Navigating the UK VAT penalty system: A comprehensive guide
As of 1 January 2023, a new VAT penalty system replaced the outgoing VAT filing and late payment penalty system. The new regime, which applies to accounting periods starting on or after 1 January 2023, includes two separate elements: one for the late submission of VAT returns and the other for the late payment of your VAT bill.
Initially scheduled to be introduced in April 2022, the new system, which is based on the accumulation of penalty points, is designed to be more forgiving of taxpayers who miss the occasional VAT deadline. Eventually, the points system will be rolled out across all taxes.
To help you stay on the right side of the new rules, we’ve put together a comprehensive guide to everything you need to know, including how the new points system works and tips to steer clear of VAT penalties.
Penalty points for late VAT returns
The first part of the new system applies to late VAT submissions. For every VAT return you do not file on time, you will receive a penalty point. Like penalty points on your driving licence, the points accumulate until you reach a certain threshold. As long as you don’t reach the threshold, each penalty point will automatically expire after two years.
If you reach one of the monthly, quarterly or annual penalty point thresholds, you will have to pay a £200 fine. After this point, you’ll also have to pay a £200 fine for every filing deadline you miss.
Some VAT returns are exempt
Under the terms of the new VAT penalty system, you will not receive a penalty point if you file certain VAT returns late. That includes:
- The first VAT when you’re newly registered.
- The final VAT return after you’ve cancelled your VAT registration.
- One-off returns that cover anything other than your usual accounting period (for example, you might be required to submit a one-off return if you change your accounting period).
Understanding the thresholds and penalties
The thresholds are the point totals that will trigger a penalty for the different accounting periods.
- Monthly VAT returns – 5 points
- Quarterly VAT returns – 4 points
- Annual VAT returns – 2 points
For example, if you file your VAT returns monthly and four of your returns have been late, you’ll have four points. If you file another late return, you’ll get a fifth penalty point. That’ll push you up to the five-point threshold, and you’ll receive a £200 fine. Every subsequent late return will also incur a £200 penalty unless you reset the penalty points clock.
Resetting the penalty points clock
Once you reach the threshold, the points you’ve accumulated will not expire automatically. Instead, you must show that you can meet your VAT filing requirements for a defined period by submitting all your returns by the deadline and submitting any other outstanding returns for the previous 24 months. This is known as your ‘good compliance period’. The length of your good compliance period depends on when you file your returns:
- Monthly VAT returns – 6 months
- Quarterly VAT returns – 12 months
- Annual VAT returns – 24 months
How do penalty points expire?
If you don’t reach the penalty point threshold, the points you receive will expire automatically. When each point expires depends on the date your return was due.
If the deadline that you missed for your return was:
- The last day of the month – the penalty point will expire on the last day of the month, 25 months after you receive it.
- Not the last day of the month – the penalty point will expire on the last day of the month, 24 months after you receive it.
Appealing against a point or financial penalty
You can appeal a penalty point or £200 fine within 30 days of receiving the notice from HMRC. The penalty decision letter will give you details of how you can appeal. You can also ask to review a decision through your VAT online account.
HMRC may decide to cancel or amend a penalty if it believes you have a ‘reasonable excuse’ for not meeting the deadline. According to the guidance, a reasonable excuse is:
- You had an unexpected stay in the hospital.
- A partner or other close relative died shortly before the tax return deadline.
- Your computer or software failed just before or while preparing your return.
- There was an issue with your HMRC online account.
- You relied on someone else to file your return and they didn’t do it.
- You misunderstood your obligation.
- You have a disability or mental illness that caused the delay.
You must submit the return as soon as you have resolved the issue that caused the delay.
Penalties for the late payment of VAT
Now we’ve covered the VAT late filing penalties, let’s look at what you can expect if you’re late to pay your bill. This part of the new regime is slightly more complicated, with two different types of penalties that can apply: fixed penalties and daily penalties.
Late payment penalties
Here’s a breakdown of how it works:
- You will not receive a penalty if you make a payment up to 15 days after the deadline.
- You will pay a fixed penalty of 2% of the outstanding amount if a payment is between 16 and 30 days late.
- You will pay a fixed penalty of 4% of the outstanding amount if a payment is 31 days late or more.
