The new late filing and late payment penalty regime for UK VAT and other taxes

These introduction dates have been deferred a number of times, but implementing regulations have been laid for the commencement of the regime from 1 January 2023.

Under the new regime:

• late submission penalties use a new points based system, to target repeated non-compliance;
• the penalty for late filing a return is a maximum of £200, substantially lower than the maximum late filing penalty under existing regimes;
• the initial late payment penalty applies after 15 days, halving the time to make payment without incurring a penalty;
• administration of penalties, including appeals, will proceed on broadly the same footing as existing regimes, with minor variations including the ability to appeal a point (i.e. where no penalty has yet been charged) and harmonisation of the reasonable excuse definition; and
• HMRC has confirmed that the slate will be ‘wiped clean’ – businesses within the existing VAT default surcharge regime will start from zero points.

Background to the changes

Plans to harmonise the UK tax penalty regimes have been underway for decades. The 2009 Finance Act introduced new regimes for late payment and late filing penalties that were intended to be rolled out across all taxes on a gradual basis. While a number of taxes - including the majority of new taxes introduced since that time - have been moved onto those regimes, VAT has been notably left out. Instead, the default surcharge regime, which deals with both late payment and late filing, continued to apply.

HMRC issued a discussion document in 2015 about the penalty regime as a whole. This, in turn, spawned many more consultations and eventually joined in with the ‘Making Tax Digital’ (MTD) plans. These originally came to fruition in draft legislation which had been intended to be contained in the 2019 Finance Act, but was dropped at the last minute. A new late filing and late submission regime was finally brought into law in the 2021 Finance Act. Since then, there have been two further delays to implementation and the extension to income tax has been pushed further back.

After so many years of being left out of harmonisation, VAT is now leapfrogging the other taxes to be the first into the new regime. VAT’s first place in this new race is, realistically, less to do with having been left in the corner and more to do with the fact that it has also been the first tax into the MTD process.

The continued roll out of the new regime to other taxes, most notably corporation tax (which has also been left out of the original harmonisation), has not been given any kind of timetable. As such, the introduction of this new harmonised system in fact does nothing of the sort – in fact it introduces more different types of penalty regime. It does, however, see the death of the VAT default surcharge regime, which will be a welcome relief to many.

New regime for late submission penalties

The regime is a ‘points-based system’ along similar lines to driving penalties, so that one-off mistakes are not penalised but repeated non-compliance is.

Accumulation of points

A taxpayer that fails to submit a return on time accumulates one point for each missed deadline. When the taxpayer meets the specified threshold (which varies depending on how often they need to submit a return), a penalty of £200 arises for that missed deadline and each subsequent failure to make a submission on time.

The thresholds (in relation to VAT) are:

• two points if the returns are submitted annually (or for a non-standard period exceeding 20 weeks) (Group A/annual returns);
• four points if the returns are submitted quarterly (or for a non-standard period between 8 and 20 weeks) (Group B/quarterly returns); and
• five points if the returns are submitted monthly (or for a non-standard period of less than 8 weeks) (group C/monthly returns).

This means that a business that submits quarterly VAT returns can miss the deadline three times and not trigger a penalty.

Although initially relevant only for VAT, once the regime is extended, there will be separate points totals for each submission obligation - for example, a taxpayer will accumulate separate points totals for their income tax and VAT obligations.

Once a threshold has been reached, a person cannot accumulate further points in that group - that is, there is a maximum number of points for each group of returns.

Expiry of points

In order to encourage future compliance, points expire after a period. It is more difficult to achieve expiry of points if the business has already reached the threshold.

If a taxpayer has not reached threshold of points, a given point will expire after two years (calculated from the beginning of the month after the point-triggering failure). For example, if a taxpayer has failed to submit a quarterly return in April 2023, the point will expire in May 2025.

Where a taxpayer has reached the maximum number of points for a given group, there are two required elements of ongoing compliance. When they are both met, all the points expire at once.

Firstly, returns must be submitted on time for a period of compliance (starting the first day of the month following the most recent failure):

• 24 months for group A/annual returns;
• 12 months for group B/quarterly returns;
• six months for group C/monthly returns.

Secondly, the taxpayer must also have submitted, whether on time or not, all the returns in the relevant group for a period of 24 months ending with the day that it is being considered. In other words, it is always necessary to have caught up on compliance for a period of two years regardless of the type of return.

So, if a taxpayer has failed to deliver five monthly returns in January to May 2023, the maximum of five points has been reached. The points will only expire if the taxpayer submits all of the monthly returns from June to November 2023 on time AND has submitted all its monthly returns looking back two years from December 2023. Because the second condition is two years regardless of the type of return and does not consider the lateness of the return, the ‘look back’ period of two years includes the five months of failure to submit on time that triggered the points in the first place.

The expiry of the points encourages those who have only had one or two failures to amend their ways so that they never reach the point of a penalty arising. It also recognises that failures with more than two years in between are more likely to be unrelated failures and should not therefore be joined together. The higher compliance burden for serially non-compliant taxpayers also reflects the need to change behaviour over a longer period.

Amount of penalty

Once a penalty is triggered, the penalty imposed is £200. A penalty is then triggered each time there is a new default, but the amount of the penalty does not increase as the lateness of the submission continues or as a result of repeated failures. This is a significant divergence between the old VAT default surcharge and income tax self assessment late filing penalty regimes.

Administration of points and penalties

A point only accumulates if HMRC notifies the taxpayer of the point, including the relevant failure and the group to which the point belongs.

Once the threshold is met, a penalty is only charged if HMRC decides to assess it and notifies the taxpayer of the penalty.

In contrast to the existing VAT default surcharge regime, penalties and points are within the discretion of HMRC, which has said that it will “ordinarily levy” points and penalties for late submission. HMRC has stated that any use of the discretionary power not to issue a penalty will be “carefully considered”. HMRC has also instructed taxpayers who have already received a point or penalty to appeal, presumably rather than challenging HMRC’s exercise of discretion by way of judicial review.

There are time limits for HMRC to notify the taxpayer of points and penalties. It will be important for taxpayers to check that these are met when they receive notifications.

The penalty is payable within 30 days of being notified.

Appeals

A taxpayer can challenge both points and penalties by way of appeal to the tax tribunal, including the option of an internal HMRC review prior to the appeal if the taxpayer chooses.

When the tribunal hears an appeal it can affirm or cancel HMRC’s decision that the taxpayer is liable to a point or penalty. Notably, when the tribunal hears an appeal against a penalty, it also has the power to affirm or cancel any or all of the points that gave rise to the penalty.

Therefore a taxpayer has the choice to appeal a point when it is assessed or to wait until the penalty is assessed, but it cannot have two bites at the same cherry – if the taxpayer has appealed against a point and lost, the same point cannot be considered again by the tribunal.

Note, however, that there is an additional right for HMRC to issue a point out of the normal time limits where it would not previously have issued a point because the taxpayer had reached the threshold, but the decision of the tribunal to cancel some or all of the points means that HMRC then can issue a point in relation to a later failure.

A point or penalty does not arise where the taxpayer has a reasonable excuse for the failure. The concept of reasonable excuse is taken not from the previous VAT default surcharge regime, but from the existing late payment penalty regime and therefore includes a defence for the acts of others where the taxpayer took reasonable care.

Transitional/commencement arrangements

HMRC has not indicated any intention to provide a ‘soft landing’ period of familiarisation for late submission penalties. This is presumably because the points-based system allows for an element of familiarisation before financial consequences arise. 

No specific transitional provisions have been set out for taxpayers who are already in the default surcharge regime when the system switches over. However, we have had confirmation from HMRC that all businesses will start the new regime with a clean slate, so any businesses that are within the default surcharge regime in relation to their last accounting period commencing before 1 January 2023 will not have any points at the start of the new regime.

Specialist considerations

There are special rules in place to deal with less common scenarios including the changing of representative members for corporate groups, changes to the frequency of reporting and non-standard accounting periods. It will be important for taxpayers to consider these issues where they are relevant.

