What is a Digital Link?

The second phase of MTD for VAT will see businesses required to implement digital links to create an end-to-end digital reporting process. But what IS a digital link? Many will already consider their systems digitalised in that they hold data in accountancy systems and use electronic spreadsheets to record calculations, but these act as silos of data. Under HMRC’s definition, these silos will be linked in an effort to minimise human intervention and the prospect of errors.

Digital links defined

HMRC defines a digital link as the “data transfer or exchange within and between software programs, applications or products that make up functional compatible software [and these] must be digital where the information continues to form part of the digital records” in VAT Notice 700/22. This can be interpreted quite loosely which is why the tax authority gives a number of compliance options. These include:

 
Digital linking essentially means a digital connection needs to be created between the digital records and the return and between the return and HMRC to create a digital chain. We can see how this works in practice in a simplified version of the pre-MTD reporting process below.

Linear and non-linear approaches

However, digital linking is not necessarily linear in form. As HMRC explains, “any further transfer, recapture or modification of that data must be done using digital links” which means links can come in during the process. For example, if at the start of the process, source data used is housed in multiple software programs then there must be digital links from each of these. Similarly, each group or entity must amalgamate and digitally submit its data to the reporting team.

In addition, data can be added into the chain digitally during the process, so that calculations, adjustments or amendments can, if need be, be made outside the process and factored back in. Needless to say, this does have its drawbacks. It creates further complexity and, because it sees manual computations performed outside the process, increases the risk of error.

A digital audit trail is vital

HMRC goes on to state that “each piece of software must be digitally linked to other pieces of software to create the digital journey”. This “digital journey” is in fact a digital audit trail that reveals a clear unbroken passage from the digital record through to the VAT return numbers that are then submitted to HMRC.

It’s this digital audit trail that will be essential in proving compliance with the digital links mandate. Reducing complexity in the process is far more likely to result in an unbroken chain which is why we believe it’s advisable not to perform amendments and adjustments outside of the process in manual spreadsheets.

Getting the most out of digital linking

What’s far more preferable is to use a dedicated software compliance engine as your MTD solution and to carry out your changes within the safety of this environment. This means you can carry out even highly complex calculations within the process itself. Reports also track any changes made so that in the event of a query you can trace back when and by whom a change was made to demonstrate compliance.

The compliance engine places the return in historical context because it provides access to Business Tax Account data. All of the entity’s obligations, submission receipts and VAT return summaries are recorded, enabling the solution to build-up, over time, a picture of your best practice return and to flag any potential anomalies.

Using a compliance engine in this way ensures you create a linear end-to-end process that protects your digital links. You can then provide irrefutable evidence of how calculations were made and show the link back to source data, thus helping to quickly resolve any queries from HMRC.

Finally, a compliance engine is highly adaptable in that it is updated using tax logic to support changes in legislation. So it not only meets evolving demands under MTD for VAT but can even ensure compliance with other tax regimes such as MTD for Corporation Tax as and when they come online, helping to futureproof the business.

To find out more about how a compliance engine can help you create a linear digital process, please go to How to Make Tax Digital 2020, sign up for one of our Demystifying Digital Links webinars, or contact us at [email protected] or on 01784 777 700.