New year, new VAT penalties

In the new year we will be saying goodbye to the longstanding, if not much-loved, default surcharge regime. Instead, for VAT periods starting on or after January 1 2023, new penalties will apply if you are late filing a VAT return or paying your VAT bill. The way interest applies to late VAT payments, and late repayments by HMRC, will also change.

These new rules have some features which are a distinct improvement on the old default surcharge regime. However, other aspects could catch out taxpayers and their agents.

Late filing

The new late filing penalties will be points based, with taxpayers receiving a point for each VAT return they file late. Once the taxpayer’s total number of points reaches a certain threshold, a fixed £200 penalty will be charged. This threshold depends on how often the taxpayer files their VAT returns – four points for quarterly, five points for monthly and two points for annually.

Once a taxpayer reaches their penalty threshold, each and every additional late VAT return will trigger a further £200 penalty. However, it is possible for points to expire:

• If the taxpayer is below their penalty threshold, points will automatically expire after 24 months.
• If the taxpayer has reached their penalty threshold, points will only expire after a ‘period of compliance’.

The period of compliance broadly requires all returns for a certain period of time (e.g. 12 months for quarterly VAT returns) to be filed on time, and all outstanding VAT returns for the past 24 months to have been submitted. Once both of these conditions are met, the good news is that the taxpayer’s points total will be reset to zero.

Importantly, unlike default surcharge, under the new regime there is no connection between the amount of any late filing penalty and the VAT due on the return. As a result, repayment traders and taxpayers filing nil returns will be in the scope of late filing penalties for the very first time.

Late payment

The new late payment penalties are designed to encourage taxpayers who are struggling to pay to engage with HMRC as soon as possible.

There will be two separate penalties, based on how late payment is:

• A first penalty of 2% of the VAT unpaid at day 15, and a further 2% of the VAT unpaid at day 30.
• A second penalty starting at day 31, charged daily based on an annual rate of 4% of the outstanding amount.

For the purposes of both penalties, agreeing a Time to Pay (TTP) arrangement with HMRC is effectively treated in the same way as payment, with the penalty clock being ‘stopped’ on the date of the original TTP application. However, if the terms of that TTP are subsequently broken, it will be treated as if it never existed and full penalties will be charged.

Under the new rules, paying or requesting a TTP within 15 days of the due date means no penalty arises. In addition, in the first year the rules are in place there will be a ‘period of familiarisation’, with HMRC not charging the first leg of the first penalty (i.e. the 2% at day 15) from January 1 until December 31, 2023. As a result, in that period, taxpayers will be able to pay their VAT bills up to 30 days late without incurring a penalty (though interest will still be charged).

Interest

It’s not just penalties that are changing this January, but interest too.

Late payment interest for VAT will be brought in line with other taxes, being charged at the Bank of England base rate plus 2.5%.

The existing repayment supplement will be withdrawn for VAT periods beginning on or after January 1, 2023. Instead, a much less generous repayment interest will be payable by HMRC at the Bank of England base rate minus 1% (with a minimum of 0.5%)

What’s next?

We’re expecting further detailed guidance from HMRC later this year. In the meantime, there is high level ‘prepare’ guidance and communications resources available on GOV.UK.

HMRC are starting to roll out their communications to raise awareness of the changes, and VAT registered businesses should hear from them directly as they come up to their first filing deadline under the new rules.

In the meantime, agents should start talking to those clients who might be affected – in particular those repayment traders or nil return filers who have fallen into bad habits due to not receiving late filing penalties in the past.

Looking slightly further into the future, penalty reform isn’t stopping here – the new regime will be extended to income tax self-assessment in the coming years, starting with MTD taxpayers in April 2024, and all other taxpayers in April 2025.