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In January 2023, HM Revenue and Customs introduced a revamped penalty system for late VAT return submissions. This new framework replaces the previous VAT default surcharge and applies to VAT accounting periods that begin on or after 1 January 2023. Businesses that submit their VAT returns late, whether they are due to pay VAT, are claiming a refund, or are submitting a nil return, are all subject to these new penalties.

The new regime is designed to be fairer and more consistent, focusing on a points-based mechanism rather than the older percentage-based surcharges. It aims to encourage regular and timely filing by penalising repeated failures to submit returns on time while being more forgiving of occasional lapses.

What Triggers a Penalty Under the New System?

Any late submission of a VAT return triggers a penalty point. It does not matter whether VAT is owed or not. This means that even if a business is submitting a nil return or is due to receive a refund from HMRC, submitting that return late will still result in a penalty point.

Each time a VAT return is filed after the deadline, HMRC issues a penalty point to the business. These points accumulate until they reach a certain threshold, determined by the frequency of VAT submissions. Once that threshold is reached, the business faces a financial penalty.

How the Points-Based Penalty System Works

The core of the new VAT penalty framework is the penalty point system. Here’s how it operates:

• Each late VAT return submission earns the business one penalty point.
• Points accumulate over time, up to a specific threshold.
• When the threshold is reached, a financial penalty of £200 is imposed.
• Any additional late submission beyond that threshold triggers an additional £200 penalty.

This approach means that the penalties become more serious as non-compliance continues, but businesses are not penalised financially for a one-off late submission.

Penalty Point Thresholds Based on Filing Frequency

The penalty point threshold is linked to how frequently the business is required to submit its VAT returns:

• Businesses submitting VAT returns annually have a penalty point threshold of 2.
• Businesses submitting quarterly VAT returns face a threshold of 4.
• Businesses submitting VAT returns monthly have the highest threshold at 5.

These thresholds reflect the number of opportunities businesses have to file throughout the year. A business submitting monthly returns has more chances to build up penalty points, hence the higher threshold.

Example: Quarterly VAT Return Submissions

Let’s consider an example to clarify how the penalties work for a business filing quarterly returns.

A business submits VAT returns every three months. Suppose the business submits three of its quarterly returns late. At this point, it accumulates three penalty points but no financial penalty is charged yet. Upon submitting a fourth return late, the business reaches the penalty point threshold of four.

Now, a £200 penalty is issued. If the business continues to submit subsequent VAT returns late, each of those will also incur a £200 penalty as long as the threshold remains met or exceeded.

If the business starts submitting returns on time after reaching the threshold, no additional penalties are incurred. However, the penalty points remain unless specific actions are taken to remove them.

How to Remove Penalty Points

There are two pathways for removing penalty points under the new system, depending on whether the business has reached the penalty point threshold.

For Businesses Below the Threshold

If a business has not yet reached the threshold for its filing frequency, the penalty points will expire automatically. Each point expires two years after the due date of the VAT return it relates to.

This gives businesses a natural opportunity to cleanse their record by returning to regular and timely filing habits. There’s no need for formal action as long as the threshold hasn’t been reached.

For Businesses at or Above the Threshold

If a business has reached the penalty point threshold and has already received financial penalties, it must actively demonstrate compliance to have its points reset to zero.

To do this, the business must:

• Submit all outstanding VAT returns for the previous 24 months.

• Complete a period of compliance—filing all VAT returns on time—for a designated period. The length of this period depends on the business’s VAT return frequency:

1. • 6 months for monthly returns
   • 12 months for quarterly returns
   • 24 months for annual returns

After completing this period of compliance and clearing any backlogged returns, HMRC will remove the penalty points and reset the account.

