Practical guide: getting ready for the new VAT penalty system

Current system issues

There are two main problems with the current default surcharge system:

1. You will receive the same surcharge if you pay your VAT bill one day late or one year late. This surcharge could be up to 15% of the tax outstanding, which is a very draconian penalty.
2. There is no penalty issued for submitting a return late, only for paying tax late. In the absence of a VAT return, HMRC will issue a central assessment, which is an estimate of the liability. The assessment is often too low, therefore storing up potential problems for the future.

According to HMRC’s guidance, the aim of the new VAT penalty regime is to penalise “only the small minority who persistently miss their submission obligations rather than those who make occasional mistakes.” This is good news. 

With both the existing and new penalty regimes, you should always aim to submit returns on time, even if you cannot fully pay the tax owed.

New system is actually two-legged

For periods beginning on or after 1 January 2023, the default surcharge will be completely abolished and replaced with two new VAT penalty regimes:

Late returns. A points-accumulation system will be introduced which, after a specific number of points have been issued by HMRC, will lead to a fixed penalty of £200. The points threshold depends on whether you submit monthly, quarterly or annual returns - see below.

Late payments. You will not receive any penalty if you fully settle the liability within 14 days of the due payment date. A 2% penalty will be issued for tax outstanding on this date, rising to 4% for any tax still unpaid 30 days after the due date. For tax still unpaid after 30 days, an annualised penalty rate of 4% will be applied thereafter.

It’s important to be clear about the maths with the new late payment regime. Any tax paid between days 15 and 30 after the due date will be subject to a 2% penalty. On day 31, a 4% penalty will be charged for tax that is still outstanding. Some wrongly think that the penalty will be 6% for tax outstanding on day 30, i.e. 2% plus 4%. But this is not the case, it’s 2% plus 2%.

Points-based system

Each late VAT return you submit to HMRC for periods beginning on or after 1 January 2023 will incur a penalty point. However, you won’t get a financial penalty until you reach the points threshold, when a £200 penalty will be charged. The points thresholds are as follows:

• Monthly returns - five
• Quarterly returns - four
• Annual returns - two.

The threshold limits mean that the earliest possible date for any late return penalty to be issued will be 7 July 2023. This will be relevant to a business that submits late monthly returns from January to May 2023 - reaching its threshold of five - the latter period having a submission date of 7 July.

Example. Jane trades as an architect and always submits her calendar quarter returns late because she is so busy. With the new system, Jane will incur her first £200 fixed penalty on 7 February 2024, i.e. the due submission date of her December 2023 return. This is because she will reach four points for this period, assuming she was also late submitting her returns for March, June and September 2023.

Once you have reached the points threshold and been charged a penalty, each subsequent late return will incur a further £200 penalty. You must then have a period of full compliance to return to zero points. The other big change with the new system is that points and penalties will be incurred for late repayment (or nil) returns. Escaping the points regime

As explained above, a business submitting quarterly returns will receive a £200 penalty once it has accumulated four points, i.e. submitted four returns after the due date. Each subsequent late return will incur a further penalty of £200. However, it is possible to wipe the slate clean and return to zero points as long as you meet two conditions:

• all returns for the previous 24 months must have been submitted to HMRC; and
• you must have submitted all returns on time for the twelve-month period after reaching their points threshold. The relevant time period is 24 months for a business on annual returns and six months for those  on monthly returns.

Example. Marie submitted all of her 2023 quarterly returns late, so incurred a £200 penalty for the December period when she reached her four points threshold. She must submit all returns on time until December 2024 otherwise each late return will incur a further £200 penalty. If she has a clean slate until December 2024, she will return to zero points again.

First year concession

As a welcome concession, you will not be charged any late payment penalty in the first twelve months of the new system if you pay all of the tax owed within 30 days of the due payment date. You will still be charged interest but not a penalty. The concession only applies if all tax is paid; any part payments made by day 30 will still leave an unpaid balance which will be subject to a 2% penalty.

For all aspects of the new regime - for both late returns and late payments - you will be able to appeal against any points or penalties if you have a reasonable excuse for the lateness. The same principles will apply as for the existing default surcharge system - for example, a lack of funds is not classed as a reasonable excuse.

Late payment and repayment interest

You might think that you can delay paying the tax owed on their returns until day 14 without incurring a penalty. This is correct but the new system also introduces an interest charge for any tax paid late, which will be charged from day one. The annual interest rate will be calculated according to the Bank of England base rate plus 2.5%.

However, if you submit a repayment return on time, which HMRC delays repaying, you will be paid interest by HMRC, based on the Bank of England base rate less 1%, subject to a minimum annual rate of 0.5%.

Example. Bob the builder submitted his return for March 2023 before 7 May 2023 - the filing and payment deadline - but did not pay his tax bill of £75,000 until 7 September 2023, i.e. four months late. He will be subject to a 4% penalty on day 30 after the due payment date, and an annualised penalty of 4% for the next three months.

Total penalty = (£75,000 x 4%) + (£75,000 x 4% x 3 months/12 months) = £3,750.

This is a better result for Bob than the maximum 15% default surcharge that he could pay with the existing system. As well as a penalty of £3,750, he will also incur an extra charge for late payment interest.

If you agree a time-to-pay deal with HMRC for tax you owe, this will stop the penalty clock from ticking from the date that the agreement is reached.