VAT is no longer the "simple tax", as described by Anthony Barber, Chancellor of the Exchequer in 1973 when it was first introduced in the UK. VAT has subsequently been described as a fiscal theme park a decision in a superior court.
Charities face a complex set of challenges in respect of VAT accounting. Filing is now digital and almost every interaction with HMRC must be made electronically or you face a long call time wait, hoping the call will not be dropped. You then have to hope that the officer dealing with the enquiry is able to help when you get through.
Historic context of VAT
VAT was introduced in the UK in 1973, initially administered by HM Customs & Excise, who had extensive powers and could call on the coast guard as well as the police and other agencies.
Initially, there were no penalties for non-compliance, but penalties were later introduced to encourage adherence to VAT regulations.
VAT has traditionally been one of the cheapest taxes to collect, as the VAT registered entity does that on behalf of the Treasury. But there was always a significant tax gap: the difference between the expected revenue and the actual revenue collected.
Recent challenges with VAT penalties
Roll forward to today, administration is now carried out by HM Revenue & Customs (HMRC), and penalties for late submissions and errors are around £850m per annum currently. Penalties are supposed to improve compliance, so they should be reducing rather than increasing.
We are aware of one business incurring a default surcharge more than £500k for filing three days late. This penalty was upheld by the courts as there is a concept of proportionality in respect of the default surcharge. But where there is unfairness, pressure for change is created.
Current position
The application of the Finance Act to VAT penalties from 1 January 2023 saw a fundamental and long overdue revision to the VAT penalty regime. These changes affected the submission deadlines for VAT returns and the application of interest.
While the new rules removed the inequitable flat rate penalties, they extended the scope of penalties and interest charges for mistakes. For instance, penalties now apply to nil returns (where no tax is due) and repayment returns.
Previously, no interest was charged if HMRC had not suffered a loss, known as commercial restitution. This fair practice was, however, a concession that is no longer applied. Consequently, HMRC now imposes interest charges (particularly notable given recent high interest rates) even when there is no case for commercial restitution.
Managing penalty risk
Penalties for errors in submitted VAT returns can be mitigated if identified by the VAT-registered entity and an Error Correction Notice (ECN) is submitted within the standard four-year adjustment period.
To avoid penalties, notifications must be unprompted. Therefore, it’s essential to inform HMRC immediately when preparing an ECN if an error is discovered. If HMRC initiates contact, typically to schedule an inspection, any subsequent notification will be considered prompted, regardless of any contrary evidence.
Penalties typically range from 30% to 70% of the error, with several factors influencing the exact amount. Taxpayers will also receive information regarding Human Rights legislation during this process.
Timely submissions and payments are crucial. Most organisations have robust processes to ensure VAT return preparation, review, submission, and payment are completed on time. Documenting these processes provides evidence of reasonable care and helps in penalty mitigation.
Interest
Interest is not a penalty but compensation for the loss of access or use of money. It is not an appealable matter — you can only challenge the calculation basis. For VAT accounting periods starting before 1 January 2023, interest should not be charged if there is no case for commercial restitution.
Mitigating VAT penalties
VAT penalties can be removed if there is a reasonable excuse, typically something unexpected and beyond the control of the VAT-registered organisation. Evidence of reasonable care, such as documented processes and engagement with VAT advisors like UHY, can reduce penalties.
HMRC may suspend a penalty if appropriate, requiring clear evidence of implemented controls to prevent future errors. Once the suspension period expires, the risk of the penalty being applied is removed, provided no further errors occur. Careful monitoring is essential during this period.
Summary
The need for penalties is hard to argue against. Proportionality has never been properly applied, and the new system seems in many respects harsher for many VAT registered organisations.
Charities need to ensure appropriate governance processes are in place and documented. Engagement with HMRC or advisors is also important as evidence of reasonable care. It is disappointing HMRC can be difficult to contact and heavily caveat any advice, meaning it cannot be relied upon. The courts have noted this conduct from HMRC.
The next step
UHY offer a fixed fee VAT support service for charities. If this is of interest, please contact Sean Glancy on s.glancy@uhy-uk.com or your usual UHY adviser.