Treatment of Non-Standard VAT Accounting Periods

Some businesses operate on non-standard VAT accounting periods with HMRC’s approval. These might not align perfectly with the traditional monthly, quarterly, or annual schedules. To accommodate this, HMRC applies the following rules to determine the appropriate penalty point threshold:

• If the accounting period is longer than 20 weeks, the business has a threshold of 2 penalty points.
• If the accounting period falls between 8 and 20 weeks, the threshold is 4 points.
• If the accounting period is 8 weeks or less, the threshold is 5 points.

This framework ensures consistency and fairness regardless of the business’s VAT schedule.

Changing Your VAT Accounting Period

If HMRC approves a change to your VAT accounting period, they will also adjust your penalty points and thresholds accordingly.

• If the adjustment of your schedule results in a negative penalty point balance, your points will be reset to zero.
• If you had zero points prior to the change, no adjustment is made.
• Switching from a non-standard accounting period to an equivalent standard one (e.g., from a 10-week custom period to a standard quarterly period) won’t affect your penalty points.

It’s important to note that adjustments to penalty points due to a change in accounting period cannot be appealed. These are automatic administrative updates meant to align your penalty status with the new filing frequency.

When the New Penalty Rules Don’t Apply

There are limited circumstances under which the new VAT penalty rules are not enforced:

• First VAT Return: If a business is newly VAT registered and is submitting its first VAT return, the new penalty rules do not apply.
• Final VAT Return: If a business has cancelled its VAT registration, the last return submitted post-cancellation is also exempt.
• One-off VAT Returns: When a business submits a one-time return that doesn’t correspond to a typical monthly, quarterly, or annual cycle—such as a four-month return due to a change in reporting frequency—the new rules are not applied.

These exceptions provide some flexibility for unique circumstances, such as new registrations or structural changes in the business.

Keeping Track of Your Penalty Points

HMRC maintains a digital record of all penalty points and financial penalties associated with your VAT account. Business owners can view this information by logging into their VAT online account. This helps ensure transparency and allows businesses to track how close they are to the penalty threshold.

Receiving timely notifications from HMRC is crucial. Businesses are advised to keep their contact information up to date in their online VAT account and regularly check for messages from HMRC to avoid missing deadlines inadvertently.

Administrative Notifications from HMRC

When a VAT return is submitted late, HMRC issues a formal letter or electronic notification stating that a penalty point has been added to the business’s record. If a £200 financial penalty has been incurred due to reaching or exceeding the threshold, this will also be outlined in the notification.

The communication will provide the date the penalty was issued and information about how to appeal (if applicable). Businesses should keep these documents for their records and review them carefully.

Late Payment Penalties and Interest

In addition to the points-based penalty system for late submissions, HMRC introduced a new framework for handling late VAT payments from 1 January 2023. This is a separate component of the VAT penalty regime and applies to VAT accounting periods starting on or after this date.

Late payment penalties and interest charges are designed to encourage timely payments of VAT liabilities and ensure that businesses meet their obligations in full. The structure of this system is progressive and time-sensitive, meaning the longer a payment remains overdue, the more severe the financial consequences.

Understanding how these penalties work, when they are applied, and how to minimise their impact is crucial for any VAT-registered business operating under the new HMRC rules.

When Do Late Payment Penalties Apply?

Late payment penalties come into effect when a business fails to pay its VAT bill by the due date. Unlike the submission penalty system, there is no grace period before penalties start to accrue. Interest begins to accumulate from the very first day the VAT payment is overdue.

Penalties escalate as the delay in payment increases, introducing additional financial pressure on businesses that fail to settle their VAT liabilities promptly. The penalties are calculated in stages, with initial fixed percentages followed by daily accruals for extended delays.

Role of Late Payment Interest

Interest is a fundamental part of the new system. It is charged automatically on any VAT amounts that remain unpaid after the due date. The rate is set at the Bank of England base rate plus an additional 2.5 percent. This ensures that the interest charge reflects current economic conditions while still acting as a deterrent against late payments.

Interest is applied on a daily basis, calculated from the day after the due date until the payment is received in full. This mechanism means that even minor delays in payment can lead to noticeable increases in overall liability.

