In December, Graeme Blair, Tax Partner at Goodman Jones, sat down with VAT consultant Robert Facer to discuss the changes to late filing and late payment penalties that came into effect on 1 January 2023.
Graeme: Good afternoon, I’m here with Robert Facer, our VAT consultant, and today’s discussion is about the changes to late filing and late payment penalties for VAT, which are coming into force soon. And with that, I would start with the first question, which has been sent in, which is, there’s been a lot of talk about new VAT penalties. What is changing?
Robert: Yes. So, there are some very significant changes taking place to VAT penalties for late payment and late filing coming in on the 1st of January, 2023. What we have at the moment for VAT penalties is a single penalty regime known as the default surcharge penalty that covers both late payment and late filing. What we’re going to have from the 1st of January 2023 is two separate penalties, one for late payment, and one for late filing. So, we’ll have a very different picture in terms of VAT penalties from that date. Another change that’s also taking place is the introduction of late payment interest, which is something that we don’t have at the moment under the existing rules. So, there’s really going to be a very different penalty environment from the start of 2023.
Graeme: As you say, Robert, we’re having a very different penalty environment. And just how do the new penalty rules differ from the existing regime?
Robert: So, under the existing default surcharge penalty system, broadly the way it works is each time you either file late or pay late, that is treated as a default. The first default doesn’t trigger a penalty. You will just get a warning letter. If you then default again within the next 12 months, you will get a 2% penalty based on 2% of the VAT that’s outstanding. If you’re then late again within the next 12 months, the penalty goes up to 5%, then 10%, and then up to a maximum of 15%. So, the existing penalty regime has often been criticized for being quite a blunt instrument. It imposes the same penalty on someone who is a day late in paying their VAT as someone who is six months or a year late in paying their VAT.
Robert: And there are a lot of cases that we’ve seen go through the VAT tribunal where businesses that have perhaps clocks up a number of relatively minor defaults, found themselves on the 10 or 15% penalty rate and then incurred a very substantial penalty in some cases, tens or even hundreds of thousands of pounds because they’ve paid a return maybe a day or two late. And in those cases, the VAT tribunal’s hands have been tied, really, because that is the way the rules work. The tribunal doesn’t have any discretion to vary the penalty in those cases. So, the existing regime can be very harsh. The new penalty regime will be fairer in the sense that it will impose a higher penalty on people who are late. So, the later you are, the higher the penalty will be. So, in that sense, the new penalty regime will be much fairer than the existing system.
Graeme: So, in practice, what will the new penalty regime mean for VAT registered businesses?
Robert: So, as I say, the new regime is split into two separate penalties. So, if we talk about the late payment penalty, first of all, the way that this will work is if you are late in paying your VAT return, provided you pay the VAT liability in full by the 15th day after the deadline date, then no penalty will be incurred. Similarly, if you are late in paying your VAT return, but you have agreed a time to pay arrangement with HMRC, which essentially is a payment plan and that agreement is in place by the 15th date, the 15th day after the deadline date, then again, no penalty will be incurred. Any VAT that is still outstanding at the end of the 15th day after the deadline, there will then be a 2% penalty imposed.
Robert: That’s 2% of the amount that’s outstanding at that date. If you then pay in full by the 30th day after the deadline date, there’s no further penalty. And again, if you put in place a time to pay arrangement by that 30th day after the deadline, there’s no further penalty. If there is any VAT still outstanding on the 30th day, there’s a further 2% penalty based on the amount that is still outstanding at the end of day 30. And then any outstanding VAT beyond day 30, there is a further penalty calculated at an annual percentage rate of 4%. So, you can see that under the new penalty regime, the penalty is designed to increase the later you are in paying your VAT. So, it addresses that criticism that there has been of the default surcharge penalty, where under the default surcharge you essentially have a cliff edge where, you know, even if you’re just a day late, the penalty arises.
Robert: Here the penalty increases at the later that you are. And it’s worth saying that there is also a late payment interest that will apply. A late payment interest is calculated from the due date until the date that the VAT is actually paid, and that’s a new feature from January 2023 as well. The second part of the new penalty regime is the late filing penalty. And this is a points-based penalty system much like points that can be incurred on your driving license for speeding offenses and that kind of thing. So, the way that this will work is that if you are late in filing a VAT return, you will incur a penalty point. If the number of penalty points that you have incurred reaches the points threshold, then at that time, you then start to incur a fixed 200-pound penalty for each late filing that you make. Now, the points threshold depends on how frequently you submit VAT returns. So, if you are a business that submits monthly VAT returns, the points threshold is five points. So, you have to submit five VAT returns late before you incur that 200-pound penalty. Most businesses submit VAT returns on a quarterly basis. So, for those businesses, the points threshold is four points. And for business that submit their VAT returns annually, the threshold is two.