New regime for late payment penalties

A taxpayer that fails to make a payment of tax on time will suffer two different penalties, which arise depending on the amount of time the payment remains outstanding past its due date:

• if the tax is paid within 15 days of the due date, no penalty is charged;
• if the tax is paid between days 15 and 30, a penalty of 2% of the tax outstanding at day 15 is chargeable;
• if the tax remains outstanding after 30 days the initial penalty rises to 4% (in substitution for, not in addition to the 2% penalty). A second penalty, calculated on a daily basis from day 31 until the tax is paid, is charged at a rate of 4% per annum (this is sometimes referred to as ‘penalty interest’ because it is calculated on a daily basis).

Time to pay arrangements

A taxpayer can avoid a penalty (or stop further daily amounts accruing) at any stage by applying for and agreeing a time to pay (TTP) arrangement with HMRC.

At each potential penalty trigger – 15 days, 30 days and any day thereafter – if a TTP arrangement is made with HMRC as a result of proposals made by the taxpayer to HMRC on or before that date, the penalty will not arise.

So, for example, a business is required to pay VAT due on 7 April 2023 but it is going to be unable to pay the full amount in one go. If it makes a proposal to HMRC to pay in six monthly instalments before 22 April 2023, which is subsequently accepted, the 2% initial penalty is not charged.

If the taxpayer subsequently fails to meet its TTP arrangement, HMRC can go back and charge the penalties that would have arisen if no TTP arrangement had been agreed.

What tax does the new late payment regime apply to?

For accounting periods beginning on or after 1 January 2023, this new late payment regime will apply to VAT payments only: specifically, VAT payments due in respect of each VAT return, payments on account, instalments under the annual accounting regime, payments due following HMRC making an assessment because no return has been made; and payments that become due as a result of amendments or adjustments to a return.

The regime is currently scheduled to be extended to income taxpayers on a graduated basis as those taxpayers are mandated to apply MTD for income tax self-assessment, as follows:

• from 6 April 2026, for income tax self-assessment taxpayers with business or property income over £50,000; and
• from 6 April 2027 for income tax self-assessment taxpayers with business or property income over £30,000.

This staged introduction was changed in December 2022, delaying the first start date from 2024 and increasing the threshold from £10,000. The second phase was originally intended to cover all other self-assessment taxpayers, but there is now no scheduled start date for those with income under £30,000.

There were comments in earlier consultations on penalty reform that these penalties would be rolled out to other taxes later, but no firm timelines have been included.

Administration of penalties

A penalty, if HMRC exercises the discretion to charge one, must be assessed by HMRC and notified to the taxpayer. The penalty is payable within 30 days of being notified.

In the context of the second penalty, there are provisions to enable HMRC to make regulations allowing the levying of such a penalty before the tax is paid. This is presumably to allow HMRC to issue staging penalties where non-compliance goes on for an extended period. These regulations have not yet been made.

As with late submission penalties, there are time limits for HMRC to assess and notify the taxpayer of penalties. It will be important for taxpayers to check that these are met when they receive notifications.

Appeals

A taxpayer may appeal against the decision to impose a penalty and the amount. As with other penalty appeals, it is treated as if it were an appeal against an assessment to tax, save for the obligation to pay the tax before bringing an appeal. Therefore the usual provisions relating to bringing an appeal to HMRC first, HMRC reviews and tribunal appeals apply equally to these new penalties.

Note that because the legislation treats the initial 15 and 30 day penalties as a single penalty (with a variation in the percentage charged depending on how late the payment is), an appeal may only be brought against the penalty as a whole, not the separate parts of it at 15 and 30 days.

The usual taxpayer safeguards of reasonable excuse and special circumstances have been included in the new late payment regime in the same terms as the existing provisions on late payment of income and other taxes.

Transitional/commencement provisions

Commencement regulations have confirmed the start date of 1 January 2023. Further, in light of the reduction in time for the first penalty to 15 days, HMRC states that it will apply a light touch to the first penalty in the first year of operation, not charging the 2% penalty at 15 days, but waiting until 30 days, at which point it will charge the full 4% penalty. This ‘first year of operation’ will apply separately for VAT and income tax self-assessment.