Interest Example

Consider a VAT liability of £10,000 that is paid 10 days late. If the Bank of England base rate is 5.25 percent, the interest rate applied by HMRC would be 7.75 percent per annum. Over 10 days, the interest would be approximately £21.23, depending on how HMRC calculates the daily rate. While this may seem minimal, the cost increases significantly with higher liabilities or longer delays.

First Stage Penalty: 16 to 30 Days Overdue

The first stage of the late payment penalty applies if the VAT remains unpaid between 16 and 30 days after the due date. Once the 15-day grace period has passed, HMRC charges a penalty of 2 percent of the VAT owed as of day 15.

This initial penalty aims to prompt businesses to act quickly after a short delay. Although a 2 percent charge might seem modest, it represents a tangible cost for missing payment deadlines.

Example of First Stage Penalty

If a business owes £8,000 in VAT and pays it on day 20, the first stage penalty is calculated based on the amount due on day 15. Assuming no payment was made by that point, the penalty would be:

2 percent of £8,000 = £160

This is in addition to any interest that has already started to accrue.

Second Stage Penalty: 31 Days or More Overdue

When the VAT payment is still outstanding 31 days after the due date, the second stage penalty applies. This includes two additional charges:

• A further 2 percent of the VAT still unpaid at day 30
• A daily penalty charge based on 4 percent per year, calculated from day 31 until the balance is fully paid

This tiered structure reinforces the importance of settling VAT debts quickly. The longer the payment is delayed beyond 30 days, the more the daily penalty adds up.

Example of Second Stage Penalty

If the same business still owes the full £8,000 on day 30, the second penalty would be:

2 percent of £8,000 = £160

If the business delays payment for another 60 days, the daily penalty is calculated as follows:

Daily rate = 4 percent per annum = 0.01096 percent per day

Daily charge on £8,000 = £0.8768

Total daily penalty over 60 days = £0.8768 × 60 = £52.61

So, the total second stage penalty would be £160 + £52.61 = £212.61, plus any interest that has been accruing since the original due date.

Total Cost of Late VAT Payment

When considering both penalties and interest, the cost of late VAT payment can grow rapidly. Businesses must factor in:

• Interest from day one
• First penalty after 15 days
• Second penalty components after 30 days

Even a relatively small VAT bill can attract substantial additional costs if left unpaid. Businesses should review their cash flow processes and set internal deadlines well in advance of HMRC’s due dates to avoid these charges.

Time to Pay Arrangements

HMRC recognises that businesses can sometimes face cash flow issues that make it difficult to meet VAT obligations on time. To accommodate this, HMRC offers Time to Pay arrangements, allowing businesses to spread their VAT payments over an agreed period.

A Time to Pay agreement must be arranged in advance or as soon as possible after recognising a payment issue. If agreed before penalties apply, the business can avoid additional charges. However, if the agreement is made after the 15-day or 30-day periods, penalties already incurred may still stand.

The terms of a Time to Pay agreement depend on the business’s circumstances. HMRC assesses ability to pay, previous compliance history, and projected income before granting the arrangement.

Impact of Time to Pay on Penalties

Once a Time to Pay plan is in place, HMRC generally suspends further penalties, provided the business complies with the terms. This means that ongoing daily penalties from day 31 can be stopped if an agreement is reached promptly.

However, interest may continue to accrue during the term of the agreement, depending on how the plan is structured. Businesses should factor in this cost when negotiating repayment schedules.

Communication from HMRC

When a VAT payment is late, HMRC typically issues a notification informing the business of:

• The amount of VAT overdue
• Any penalties incurred
• The interest charged to date
• Instructions for making payment

This communication also includes guidance on how to appeal the penalty or request a Time to Pay arrangement. Businesses should respond quickly to these letters and not ignore HMRC communications, as penalties can escalate rapidly.

Avoiding Late Payment Penalties

The best strategy to avoid penalties is to establish clear internal processes for managing VAT obligations. These may include:

• Setting calendar reminders for return submission and payment deadlines
• Regular reconciliation of VAT records to confirm liabilities early
• Allocating sufficient cash reserves to cover VAT bills
• Using direct debit or standing orders to automate payments

In addition, businesses should regularly check their VAT online account for updates or alerts from HMRC. This ensures that nothing is missed and gives time to act if a payment is due soon.

Repeated Offences and Escalating Risk

While the late payment penalty structure does not currently escalate with each additional late payment, repeated non-compliance may affect HMRC’s view of the business’s reliability. It may also influence the likelihood of HMRC approving future Time to Pay arrangements or reduce flexibility in other interactions with tax authorities. 

Although each late payment is assessed independently in terms of penalties and interest, a pattern of non-compliance could increase the likelihood of audits or additional scrutiny.

Interaction with the Points-Based Submission System

It is important to distinguish between penalties for late submission of returns and penalties for late payment of VAT. These are two separate systems that run in parallel:

• Submission penalties are based on points that lead to fixed penalties after thresholds are reached.
• Payment penalties are calculated based on the duration of overdue balances.

A business could theoretically submit a return on time but fail to make the payment, triggering payment penalties while avoiding submission points. Conversely, a return submitted late but with payment made on time could attract submission penalties but not payment penalties. This dual framework means businesses must manage both timelines with equal diligence.

Practical Steps to Minimise Risk

To reduce the likelihood of triggering late payment penalties and interest, businesses should consider the following actions:

• Monitor due dates regularly and build internal reminders.
• Ensure VAT return preparation begins well before the end of the accounting period.
• Use accounting software to project VAT liabilities in advance.
• Consider setting aside funds regularly, especially for quarterly or annual returns.
• Communicate with HMRC early if payment issues arise, ideally before the due date.

Even if a payment cannot be made in full, partial payments reduce the interest and penalty amounts applied to the remaining balance. Businesses should always pay what they can, when they can, rather than wait until they have the full amount.

Appealing VAT Penalties and Managing Compliance

The introduction of HMRC’s new VAT penalty points system, alongside new interest and late payment rules, has significantly reshaped the way VAT-registered businesses manage their tax obligations. Ensuring compliance is now more than just meeting deadlines; it also involves maintaining accurate records, understanding how penalties are calculated, and knowing how to challenge them when necessary.

We will examine how to appeal VAT penalty points and financial penalties, how to manage VAT compliance effectively under the new regime, and how businesses can stay up to date with changes while avoiding escalating penalties.

The Right to Appeal: When and How

Every business has the right to appeal against VAT penalties if they believe there is a valid reason why the return or payment was submitted late. This appeal process applies both to submission penalty points and financial penalties for late payments.

An appeal should be made promptly and must provide sufficient evidence to support the reason for the delay. HMRC will review the information provided and make a decision on whether the penalty or points should be cancelled.

Grounds for a Reasonable Excuse

To appeal successfully, a business must prove that it had a reasonable excuse for the failure. HMRC defines a reasonable excuse as something unexpected or outside the business’s control that prevented it from meeting its obligations. Common examples include:

• A serious illness or accident affecting the business owner or key staff
• The death of a close relative or partner
• Major IT system failures or power outages
• Fire, flood, or other significant disruptions to business premises
• Postal delays caused by industrial action

Simply forgetting a deadline or being short on cash is not usually accepted as a reasonable excuse. However, in some cases, HMRC may consider mitigating factors if the business has a good compliance history.

Submitting an Appeal

Once HMRC issues a penalty notice, the business will receive written confirmation either by letter or through their online VAT account. This notice will contain instructions for submitting an appeal.

There are two main ways to submit an appeal:

• Using the HMRC appeal form, which is often included with the penalty letter.

