How to use Xero to get MTD compliant: complete guide to MTD ITSA and VAT

Making Tax Digital (MTD) is changing the way businesses report tax to HMRC. Learn how to use Xero to connect with HMRC, submit MTD for Income Tax updates and VAT returns, and stay on top of your MTD obligations. Making Tax Digital for Income Tax (MTD ITSA) is mandatory for sole traders and landlords earning over £50,000 in qualifying gross annual income as of April 2026. Thresholds will be lowered to £30,000 in April 2027 and £20,000 in April 2028. If you’re eligible for MTD, you’ll need to keep digital records and send updates to HMRC using MTD-compatible accounting software, such as Xero. Fortunately, you can connect Xero to HMRC for this very purpose. Below, we’ll share how to use Xero accounting software for MTD, including submitting Income Tax and VAT, fixing past errors, and keeping accurate sales data. Key takeaways Xero lets you keep digital records, submit quarterly Income Tax updates, and file VAT returns with HMRC. Connecting Xero to HMRC is a one-time setup, although you may need to reauthorise the connection from time to time. You should reconcile your accounts before filing to ensure your VAT and quarterly updates are accurate and complete. Most VAT errors can be corrected on your next return, but larger errors must be reported directly to HMRC. You will need to submit quarterly Income Tax updates within one month and two days following the end of each quarter. Get 90% off Xero for the first six months Supercharge your small business accounting 90% off for 6 months In this article, we’ll cover: What is Making Tax Digital for Income Tax? Overview of MTD tasks and pricing in Xero How to connect Xero to HMRC for MTD How to handle MTD VAT returns on Xero How to ensure your sales data is accurate for MTD compliance How to submit quarterly updates with Xero What is Making Tax Digital for Income Tax? Making Tax Digital for Income Tax (MTDITSA) is an initiative set out by the UK government and managed by HMRC. It changes how self-employed people (sole traders) and landlords keep business records and report income to HMRC. Under MTD for Income Tax, you keep digital records and send quarterly updates and a final declaration to HMRC using MTD-compatible software such as Xero. Under these new rules, you must log digital records of all business income and expenses through your accounting software. Every quarter, you review a summary of your income and expenses in your software and send it to HMRC. By 31 January following the end of the tax year, you must submit your final declaration. Who must comply and when? The rollout of MTD for Income Tax is based on qualifying gross income. As of 6 April 2026, it is mandatory for sole traders and landlords earning over £50,000 in qualifying gross income annually. However, the income threshold is expected to decrease over the next two years: 6 April 2027: The threshold drops to cover those earning over £30,000 in gross qualifying income. 6 April 2028: The threshold drops further to cover those earning over £20,000 in gross qualifying income. Navigating these changing thresholds doesn’t mean you need to hire a full-time bookkeeping service. Many business owners choose to manage their everyday finances in software like Xero while working with an accountant for specialist support. This can include setting up the system correctly, reviewing records, checking compliance, and helping ensure your year-end tax position is accurate. Overview of MTD tasks and pricing in Xero Before you start using Xero for Making Tax Digital (MTD), it’s helpful to understand the different compliance tasks you’ll need to complete. While the exact requirements depend on whether you’re managing Income Tax or value-added tax (VAT), Xero brings these processes together in one place. MTD taskWhere to do itWhat you’ll needFrequency Set up MTD for Income TaxTax > MTD for Income TaxXero subscription and Government Gateway credentialsOnce during setup Connect Xero to HMRCTax > MTD for Income Tax > Get startedGovernment Gateway ID and permission to authoriseOnce (unless reconnection is required) Submit MTD VAT returnsTax > VAT ReturnVAT registration and connected HMRC accountUsually quarterly (or as required by your VAT scheme) Correct a VAT return errorReporting > All reports > UK VAT Return > Click “Adjust” next to the VAT box you need to changeDetails of the original error and HMRC correction rulesAs needed Submit quarterly Income Tax updatesTax > MTD for Income Tax > MTD for IT Overview > To Do > Find the quarter that is due for submission and click “View”Up-to-date bookkeeping and connected HMRC accountEvery quarter Note: You can only get the Comprehensive or Ultimate plan if your business is VAT-registered. If it isn’t, you’ll only have access to the Simple, Ignite, and Grow plans. How to connect Xero to HMRC for MTD You can connect Xero to HMRC from within Xero. However, before you begin, you should ensure you have: Signed up for MTD via your HMRC Government Gateway account Your Government Gateway User ID and password ready Your VAT/tax details (to make sure that your VAT registration number or National Insurance number in Xero matches HMRC’s records) It’s also important to note that if you work with an accountant, they can set up MTD for Income Tax on your behalf using an Agent Services Account (ASA). This way, you can take care of the day-to-day bookkeeping – like recording transactions, managing invoices and keeping financial records up to date – while the accountant can review submissions and provide support with compliance and filing requirements. How to connect Xero to HMRC for MTD for Income Tax With Xero, you can connect to HMRC in just a few steps: In Xero, go to Tax > MTD for Income Tax, click “Get Started” and then “Next” After you are redirected to HMRC, log in with your Government Gateway credentials and select “Give permission”. Once directed back to Xero, enter your NI number and select your business from the list and the relevant tax year. Note: HMRC’s authorisation for Xero