A much-needed new penalty system will take effect for VAT periods beginning on or after 1 January 2023, which will penalise businesses that submit late returns and payments. It will replace the current default surcharge system that has been an important part of the VAT regime for more than 30 years.

The new system will be good news for all VAT-registered entities because it will penalise persistent offenders rather than those who make occasional mistakes. That objective is to be welcomed.

Two systems

Two completely different penalty systems will be introduced on 1 January – one will deal with late returns and the other when tax has not been fully paid by the due date.

• The regime for late returns will be based on a points-accumulation system: businesses will get one point for each late return they submit and then a £200 penalty will be issued by HMRC when the business reaches its points threshold. The threshold depends on the frequency that returns are submitted:
• monthly returns – the threshold is five points;
• quarterly returns – the threshold is four; and
• annual returns – the threshold is two.

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

Advisers should inform all clients who submit monthly returns about the new system because it will be the first time in the 49-year history of our favourite tax that repayment returns will be subject to a potential penalty. HMRC will carry out a publicity operation to highlight this issue to relevant repayment traders, such as farmers. 

Fifteen-day concession for late payments

If a business is one day late paying its VAT return with the current default surcharge system, it could get a penalty of up to 15% of the tax unpaid on the due date. It has always been acknowledged that this draconian rule can produce some very unfair results because it applies the same penalty for being one day late with a payment as being one year late. That is very harsh.

The new system will not charge a penalty for any tax paid (or payment plan agreed) in the first 15 days after the due date. For tax paid between days 16 and 30, there will be a 2% penalty on the VAT outstanding at day 15. For tax unpaid by day 30, a 2% penalty applies to the amount owed at day 15 and a further 2% is charged on the amount still owed at day 30. Payments made or payment plans agreed after 30 days will be subject to a further penalty based on an annualised rate of 4%.

Note that, as a special first-year concession until 31 December 2023, a late payment penalty will not be issued by HMRC if all tax owed is fully paid by day 30 after the due payment date.

Late payment interest and repayment interest

You might think the new system will give your clients the opportunity to delay paying their VAT liability until day 15 after the due date without incurring any penalty. That is correct, but there is a separate interest charge for any tax paid late; the clock starts ticking from day one here. Interest is calculated according to the Bank of England base rate plus 2.5%.

A downside of the new regime is that repayment supplement procedures – where HMRC pays a 5% supplement in cases where it delays repayment returns by more than 30 days – will be abolished. It will be replaced by repayment interest (RI) instead. Another disappointment is that RI will be calculated according to the Bank of England base rate minus 1%, subject to a minimum annual rate of 0.5%. The base rate would have to be 11% before the amount of interest on a VAT return repaid six months late by HMRC would get an RI payment to match the current 5% windfall.

Example 1

Marie the florist submitted her VAT return for March 2023 before 7 May 2023 – the filing and payment deadline – but did not pay her tax bill of £100,000 until 7 August 2023 (ie, three months late). She will be subject to a 2% penalty on the tax still owing on day 15 after the due payment date, a 2% penalty on the tax still owing on day 30 after the due payment date, and an annualised penalty of 4% for the next two months.

Total penalty = (£100,000 x (2% +2%)) + (£100,000 x 4% x two months/12 months) = £4,666.

Note: this is better than the maximum 15% default surcharge of £15,000 that Marie could pay with the existing system. As well as the penalty of £4,666, she will incur an extra charge for late payment interest.

Escaping the points regime

As explained above, a business submitting quarterly returns will get a £200 penalty once it has accumulated four points (ie, 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 two conditions are fulfilled:

• all returns for the previous 24 months must have been submitted by the business; and
• the business must have submitted all returns on time for 12 months after reaching the relevant points threshold. The relevant period is 24 months for a business on annual returns and six months for monthly returns.

Example 2

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

Appeal procedures

The new system should produce a greatly reduced number of court hearings in the First-tier Tribunal about whether a business had a reasonable excuse for making a late payment. This is because the new system will not produce a massive penalty for a business that slips up with an occasional misdemeanour, such as a payment that has been made one day late because of confusion about online banking procedures. This will also benefit both HMRC and taxpayers by reducing time-consuming internal appeals. Appeals can still be made with the new system and the reasonable excuse provision will continue to be relevant.

Conclusion

To give HMRC the final word, the aim of the new system is to penalise “only the small minority who persistently miss their submission obligations rather than those who make occasional mistakes”.

Here are four final tips:

• direct debit – it makes sense to pay all VAT returns by direct debit, so that HMRC will automatically collect the payment three working days after the due date;
• time-to-pay agreements – no penalty will be applied once a time-to-pay agreement has been accepted by HMRC. So, for example, if an agreement is reached on day 20 after the due payment date, this will avoid a penalty being charged in the first year due to HMRC’s temporary 30-day concession explained above;
• submit returns on time – make sure that your clients submit their return on time, even if they cannot pay the tax owed by the due date; andmake part-payments – penalties are charged according to unpaid tax after days 15 and 30. This gives a clear incentive to pay as much tax on time as possible, and part-payments thereafter to reduce the scope for HMRC to issue late payment penalty notices and charge interest.

About the author

Neil Warren, CTA (Fellow), ATT, independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997