• Writing a signed letter, explaining:

1. • The reason for the delay
   • Relevant dates and supporting evidence
   • The business name and VAT registration number

The appeal must be received within 30 days of the date HMRC issued the penalty. Delays in submitting the appeal may result in the penalty becoming final, although extensions may be granted in exceptional circumstances.

Requesting a Review

If HMRC rejects the initial appeal and the business disagrees with the decision, the next step is to request a review. HMRC has an internal team that independently reviews penalty decisions. This review process can lead to a change in the decision if new evidence is presented or if the original decision is found to be incorrect.

During the review, the business can continue to make representations and clarify their case. The review must be requested within 30 days of receiving the original decision letter. HMRC typically completes the review within 45 days.

Taking the Case to Tribunal

If the review does not resolve the dispute, the business can escalate the matter to a tax tribunal. This is a formal legal process where a tribunal will examine the facts and make a ruling. The tribunal is independent of HMRC and has the power to overturn or uphold penalties.

While most VAT penalty appeals are resolved during the initial stages, the option of going to a tribunal provides an extra layer of protection for businesses that feel they have been unfairly penalised.

Maintaining Compliance Under the New Rules

Avoiding penalties under the new VAT system requires a consistent approach to compliance. Businesses must take proactive steps to stay organised, meet deadlines, and monitor their VAT obligations regularly.

Set Internal Deadlines

VAT returns and payments are usually due one month and seven days after the end of the accounting period. Businesses should establish internal deadlines at least a week before the official due date to allow time for checking and submission.

Use Accounting Software

Modern accounting software can help track VAT liabilities, generate reports, and send automated reminders about upcoming deadlines. These tools reduce human error and can be integrated with HMRC’s Making Tax Digital (MTD) system for seamless submissions.

Keep Digital Records

HMRC requires digital records as part of MTD for VAT. This includes sales and purchase invoices, receipts, and other supporting documents. Keeping records up to date allows for quicker returns processing and provides evidence in case of a dispute.

Monitor Points and Penalties Online

Businesses can check their VAT online account to track penalty points, view outstanding penalties, and confirm payment history. Regular monitoring ensures that any issues are spotted early and can be dealt with before they escalate.

Impact of Penalties on Cash Flow and Operations

Frequent penalties can have a serious impact on business finances. The cost of late submission penalties, late payment interest, and daily charges can add up quickly. In addition, time spent dealing with appeals and reviews can take attention away from day-to-day operations.

The £200 flat penalty for late submissions at the threshold is particularly impactful for smaller businesses or those with seasonal cash flow patterns. Accumulating multiple penalties may also damage a business’s relationship with HMRC, especially if Time to Pay arrangements are needed in the future.

To avoid financial strain, it is advisable to maintain a VAT reserve account where funds are set aside specifically for VAT obligations. This practice can cushion the business against delays in customer payments or other unforeseen issues.

When Points Expire and How to Reset the Count

Penalty points do not remain indefinitely. If a business does not reach the threshold, individual points will expire automatically around two years after the due date of the return to which they relate.

However, if the threshold is reached, the business must take specific action to have points removed:

• All outstanding VAT returns for the past 24 months must be submitted.
• A period of compliance must be completed, during which all returns are submitted on time.

The length of the compliance period depends on the business’s accounting frequency:

• Monthly filers: 6 months
• Quarterly filers: 12 months
• Annual filers: 24 months

If the business successfully completes the compliance period, HMRC will remove the penalty points and return the business to zero.

What Happens if You Change Accounting Periods?

When a business changes its accounting period (for example, moving from quarterly to annual returns), HMRC will adjust the penalty point threshold accordingly. If this results in a minus figure, HMRC may reset the points to zero. If the business already had zero points, no adjustment is made.

It’s important to note that businesses cannot appeal point adjustments related to changes in accounting periods. The rules are designed to ensure consistency regardless of filing frequency.

Switching from a non-standard accounting period to an equivalent standard one (such as moving from a 10-week cycle to a quarterly return) does not affect the number of penalty points.

