How does Making Tax Digital affect solicitors?

Making Tax Digital is a government initiative introduced by HMRC to make tax administration more efficient and transparent. It requires businesses to maintain digital financial records and submit returns through approved accounting software rather than entering figures manually online. For solicitor firms, this change has a direct impact on how financial data is recorded, stored, and reported.

Understanding Making Tax Digital

Making Tax Digital is being implemented in stages. The first phase, MTD for VAT, came into effect for most VAT-registered businesses in April 2019 and became mandatory for all VAT-registered firms, regardless of turnover, from April 2022.

Future phases will extend MTD to Income Tax Self Assessment (ITSA) and Corporation Tax, meaning solicitors operating as sole traders or limited companies will eventually need to report all taxable income digitally.

The core objectives of MTD are to:

• Reduce tax errors caused by manual record keeping.

• Encourage real-time data sharing with HMRC.

• Improve accuracy and efficiency in business accounting.

For law firms, which handle large volumes of transactions and client money, this move to digital compliance offers both challenges and opportunities.

How Making Tax Digital affects solicitors’ accounting

1. Digital record keeping

Under MTD, solicitors must maintain digital records of all transactions, including sales, purchases, and VAT adjustments. Paper ledgers and spreadsheet-based systems that require manual updates are no longer sufficient on their own unless they link directly to compatible digital software.

This means that solicitor firms must use accounting systems capable of:

• Recording each transaction in real time.

• Storing data securely for at least six years.

• Integrating with HMRC’s online systems for direct submission.

Commonly used MTD-compliant software includes Xero, QuickBooks, and Sage, often integrated with legal practice management systems such as LEAP, Clio, or Actionstep.

2. VAT submissions

The most immediate impact of MTD for solicitors has been on VAT. Firms must now:

• Submit VAT returns digitally through MTD-compatible software.

• Maintain a digital audit trail linking each VAT figure to its original transaction.

• Avoid manual re-entry of VAT data when transferring information between systems.

For example, if a solicitor previously entered total VAT figures into HMRC’s online portal, they must now generate and file the return directly from their accounting software.

3. Digital links and data flow

MTD requires all VAT information to be connected through digital links, meaning data cannot be copied or pasted manually between different systems. This ensures accuracy and reduces the risk of human error.

Solicitors who use separate systems for billing, client accounting, and VAT reporting must ensure these platforms communicate automatically or are connected via approved digital bridging software.

4. Compliance with the SRA Accounts Rules

The move to digital accounting also supports compliance with the SRA Accounts Rules, which require law firms to maintain accurate records of client money and reconcile client accounts regularly.

MTD-compatible accounting systems can automate reconciliation processes and create digital audit trails, making it easier for solicitors and their COFAs (Compliance Officers for Finance and Administration) to demonstrate compliance during audits or SRA inspections.

5. Preparing for future phases

While MTD currently applies mainly to VAT, HMRC plans to extend the system to cover Income Tax and Corporation Tax. This will affect:

• Sole practitioners and partnerships, who will be required to report income and expenses quarterly under MTD for Income Tax.

• Incorporated law firms, which will eventually file Corporation Tax returns through digital software instead of HMRC’s current portal.

Solicitors who adopt digital accounting early will find these future transitions much easier.

Challenges for solicitor firms

Although MTD brings long-term efficiency, the transition can be challenging, particularly for firms that still rely on manual processes. Common issues include:

• The cost and time involved in adopting new software.

• Integrating digital accounting with existing case management systems.

• Training staff to use the new systems effectively.

• Ensuring compliance across multiple office locations or departments.

Firms that fail to adopt MTD-compliant systems risk errors in reporting, penalties from HMRC, and reputational damage if client financial data is mishandled.

How accountants help solicitors comply with MTD

Accountants play a vital role in guiding solicitors through the Making Tax Digital process. Their support covers several key areas:

System selection and setup

Accountants help firms choose MTD-compatible software that meets both HMRC and SRA requirements. They also configure client and office ledgers, VAT codes, and digital links to ensure seamless reporting.

Data migration and reconciliation

Moving from manual or legacy systems to digital platforms requires careful planning. Accountants oversee data migration, reconcile balances, and verify that client money records remain accurate during the transition.

VAT submission and monitoring

Accountants manage quarterly VAT submissions, ensuring they are filed correctly and on time. They also monitor compliance, checking that all digital records meet HMRC’s requirements.

Staff training and support

To ensure compliance across the firm, accountants provide training for solicitors, partners, and administrative staff. This helps everyone understand how to record transactions correctly, reconcile accounts, and handle VAT adjustments within the new system.

Preparing for future MTD phases

Accountants help firms prepare for MTD for Income Tax and Corporation Tax by setting up digital reporting systems now. This proactive approach avoids last-minute disruption when new rules are introduced.

Benefits of MTD for solicitors

When implemented correctly, Making Tax Digital brings significant benefits for law firms:

• Improved accuracy: Automated data entry reduces errors and miscalculations.

• Time savings: Digital processes replace manual reconciliation and reporting.

• Real-time visibility: Partners can access up-to-date financial data for decision making.

• Better compliance: Audit trails make it easier to demonstrate adherence to SRA and HMRC rules.

• Scalability: Digital systems can grow with the firm as new clients and staff are added.

For firms already operating digitally, MTD simply strengthens existing practices and ensures a higher level of financial transparency.

Example in practice

A mid-sized legal firm using spreadsheets for VAT reporting switched to Xero integrated with LEAP to comply with MTD. The firm’s accountant migrated the data, set up digital bank feeds, and automated VAT submissions. Within the first quarter, the firm reduced manual errors, saved several hours on reconciliations, and improved real-time visibility of client account balances.

The transition also improved the COFA’s ability to monitor compliance under the SRA Accounts Rules, creating a more efficient and transparent operation.

How to prepare your firm for MTD

Solicitors preparing for MTD should:

1. Review their current accounting systems and identify gaps.

2. Choose MTD-compatible software that integrates with existing legal tools.

3. Work with an accountant to set up digital links and VAT workflows.

4. Train all staff involved in financial administration.

5. Maintain digital records of all transactions and reconciliations.

Taking these steps now will make compliance smoother and reduce the risk of penalties as MTD expands.

Conclusion

Making Tax Digital marks a major shift in how solicitors manage and report their financial information. It requires law firms to adopt digital systems for VAT submissions and maintain accurate electronic records.

While the transition can be challenging, accountants play a key role in ensuring compliance and making the process efficient. By embracing digital accounting early, solicitors can not only meet HMRC requirements but also strengthen their financial management, transparency, and client trust.