The New VAT Penalty System – All You Need To Know

Receiving a late penalty or fine is one of life’s pain in the neck moments. This is especially so for HMRC, who are known to be unforgiving when it comes to unmet deadlines. For many of those late filers/submitters, it will be unwelcoming news to hear that HMRC are reforming sanctions for late penalties.

As part of this reform, interest charges and repayment interest will be harmonised. This is to bring VAT in line with other tax regimes, including ITSA. The changes will apply to VAT customers for accounting periods beginning on or after 1st January 2023. As well as this, the changes will also apply to ITSA customers. This is for those with business or property income over £10,000 per year (who are mandated for MTD for ITSA). It will begin from the tax year beginning 6th April 2024. For all other ITSA customers, the changes will apply from the tax year beginning 6th April 2025.

We break down the new reforms to the VAT penalty system, and why HMRC have decided to shake things up…

What Is The New VAT Penalty & Interest Changes?

The new late payment penalty system will apply to payments due from VAT businesses and ITSA taxpayers. For ITSA taxpayers, the new regime replaces the current late payment penalties in schedule 56 of the Finance Act 2009. For VAT businesses, it will replace the Default Surcharge, which served as a combined late submission and late payment sanction. The changes will affect everyone submitting VAT Returns for accounting periods starting on or after 1st January 2023. Any nil or repayment VAT returns received late will also be subject to late submission penalty points and financial penalties.

Late submission penalties will work on a points-based system. For each VAT Return you submit late you will receive one late submission penalty point. Once a penalty threshold is reached, you will receive a £200 penalty and a further £200 penalty for each subsequent late submission. The late submission penalty points threshold will vary according to your submission frequency, and is as follows:

Submission FrequencyPenalty Points ThresholdPeriod of Compliance
Annually224 Months
Quarterly412 Months
Monthly56 Months

You will be able to reset your points back to zero if you:

  • submit your returns on or before the due date for your period of compliance — this will be based on your submission frequency
  • make sure all outstanding returns due for the previous 24 months have been received by HMRC

There are two late payment penalties that may apply. There will be a first penalty and then an additional or second penalty, with an annualised penalty rate. All taxpayers, regardless of the tax regime, have a legal obligation to pay their tax by the due date.

What Is The Process If You Don’t Pay VAT On Time?

For late payment penalties, the sooner you pay the lower the penalty rate will be. From 1st January 2023, HMRC will charge late payment interest from the day a payment is overdue to the day your payment is made in full. Late payment interest is calculated as the Bank of England base rate plus 2.5%.

If you are up to 15 days overdue,you will not be charged a penalty if you pay the VAT you owe in full or agree a payment plan on or between days 1 and 15. Between 16 and 30 days overdue will receive a first penalty calculated at 2% on the VAT you owe at day 15 if you pay in full or agree a payment plan on or between days 16 and 30. If you are 31 days or more overdue, you will receive a first penalty calculated at 2% on the VAT you owe at day 15 plus 2% on the VAT you owe at day 30.

You will receive a second penalty calculated at a daily rate of 4% per year for the duration of the outstanding balance. This is calculated when the outstanding balance is paid in full, or a payment plan is agreed.

There will be a period of familiarisation to give people time to adjust to the changes. HMRC will not be charging a first late payment penalty for the first year from 1st January 2023 until 31st December 2023. This is only if you pay in full within 30 days of the payment due date.

Why Have HMRC Made Changes To The VAT Penalty System?

HMRC wish to make the tax penalty system a fairer process for all, ensuring that late payees are provided with enough leeway. The previous Default Surcharge system was a rather rigid system which had caught many businesses and people off guard. This resulted in unexpectedly large fines for businesses making a genuine and uncommon mistake in filing their VAT and ITSA.

By introducing the new penalty system, it’s also clearly evident that HMRC are trying to encourage long-term late-payers to enter into ‘time to pay’ arrangements. Whilst the ‘Time To Pay’ payment plan scheme has been highly beneficial for many, particularly during the pandemic, it still won’t solve the problem of many businesses and people falling behind. By being less lenient when it comes to late payments, it will allow thousands of businesses and people more breathing space.

We hope this has outlined to you the new reform changes to the VAT and ITSA penalty system and what happens if you submit any returns late. If you’d like to know any further information on anything mentioned, or anything accounting related for that matter, please do not hesitate to get in contact with us at Nordens, where one of our trusted advisors would be happy talking you through your query.