- From day 31, you’ll also have to pay a daily penalty that’s calculated at 4% per annum of the outstanding amount. For example, a VAT bill that you pay 13 months late will attract a total penalty of 8% – a fixed penalty of 4% and a daily penalty of 4% over the year.
Interest on overdue tax and overpaid tax
Anyone familiar with the tax regime will know that late filing and payment penalties are only half the story. HMRC also charges interest on the outstanding amount. If you overpay on your VAT liability, HMRC will also pay you interest, albeit at a reduced rate.
Interest on overdue payments
HMRC charges late payment interest, also known as default interest, from the first day your payment is overdue until the day you pay the outstanding amount in full. It’s charged at the Bank of England base rate plus 2.5%. Given the high-interest rates currently, this is something to avoid if you can.
Interest on overpaid tax
HMRC also pays interest on tax you have overpaid that it’s late in returning to you. It pays interest on overpaid amounts at the base rate minus 1%, with a minimum rate of 0.5%.
If you have already made the VAT overpayment to HMRC, repayment interest applies from the date you originally paid the VAT or the deadline for the accounting period in question, whichever comes later.
Alternatively, if you have not yet made the overpayment to HMRC, repayment interest applies from the deadline for the accounting period or the date you submitted the VAT return or claim, whichever comes later.
Tips to avoid VAT penalties
VAT late filing and payment penalties cause financial losses and can damage the company’s reputation, so it’s best to put strategies in place to ensure your compliance. Here are a few tips from our VAT and duty planning team.
Keep accurate records
You should keep detailed and well-organised records of all transactions, including receipts, invoices and any other VAT-related documentation. Taking the time to make sure everything is recorded properly and readily accessible will make it easier to prepare and file your returns.
Implement software solutions to keep your VAT records and file your VAT returns
By now, every VAT-registered business must use software compatible with Making Tax Digital for VAT, to keep VAT records and file their returns. Your software can streamline the process by automating tasks such as calculations, generating VAT invoices and preparing your returns. It will also remind you when returns and payments are due.
Get professional help
If keeping up with your VAT obligations feels like one job too many, you can use a VAT outsourcing service to file your returns on your behalf. We cover all VAT filings under various schemes, will help you navigate the recent changes and can be your representative at VAT inspections.
File on time, even if you can’t pay
If you’re going to struggle to make a payment, still file your VAT return on time to avoid the £200 late filing penalty. Then contact HMRC as quickly as possible – ideally before the payment deadline has passed. HMRC will try to help businesses that are doing their best to comply.
What to do if you can’t pay
If you’re unable to pay your VAT bill, file your return on time and contact HMRC to negotiate a Time to Pay (TTP) arrangement. A Time to Pay arrangement is an instalment payment plan that typically gives you between three and six months to pay what you owe, although you can occasionally get up to 12 months. If you can make a TTP deal, it can prevent additional penalties from being added to your outstanding VAT amount. You must also stay up-to-date with your ongoing tax obligations during this time.
You can negotiate a TTP arrangement with HMRC yourself or use a third-party intermediary, such as Moore Kingston Smith, to act on your behalf. You need to propose a monthly repayment amount that you can afford but that’s also acceptable to HMRC. HMRC will also want to know why you’re unable to make the payment in full and what you’ve done to try and raise the money. It may also ask you to provide financial information, such as income and expenditure and cash flow forecasts.
HMRC’s light-touch approach – now expired
HMRC introduced a light-touch approach to the initial 2% late payment penalty while taxpayers familiarise themselves with the new regime. This period of familiarisation ran from 1 January to 31 December 2023.
If you made a payment between 16 and 30 days after the due date, HMRC may have waived the initial 2% penalty where it believed the taxpayer was doing your best to comply. However, if you did not pay what you owed by the end of day 30 or you approached HMRC about the outstanding amount, in most instances, you received a 4% penalty.
This light-touch approach ended on 31 December 2023. From 1 January 2024, the first penalty applies from day 16 on any outstanding amount due to HMRC, regardless of if payment is made before 30 days have elapsed.
*This section was revised in February 2024.
How Moore Kingston Smith can help
If you have any questions about the new VAT penalty system and how it might affect your business, please contact our expert team. We can provide initial advice about the VAT changes and manage your filing obligations on your behalf.