usually expires periodically – if it does, reconnect by clicking “Connect to HMRC” and sign in using your Government Gateway credentials through the HMRC website. Connecting Xero with HMRC for Income Tax can be completed in five simple steps (Source: Startups.co.uk) How to set up MTD for VAT on Xero MTD for VAT has applied to all VAT-registered businesses since 2022 and must be submitted to HMRC through an accounting software platform instead of the old online portal. Here’s how to set up MTD for VAT through Xero: In Xero, go to Accounting > Advanced > Financial Settings and double-check that your VAT number and tax registration details are correct. Go to Tax > VAT Return, click “Connect to HMRC” and then “Continue”. After you are redirected to HMRC, sign in with your Government Gateway credentials and select “Grant authority”. You’ll then be redirected back to Xero. After selecting “Making Tax Digital (MTD) VAT” on Xero, you will be redirected to HMRC to confirm connection (Source: Startups.co.uk) How to handle MTD VAT returns on Xero Xero helps streamline your VAT returns once your MTD connection to HMRC is active. If you work with an accountant, this will be a joint effort with different responsibilities. You will need to keep records accurate by reconciling bank accounts, recording transactions, and entering invoices throughout the VAT period. Meanwhile, the accountant reviews the return before submission, including checking for potential errors, identifying any eligible late VAT claims or adjustments, and approving the final submission to HMRC. Either way, you should make sure all your bank transactions and accounts receivable/payable for the VAT period are fully reconciled. From there, you’ll need to: Go to Reporting > VAT Return and select the open period you want to file. Click on individual boxes (such as Box 1 or Box 4) or switch to the Transactions by VAT Box tab. Check for any missing VAT rates and incorrectly coded expenses. You should also check the Late Claims tab if Xero has picked up any transactions added after the previous return was filed. Once you’ve verified the numbers, click “File with HMRC” and then “Submit”. Note: If you owe HMRC, you should set up a direct debit or make a bank transfer using the payment reference shown in your HMRC account. If HMRC owes you, they will refund the amount directly to the bank account on file with them. Xero gives you an overview of your VAT calculations, which you can review before finalising your return (Source: Startups.co.uk) How to correct an error on a previous VAT return in Xero HMRC gives you two ways to fix errors if the mistake happened in an accounting period that ended less than four years ago. One way is to correct the mistake on your next VAT return (self-correction), which you can do if: The net value of the error (underdeclarations minus overdeclarations) is £10,000 or less The net value of the error is up to £50,000 and is less than 1% of your total turnover (Box 6 figure) on your current return How it works in Xero: If you forgot to enter a bill or invoice payment and add it to Xero after the previous return was filed, Xero handles Method 1 automatically by putting those late transactions into your open return in the “Late Claims” tab. Alternatively, you or your accountant must report the error to HMRC if: The net error is over £50,000 The net error is between £10,000 and £50,000 but exceeds 1% of your Box 6 turnover The error was made deliberately To report this error, simply log in to your HMRC Government Gateway account and complete the online VAT error correction form. Note: Avoid reopening a closed accounting period to amend figures without checking whether the changes will affect a VAT return that’s already been submitted to HMRC. In many cases, minor corrections can be included in your next VAT return instead. Why an accountant is your safety net for VAT corrections While Xero helps you manage daily record-keeping in one place, an accountant can help you navigate HMRC’s strict error-correction rules so you don’t accidentally underpay tax or trigger non-compliance penalties. It’s best to review larger errors together with an accountant. For example: Errors can only be adjusted on your next return if the net mistake is £10,000 or less, or up to £50,000 if it remains under 1% of your total turnover (Box 6). An accountant can calculate this limit to confirm whether self-correction is allowed. Errors exceeding the £50,000 threshold (or exceeding 1% of your turnover if over £10,000) and any deliberate errors cannot simply be corrected in Xero and instead must be reported directly to HMRC using their official online VAT error correction service– a process your accountant can draft and submit on your behalf to minimise penalties. Changing tax amounts in Xero can have tax implications – speak with your accountant or bookkeeper to make sure you use the right method.. An accountant ensures any manual ledger journals or tax code changes are posted correctly. What are the penalties for late VAT filing? HMRC uses a points-based late submission system for MTD VAT returns, including for nil returns (where you have nothing to declare). You’ll receive one penalty point for every time you submit a return late. These points accumulate until you reach your points threshold, which depends on your filing frequency: Filing frequencyPoints threshold Monthly5 points Quarterly4 points Annually2 points Once you hit your threshold, you will receive a £200 fine. Additionally, every single late return submitted while you remain at the threshold will trigger another £200 fine. How to ensure your sales data is accurate for MTD compliance Before submitting quarterly updates or VAT returns to HMRC, you should ensure your records accurately reflect your business income and that any discrepancies have been identified and resolved (this is something you can double-check with your accountant). If your business processes a high volume of sales or sells through multiple channels, reconciliation can become a little more complicated. </