The VAT default surcharge regime, which penalises late filing or payment of VAT returns, is to be changed with effect from 1st January 2023.
The system, which can give rise to a comparatively large penalty for a very short period of default, is being updated to bring it in line with other taxes. The current rules lead to a disproportionate number of appeals to the tax tribunal, with taxpayers citing the unfairness of a perceived cliff edge and large penalties for short defaults as grounds to appeal. The tax tribunal does not have the right to apply discretion and can only rule on whether the rules have been applied correctly, not their fairness. The circumstances where HMRC can let a taxpayer off a penalty are very limited and prompt action by the taxpayer is crucial to appealing a default.
Under the current rules, if a return is filed or paid late, the taxpayer is served with a default notice which will be in place for 12 months. If there is a second or subsequent default in that 12 months, then the taxpayer will be liable for a penalty at 2%, then 5%, 10% and 15%. If a penalty at 2% or 5% is less than £400 it won’t actually be charged.
This can lead to a rather unpleasant surprise for a business on its third default. It will receive notice that it is in default for those first two periods, but no financial penalty. For the third period in default it would be charged at 10%. As a default is recorded for either late filing or late payment, a business could pay all their returns on time, but still be in default due to late filing. A payment received even one day late will still be liable for the appropriate percentage on the full amount outstanding.
From 1 January 2023 there will be separate rules for late filing and late payment.
If you submit your return late, you receive a penalty point. So file your March 2023 VAT return late, you get one point. If you are on quarterly filing and accumulate 4 points, you are liable to a £200 penalty for that failure and subsequent failures to file on time.
Ultimately the same rules will apply to other taxes as well, but the penalty points aren’t accumulated across different taxes. Points expire if the taxpayer is fully compliant for 12 months, at which time all points expire. If you are not up to the points threshold, so not consistently filing late, individual points expire after two years, even if you haven’t filed everything on time for a year.
There are two stages of penalty. Somewhat confusingly, the first stage penalty has two different rates and a nil rate, and the second penalty is calculated on a per annum basis, which looks a lot like late payment interest, which will also apply.
The first stage penalty applies to tax paid before it is 30 days late and can be up to 4%. If paid, or an arrangement proposed for time to pay, up to 15 days after the due date, there will be no penalty. Tax paid between 16 and 30 days late will give rise to a penalty at half the first stage penalty rate, being 2%. If still unpaid on day 30, then the full first stage penalty of 4% of the total outstanding is charged.
At the second stage, penalties start to accrue on a daily basis. Tax unpaid on day 31 will be liable to a penalty at 4% per annum, on top of the 4% flat charge already accrued.
As with the old regime, interest will also be charged on VAT outstanding after its due date. This is currently charged at 2.75%
A VAT liability which is paid 40 days after the due date will have a flat first stage charge of 4%, plus 10 days second stage penalty at 4% per annum. Interest will also accrue at 2.75% pa from the due date. Under the current surcharge regime, penalties at 5%, 10% or 15% can become due for a payment made one day late, with only very limited grounds available for HMRC to apply discretion.
Reducing penalties under the new rules
Even if unable to pay the liability, the return should be filed on time, to avoid accruing late filing penalty points. If the full amount cannot be paid, any payment to reduce the liability will reduce the balance which could be subject to penalties. Agreeing a time to pay arrangement with HMRC, and sticking to it, will ensure that no penalties are chargeable. In contrast to the current regime, HMRC will have scope to apply discretion in imposing penalties. By contacting HMRC and communicating with them, a taxpayer increases their potential to avoid being assessed for a penalty.
Mitigating penalties under the current rules
A business will not be held to be in default if they have filed the return and made a time to pay arrangement before the payment is due, so businesses which know they are not going to be able to pay in time, should contact HMRC as soon as possible to make arrangements to pay later.
The current surcharge penalty is based on the amount of VAT liability not paid, so a payment on account before the due date will reduce the amount of any penalty.
It is also worth noting that a business can only appeal a penalty and not a default surcharge notice so it is always worth checking that there are no mitigating circumstances for earlier defaults, as the penalty system is an accumulative one. Thus by having an earlier default withdrawn the current default penalty can be reduced
For the purposes of VAT, there are no plans to convert current defaults into points in the new system, which effectively gives a long lead time before any late filing penalties can be accrued. Late payment penalties could accrue for the first VAT period beginning after 1 January 2023.
For more information into the changing rules please contact Sarah Barron: