRC using FreeAgent.