Robert: So that fixed 200-pound penalty is the same for each default. So that points-based system gives businesses the opportunity to correct any compliance issues that are causing late filings before they reach that points threshold and start to incur the penalties. So, the idea here is that HMRC wants to give businesses an opportunity to address any issues and become compliant so that they can do that before they actually reach the point of incurring those penalties.
Graeme: Robert, you use the analogy of the points on the driving license. It’s my understanding that after a period of time, the points on driving licenses would drop off and get revoked. Is there something similar in the point system under the late filing regime?
Robert: Yes, there is a similar sort of picture. If a business has incurred some penalty points but not reached the penalty point threshold, then each of the points incurred will last for two years. So once a point reaches its second anniversary, it will then expire. So, for business on quarterly VAT returns, for example that has perhaps incurred two or three points. So, it hasn’t reached the four points thresholds yet. Each of those points will fall away as it reaches the two-year lifetime. Once a business reaches the points threshold, then there is a different set of rules which require two conditions to be satisfied in order to clear your points. So, the first of those conditions is that you must have submitted all of your VAT returns within what’s called the compliance period on time.
Robert: And the compliance period varies depending on how frequently you have to submit your VAT returns. So, for a business that submits monthly returns, the compliance period is six months. For most businesses that submit quarterly returns, the compliance period is 12 months. And for businesses on annual returns that period is 24 months. So, for a business on quarterly returns to satisfy that first condition, they will have to submit four VAT returns on four consecutive VAT returns on time in order to satisfy that first condition. The second condition that must be satisfied is that all VAT returns for the past two years must have been submitted. It doesn’t matter whether they were submitted on time or not, but they must have been submitted. So, there mustn’t be any outstanding returns in the past two years. And if both of those conditions are satisfied, then all the points are wiped clear. It’s all reset to zero. So again, the idea there, is that HMRC want businesses that have reached that points threshold to demonstrate for the compliance period that they have addressed those issues and that they are now compliant. And once they’ve demonstrated that, then everything is reset to zero and the business has a clean slate again.
Graeme: Well, that’s very interesting. And I guess it does show that the revenue is trying to make the system fairer, but it seems to me that we are now running two sets of penalties instead of one. Does this mean that the higher penalty will apply if a business is in default?
Robert: Not necessarily. So, the new penalty regime is designed to be fairer, as you say. And in a lot of cases where there is a late payment or a late filing, penalties will be lower than they would be under the existing regime. So, if you take the example of someone who is perhaps a couple of days late in paying their VAT return under the new regime, provided they pay in full by the 15th day after the deadline date, then there’ll be no penalty incurred. There’ll be late payment interest, but there’ll be no penalty incurred. So, it avoids that cliff edge that you have with the default surcharge regime. There will be circumstances where penalties are higher than they would be under the current rules.
Robert: So, for example, under the default surcharge regime, on the first occasion that you are late, you get a warning letter, whereas under the new rules you don’t have that warning letter. The penalties can apply straight away. So, it depends on the circumstances, but the overall idea is that it should be fairer because it recognizes as I say the later you are the higher the penalty. And there is a particular issue to be aware of though, and that is for businesses that submit repayment returns or perhaps are submitting nil returns, because the business is currently in a period of not having any activity. Now, under the existing default surcharge regime you can’t incur a penalty unless you’ve actually paid late.
Robert: And so, if you submit repayment returns or if you’re submitting new returns, you can’t incur a penalty in those circumstances. Under the new penalty regime, you can, so if you’re submitting a repayment return and you submit it late, if you’ve reached the points threshold, you will incur the 200 pound fixed penalty. And the same issue with nil returns. So, for those businesses that have perhaps been used to being able to perhaps file a bit late and not suffer any penalties that will change from January 23. As I say, once they reach that point’s threshold penalties will start to be incurred. So that’s a particular issue for those kinds of businesses to be aware of.
Graeme: So far in our discussions there’s been a lot of description of the penalty regime, but you did mention that late interest would also be relevant. How will this work in practice?
Robert: Yes. So, this is another new feature. At the moment, if you pay a return late, yes, you might incur a default surcharge penalty, but interest isn’t added on top of that. Under the new regime there will be late payment interest charge, which will run from the due date until the date of payment. And that will be calculated at Bank of England rate plus two and a half percent. So clearly there’s an incentive there to pay as much as you can as early as you can to stop that interest charge building up. So yes, there are really sort of three elements to this late payment penalty, late filing penalty, and late payment interest.
Graeme: If one looks at the corollary will HMRC pay interest if a VAT repayment is delayed?
