The truth about Making Tax Digital for VAT penalties

Following the official launch of Making Tax Digital (MTD) for VAT on 1st April 2019, affected businesses and their accountants are still trying to sort fact from fiction as to what they need to do and, importantly, what the penalties are for non-compliance.

Update: The scope of Making Tax Digital for VAT will expand in 2022. VAT-registered businesses with a taxable turnover below £85,000 will need to follow Making Tax Digital rules for their first VAT return starting on or after April 2022.

This guide brings together everything we know about penalties for MTD for VAT to give you an idea of the consequences of failing to meet your new digital tax obligations.

The reality of the “soft landing period”

The reality of the "soft landing period" HMRC described the first year of MTD for VAT as a "soft landing period", which is a period of time “for businesses to have in place digital links between all parts of their functional compatible software”. A “digital link” - a key requirement of MTD for VAT - is the connection between the software where you keep your accounts and HMRC.

Update: In response to the coronavirus (Covid-19) pandemic, HMRC announced that all mandated businesses now have until their first VAT period starting on or after 1 April 2021 to put digital links in place.

What does “light touch” really mean?

In the 2019 Spring Statement, shortly before the start of MTD for VAT, the Chancellor confirmed that HMRC would take a “light touch” approach to late filing and record-keeping mistakes and that “where businesses are doing their best to comply, no filing or record-keeping penalties will be issued”.

While the Chancellor’s statement is about leniency for issuing penalties, reading between the lines there are two things we can assume might still constitute a penalty offence:

  1. If your business is not doing its best to comply with MTD VAT filing and record keeping
  2. If your business pays its VAT bill late

In these two scenarios, it’s safe to assume that HMRC maintains the right to apply the current VAT penalties.

Current VAT penalties for late payments

While VAT filing deadline might not come under such harsh scrutiny in the first year of MTD for VAT, if you miss a payment deadline you will enter a 12-month period during which you may well have to pay a surcharge on top of your existing VAT bill if you continue to miss deadlines.

The surcharge amount changes depending on how many times you miss a VAT payment, as shown in the table below:

Defaults within 12 months Surcharge if annual turnover is less than £150,000 Surcharge if annual turnover is £150,000 or more
1st No surcharge No surcharge
2nd No surcharge 2% (no surcharge if this is less than £400)
3rd 2% (no surcharge if this is less than £400) 5% (no surcharge if this is less than £400)
4th 5% (no surcharge if this is less than £400) 10% or £30 (whichever is more)
5th 10% or £30 (whichever is more) 15% or £30 (whichever is more)
6 or more 15% or £30 (whichever is more) 15% or £30 (whichever is more)

HMRC is also entitled to charge penalties up to:

  • 100% of any tax under-stated or over-claimed if you send a VAT return that contains a careless or deliberate inaccuracy
  • 30% of a VAT assessment if HMRC sends you one that’s too low and you do not tell them it’s wrong within 30 days
  • £400 if you submit a paper VAT return, unless HMRC has told you that you’re exempt from submitting your return online

What does this really mean?

Although the surcharge and penalty system is complicated, the main takeaway for small businesses is that you may be penalised for failing to pay your VAT bill or if HMRC considers that you have not been making enough effort to comply with Making Tax Digital for VAT.

New penalty points system for VAT from 2020

Following the soft landing period, HMRC will update the VAT penalty system to bring it more in line with the penalties for late submission and payment of Income Tax and Corporation Tax. This will be based on a penalty points system and late VAT submissions will accrue penalty points as follows:

  • One penalty point for a missed VAT return.
  • A fine after four accumulated points for a missed quarterly VAT return.
  • A fine after four accumulated points for a missed monthly VAT return.

Penalty points will last for two years before they expire.

As well as a change to VAT submission penalties, late payment of VAT returns is also changing:

VAT payment delay Penalty
Late by 15 days No penalty
Late payment between 15 and 30 days 50% of HMRC interest rate charge
Late payment after 30 days 100% of HMRC interest rate charge plus daily interest charge

The interest rate charge changes with time so check how much interest applies on HMRC’s website.

MTD VAT penalties in summary

While the government has promised leniency on filing and record keeping for businesses doing their best to comply with MTD for VAT, it has not promised any breaks for businesses that do not pay their VAT bill on time or make any effort to comply.

MTD was described by the Chancellor as “an important first step in this modernisation of the tax system to which the government remains committed” so if it’s not on your radar quite yet, maybe it’s time to get up to speed with what you need to do.

Time to get sorted for MTD for VAT?

If you’re still putting off your MTD for VAT obligations, you should start looking for compatible accounting software to avoid any potential fines that could well come your way. Why not start with a 30-day free trial of FreeAgent to see if it’s the right fit for you?

Disclaimer: The content included in this guide is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this guide. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.