Situations Where Penalties Do Not Apply

There are a few exceptions to the application of VAT penalty points and payment penalties. These include:

• The first VAT return after a new registration
• The final VAT return after deregistration
• One-off returns that do not cover a standard accounting period (e.g., a four-month return due to a change from quarterly to annual filing)

These exceptions provide some flexibility during transitional periods and allow businesses to adjust to new VAT responsibilities without immediate penalty risk.

Tips for New VAT Registrants

Businesses that are newly VAT registered may be unfamiliar with the timing and procedures required for VAT submissions and payments. To ensure compliance from the outset, new registrants should:

• Confirm their accounting period with HMRC immediately after registration
• Understand their VAT return deadlines and set reminders
• Use an accountant or software that is MTD compliant
• File their first return accurately and on time, even if the amount due is zero

This early compliance establishes a good record with HMRC and prevents the accumulation of penalty points from the start.

Supporting Documentation for Appeals

When making an appeal, supporting documents can make a significant difference in how HMRC assesses the case. Businesses should be prepared to submit:

• Medical certificates or hospital admission records for illness-related delays
• Death certificates or funeral notices for bereavement-related delays
• IT support logs or reports of technical issues
• Police reports or insurance claims for events like fire or theft
• Proof of posting or courier tracking details for document delivery issues

Providing detailed and specific evidence increases the likelihood of a successful appeal. Vague or unsupported claims are much less likely to be accepted.

Keeping Up with Changes

VAT rules, penalties, and HMRC systems are subject to change. It is essential that businesses stay informed about updates to VAT legislation and compliance requirements. This can be done by:

• Signing up for email alerts from HMRC
• Consulting regularly with an accountant or VAT adviser
• Reviewing government guidance on VAT penalties
• Attending webinars or workshops offered by tax professionals

Staying current helps businesses prepare for new requirements and reduce the risk of falling foul of changes in the system.

Key Compliance Strategies

• Maintain accurate digital records
• Set internal deadlines ahead of HMRC’s due dates
• Use software to automate reminders and filings
• Monitor VAT account for penalties and notifications
• Establish a VAT reserve to avoid cash flow issues
• Communicate early with HMRC if payment difficulties arise

By embedding these practices into day-to-day operations, businesses can maintain compliance under the new VAT penalty regime and minimise the risk of costly penalties.

Conclusion

HMRC’s revised VAT penalty system marks a significant shift in how compliance is monitored and enforced for VAT-registered businesses in the UK. Designed to be fairer and more consistent than the previous default surcharge model, the new points-based framework rewards timely submission and penalises persistent non-compliance in a structured way.

Across this series, we’ve explored how the system works, the thresholds and penalties involved, and what businesses need to do to avoid or appeal them. The key takeaway is that consistency and organisation are more critical than ever. Even nil or repayment returns must be submitted on time to avoid accruing penalty points that can quickly lead to financial consequences.

Understanding the thresholds based on your accounting frequency, whether monthly, quarterly, or annually, is essential. Knowing how to appeal a penalty or challenge a decision with supporting evidence can make the difference between absorbing a costly fine and having it removed. For businesses that reach the penalty point threshold, taking immediate action to submit any outstanding returns and maintain timely filings going forward is vital to resetting their compliance record.

Late payment penalties and interest add another layer of risk for those struggling with cash flow. Being proactive, setting aside VAT funds, using accounting tools, and seeking a Time to Pay arrangement when needed, can help reduce financial pressure and safeguard business continuity.

Ultimately, the most effective way to manage VAT obligations under the new rules is to treat them as part of your everyday business processes. With clear deadlines, digital record-keeping, and regular checks on your VAT account, you can avoid penalties altogether and focus on growing your business with confidence.

By staying informed, maintaining good habits, and acting quickly when issues arise, businesses can navigate the VAT system successfully and avoid unnecessary costs and administrative burdens.