Robert: Well, yes, they will. But possibly not very much. Under the existing rules, we have what’s called a repayment supplement. And the way that, that works is if you submit an VAT repayment return and HMRC delay the making of that repayment, then you are entitled to a 5% repayment supplement. That is being scrapped from 31st December 2022 and instead, we are going to have repayment interest. Repayment interest will be calculated from the later of the due date of the VAT return or the submission date of the VAT return. So whichever of those two things it happens later. And the interest will be calculated up to the date that HMRC actually make the repayment to the business.
Robert: Now here repayment interest will be calculated at Bank of England interest rate minus 1% with a minimum interest rate of half a percent. So, there’s a big difference between late payment interest that’s payable to HMRC if you are late in paying your return and repayment interest that HMRC will pay to the business on any repayments that are due. So yes, there will be some interest payable, but possibly not a great deal.
Graeme: We don’t live in a perfect world and sometimes things go wrong, they get lost in the ether, and similar issues. Can a business appeal against a penalty which it genuinely believes is wrong?
Robert: Yes, it will be able to. There are rights of appeal. So, if a business believes it has what’s known as a reasonable excuse against any penalty, then yes, it can appeal against that. So, for late payment penalties, there is the right to appeal against the decision to impose the penalty. There’s also a right to appeal against the amount of the penalty. For late filing there’ll be the right to appeal against the decision to impose a penalty or the decision to impose a penalty point. So yes, there will be rights to appeal. And as with other VAT matters, you’ll be able to ask HMRC to reconsider their decision so that they get a chance to look at it again and decide whether their decision was correct. But ultimately business can also appeal to a tax tribunal for the tribunal to consider the appeal. And as always with appeals it is important to be aware of the time scales. So, any appeal needs to be made within 30 days of the date of the decision. So, if a business is going to challenge a penalty or a penalty point then it is important to do that quickly and within the time limit, so as not to lose that right of appeal.
Graeme: So, it seems to me that this is quite a big change on what’s been a very long standing process and arrangement. When do these new rules kick in?
Robert: So, the new rules affects the VAT return periods starting on or after the 1st of January, 2023. So, for example, if a business is submitting quarterly returns and it has a quarterly return ending February, 2023, that return will not fall into the new regime because that period started before 1st of January, 2023, but it’s next return, the quarterly return ending May 2023, will be within the new regime because obviously that started after 1st of January 2023.
Graeme: And obviously the new rules as you’ve described them, are trying to be fairer and have less of a cliff edge effect. But what happens if a business is already in the current default surcharge penalty regime, do these past defaults or the current regime somehow transfer into the new rules?
Robert: Well, the good news is that any defaults under the default surcharge regime do not transfer across into the new regimes. So, businesses that have had some compliance issues, some late filings, late payments they get a clean slate under the new regime. So yes, that’s good news.
Graeme: And finally, are there any tips for reducing the risk of penalties?
Robert: Yes. Well, there are a few practical things that businesses can do to reduce the risk of penalties. One thing that HMRC are very keen on is for businesses to sign up for direct debit payments for their VAT returns. And certainly, if you log into your business tax accounts, you’ll see messages about signing up for direct debits. And that means that HMRC automatically collects the VAT payment that’s due from the business bank account under the direct debit scheme. So, provided that there are sufficient funds in the account, the business will never be late in paying its VAT returns. So that’s a simple step that businesses should consider.
Robert: Another point to consider is if a business is unable to pay its VAT liability in full by the due date but can pay something towards it, then it’s best to pay as much as you can as early as you can to reduce penalties and to reduce late payment interest. And it’s also important to start a dialogue with HMRC about a time to pay arrangement as early as possible. And as I said earlier on, if a business has agreed a time to pay arrangement with HMRC, and once at the point that it has been agreed and it is only from once it has been agreed, and not from when the discussion starts. At the point that it’s been agreed, that stops any further penalties being incurred.
Robert: So that early dialogue with HMRC, if payment in full can’t be made is very important. And then I think the final point I’d suggest is having a look at internal procedures and controls. So, some simple measures such as having a diary reminder set up in the runup to VAT returns deadlines you know, particularly when things are very busy, just having that reminder popping up on the screen can be something very simple that acts as a prompt to make sure that VAT returns are filed and paid on time. But also looking at what the internal procedures are. So very often there’s a key person involved in preparing and submitting the return. What would happen if that key person was suddenly out of the office for a period of time through illness and those kinds of unexpected situations? Is there someone else in the office who knows how to prepare the return? Bearing in mind that, that returns now have to be submitted using software. Is there someone else in the office who has a login to use that software and knows how to submit the return? So having that sort of backup plan for those unexpected situations is also important and will help to reduce the risk of penalties.
Graeme: Thank you, Robert, that was quite a comprehensive review of the new regime. If you have any concerns or questions about the new regime or VAT generally, then please feel free to get in touch with your normal Goodman Jones contact or email us at firstname.lastname@example.org
The information in this article was correct at the date it was first published.
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