MTD – A time to incorporate?

After years of deferral, the long-anticipated Making Tax Digital (MTD) for Income Tax start date has finally been confirmed. This is a significant development that will impact millions of business owners and landlords, not least because it fundamentally changes how self-assessment tax returns are filed. From 6 April 2024, all unincorporated businesses with turnover above the VAT threshold (currently £85,000) are legally required to keep digital records and file quarterly reports via HMRC’s MTD-compatible software. For many, this raises an important question: is now the right time to incorporate and move to Corporation Tax instead?

Understanding the MTD requirement

Making Tax Digital represents HMRC’s shift towards real-time tax reporting. Rather than a once-yearly self-assessment return, eligible businesses must now maintain digital records using compatible accounting software and file tax updates every quarter. This applies to sole traders and partnerships with annual turnover exceeding £85,000.

The quarterly filing requirement is designed to give HMRC continuous visibility of your tax position, theoretically reducing errors and improving compliance. However, the administrative burden and the need for suitable software and processes are genuine considerations for many business owners—particularly those who’ve historically relied on spreadsheets and paper records.

The case for incorporation

Incorporation—converting your sole trader or partnership business into a limited company—could be worth exploring for several reasons, particularly in light of MTD.

Tax efficiency: Corporation Tax is currently 25% on profits above £250,000 (reduced to 19% for profits under £50,000). Depending on your circumstances, this can be more tax-efficient than Income Tax, especially if you retain profits within the company for reinvestment rather than drawing them all as salary.

MTD compliance simplification: Limited companies file Corporation Tax returns annually and maintain quarterly VAT returns (if VAT-registered). Whilst they do need digital records, the quarterly MTD requirement for income tax doesn’t apply in the same way. This can feel less onerous than quarterly self-assessment reporting.

Limited liability: Incorporation provides legal separation between you and your business, protecting personal assets should difficulties arise.

Growth and credibility: Some clients and lenders view limited companies as more established and professional, which can support business growth and access to finance.

The case against incorporating (for now)

However, incorporation isn’t a universal answer. There are costs and complications to consider.

Setup and compliance costs: Company formation typically costs £100–£200, but you’ll also need to pay annual Companies House filing fees and potentially higher accountancy charges. Our experience suggests the annual compliance burden—filing Corporation Tax returns, statutory accounts, and director confirmations—outweighs the tax savings for many smaller businesses.

National Insurance considerations: As a director, you’ll pay both employee and employer National Insurance contributions. As a sole trader earning below the Upper Earnings Limit (currently £50,270), you may pay less overall.

Dividends and withdrawals: Money taken from your company as dividends is subject to dividend tax (currently 8.75% for basic-rate taxpayers), whereas a sole trader simply pays Income Tax on profit.

Cash flow: MTD itself doesn’t require incorporation; you can fully comply with quarterly reporting as an unincorporated business. The software investment is modest, and many accountancy packages now include MTD features as standard.

Making your decision

The right choice depends on several factors: your profit level, whether you reinvest or withdraw income, your industry, and your growth plans. A business making £60,000 profit annually probably won’t benefit from incorporation, given the extra compliance costs. But a growing business turning over £200,000+ might see genuine tax and administrative advantages.

The key is to avoid making a reactive decision simply because MTD feels daunting. MTD itself is manageable with the right software and support. Incorporation is a longer-term strategic choice that should be based on your broader business and personal circumstances.

Next steps

Before you decide, assess your likely Corporation Tax position versus your current Income Tax and National Insurance liability. Factor in all compliance costs, not just the tax rate. If incorporation might benefit you, the sooner you act, the better—though there’s no urgent deadline purely because of MTD.

For tailored advice, contact Severn Accounting — we’re here to help.