MTD Penalties

As the start date for Making Tax Digital for Income Tax Self Assessment (MTD for ITSA) draws ever closer, it is important that clients for whom MTD for ITSA will be mandatory from 6 April 2026 understand not only their obligation under MTD for ITSA but also what will happen if they fail to comply.

Self-employed traders and unincorporated landlords with combined gross trading and property income (i.e. before deductions) of £50,000 or more in 2024/25 must comply with MTD for ITSA from 6 April 2026. This will necessitate maintaining digital records and making quarterly returns of trading and property income and expenses using software which is compatible with MTD for ITSA.

After the end of the tax year, they must also make a final declaration (akin to a tax return) by the normal Self Assessment deadline of 31 January after the end of the tax. This is the point at which adjustments are made, reliefs claimed and other income reported. As with the quarterly returns, the final declaration must also be made using software that is compatible with MTD for ITSA.

Self-employed traders and landlords with combined gross trading and property income for 2025/26 of £30,000 or more must join MTD for ITSA from 6 April 2027, while those whose gross trading and property income for 2026/27 is £20,000 or more must join from 6 April 2028.

New penalty regime

Legislation contained in the Finance Act 2021 introduced a new penalty system for Making Tax Digital. The regime comprises late submission penalties (FA 2021, s. 116 and Sch. 25 and 25) and late payment penalties (FA 2021, s. 117 and Sch. 26).

The penalty regime is already in force for VAT purposes having been introduced with effect from 1 January 2023.

Those volunteering to test MTD for ITSA will be subject to the regime. It will apply to those volunteering for 2024/25 from April 2024 and for those joining MTD voluntarily for 2025/26 from 6 April 2025. However, the penalties charged for 2024/25 where volunteers pay late are levied at a lower rate.

For those joining from 6 April 2026, regardless of whether it is mandatory for them to do so or because they have chosen to join voluntarily, the MTD penalty regime will apply from 2026/27. Taxpayers joining MTD in later tax years will be subject to the new penalty regime from their start date.

It is important to note that the penalty regime will continue to apply to anyone who signs up voluntarily and later opts out. This is because once a taxpayer signs up for MTD, their tax records are moved across to the new MTD- specific computer system.

Late submission penalties

Taxpayers who file their returns late may find that they are subject to a late submission penalty. This remains the case under MTD, but only in respect of the final declaration. Late submission penalties are not charged if a quarterly declaration is made late.

However, under the new penalty system the way in which the penalties are determined is different. The MTD penalty regime works on a penalty point system. The taxpayer receives a penalty point each time a relevant return is filed late. The threshold at which a penalty is triggered depends on the frequency of the returns. For annual returns, such as the final declaration, a penalty is levied once the taxpayer has accumulated two penalty points. For quarterly returns (such as VAT returns), the threshold is four points and for monthly returns, the threshold is five points. The penalty is set at £200. Once a penalty has been issued, the clock is reset.

The points have an expiry limit. Again, this depends on the frequency with which the returns are filed. For annual returns, such as the final declaration, the points expire after 24 months, and for quarterly returns, such as VAT returns, the points expire after 12 months. However, this is contingent on all required submissions in the previous 24 months having been made.

The points-based system is less harsh than the current Self Assessment late filing regime, allowing taxpayers the opportunity to miss a filing date without triggering an automatic penalty. Where a taxpayer misses the Self Assessment filing deadline, even if only by one day, they face an automatic late filing penalty of £100, even if no tax is due. Further penalties apply if the return is still outstanding after three months, at which point daily penalties of £10 a day to a maximum of £900 apply. Additional penalties of 5% of the tax due or if greater £300 apply where the return remains outstanding at the six month and 12 month points.

Under the new regime, no penalty is due even if the first return is a year late- the taxpayer will simply receive a penalty point. The taxpayer will only receive a late filing penalty if two consecutive returns are filed late.

Late payment penalties

Unlike the late submission regime, the new late payment penalty regime is harsher than that applying under Self Assessment. It applies to all taxpayers within MTD for ITSA regardless of whether it is mandatory or the taxpayer has signed up voluntarily. However, HMRC have stated that they will apply a light touch when applying later payment penalties within the first 12 months.

Under the new regime, as long as the taxpayer has paid what they owe within 15 days of the deadline, they will not be charged a late penalty even if they pay late. The late payment penalties kick in once the payment is 15 days late, with a further penalty applying if tax remains unpaid 30 days after the due date. Daily penalties are charged on any tax unpaid after 30 days.

For 2025/26 and later tax years, where the payment is made between 16 and 30 days after the due date, a late payment penalty is charged which is equal to 3% of the tax outstanding at day 15. If tax remains unpaid at 30 days, a further penalty equal to 3% of the tax outstanding on day 30 is charged. Daily penalties apply from day 31. These are charged at an annual rate of 10% on the outstanding balance.

The new regime is designed to encourage taxpayers within the MTD to pay what they owe promptly as penalties for late payment can soon mount up. It is important to remember that the penalties apply in addition to interest on the outstanding amount which is charged at the rate of 4% above the Bank of England base rate from the date that the payment was due to the date on which payment is made.

The new regime is also harsher than the late payment penalties applying under Self Assessment. Under this regime, a late payment penalty does not apply until the payment is 30 days late at which point a penalty of 5% of the tax due is charged. Further late payment penalties apply if the tax remains unpaid six months after the due date (5% of the tax outstanding at that point) and after 12 months (5% of the tax outstanding at that point).

Failure to keep digital records

One of the key requirements of MTD for ITSA is the need to keep digital records. The data held in the digital records feeds digitally into the returns filed using software compatible with MTD for ITSA. Taxpayers who fail to maintain their records in the prescribed form can be charged a penalty of up to £3,000.

Inaccuracy penalties

As under the current regime inaccuracy penalties may be charged where errors are made in the final declaration. However, they will not apply to errors in the quarterly return. Inaccuracy penalties are based on taxpayer behaviour.

Appealing a penalty notice

Taxpayers will receive a decision letter notifying them when a penalty has been charged. They will be able to appeal against the penalty as now if they believe it to be incorrect or if they have a reasonable excuse for the late submission or the late payment.

Taxpayers will also have a right of appeal against penalty points issued where the final declarations made late.