Making Tax Digital for VAT: a guide to the penalties

Making Tax Digital (MTD) for VAT requires all VAT-registered businesses to use compatible software to keep digital records and file VAT returns. As with many other areas of legislation, HMRC will issue penalties to taxpayers who fail to follow the rules correctly. This guide provides a breakdown of all of HMRC’s MTD for VAT penalties, along with a reminder of the steps you need to take to follow the rules and avoid incurring a fine.  

Penalties for failing to comply with MTD for VAT

Any VAT-registered business that fails to use MTD-compliant software, like FreeAgent, to store business records digitally and file VAT returns will be subject to a system of penalties from HMRC. These include fines of:

  • up to £400 for every VAT return not submitted through ‘functional compatible software’ 
  • between £5 and £15 per day for not keeping the required records digitally in the software
  • up to 100% of the VAT owed as a result of making a mistake by failing to use the ‘checking functions’ in the software. In this scenario, the VAT would also need to be paid.

Penalties for late submission and late payment 

In 2023, HMRC introduced additional penalty systems to address the late submission of VAT returns and the late payment of VAT. These penalties relate to VAT submissions for all VAT accounting periods starting on or after 1st January 2023.

Penalties for late submission of VAT returns

For each late VAT return submission, VAT-registered businesses will accrue one penalty point. HMRC will issue a penalty of £200 at the thresholds of: 

  • two accrued points for annual VAT return filing 
  • four accrued points for quarterly VAT return filing 
  • five accrued points for monthly VAT return filing

Once you have reached these thresholds, £200 penalties will be charged every time you file your VAT return late. To remove penalty points, you must file all your future VAT returns on time for one year and have no outstanding returns unsubmitted from the previous two years.

Penalties for late payment of VAT

In addition to the penalties for late submission outlined above, the following penalties for late payment of VAT also apply:

  • 0-15 days: no penalty
  • 16-29 days: 2% of the amount outstanding
  • 30 days: 2% of the tax outstanding at day 15 plus 2% of the tax outstanding at day 30*

HMRC’s Time to Pay service provides an option for VAT-registered businesses to agree a schedule of payment with HMRC to stop a penalty from accruing

How to avoid incurring a penalty

If your business is VAT registered, you need to follow the rules of MTD for VAT, meet each VAT return deadline and pay your VAT bills on time in order to avoid incurring any of HMRC’s MTD for VAT penalties. 

If you haven’t done so already, this means you need to sign up to MTD-compliant software, like FreeAgent. If you have a business bank account with NatWest, Royal Bank of Scotland or Ulster Bank, or a Mettle account, you can get FreeAgent for free, for as long as you retain your account or make one transaction a month through your Mettle account (optional add-ons may be chargeable). You can also sign up for a 30-day free trial of the software

FreeAgent generates each of your VAT returns automatically and uses the data in your account to populate it. Once you’ve connected FreeAgent with HMRC, you can use the software to file your completed VAT return directly to HMRC in just a few clicks.

*HMRC has said that “where a taxpayer is doing their best to comply” with MTD for VAT rules, it will take a “light-touch approach” during the first year of the points-based penalty system by not assessing the first penalty at 2% after 15 days. Find out more on the government’s website.

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.