HMRC have achieved record penalties of £851m in 2023, highlighting increased scrutiny on VAT compliance. We are seeing penalties as an issue for clients when a mistake has been made in respect of this self-assessed tax.
There has been a significant change to the penalty regime that is now ‘biting’ VAT registered organisations. In this blog, we discuss how to secure agreement from HMRC to ensure the VAT treatment is correct and how to manage cost and reputational risk.
The background of VAT
When VAT was originally introduced, there were no penalties for underpayment. This was quite naïve and surprising given the self-assessment nature of the tax, and the scope for abuse became clear. The potential for unfair advantages and misuse became evident, prompting the introduction of penalties 20 years later. Since then, these penalties have evolved into a complex system with significant consequences for businesses.
Penalties have become something of a niche advisory area. VAT is complicated and HMRC guidance is not always clear or able to cover every aspect of a transaction tax. The risk of penalties has increased significantly and become meaningful if applied.
If an error is found on an inspection, HMRC will issue a Human Rights Act notification to ensure that taxpayers are aware of their rights. This underlines the seriousness of the issue.
The old VAT penalty regime
Under the previous regime, when a VAT return payment was made late, there was a flat rate penalty maxing out at 15% of the error. This was considered draconian by taxpayers and most advisers, but the courts endorsed this system.
One taxpayer received a penalty more than £500k for a payment just three days late. It underscored the disproportionate nature of the penalty system but this ‘unfair’ approach was approved when the courts upheld the penalty.
However, in one case, a small business took HMRC to the House of Lords, which ruled in the taxpayer’s favour. Late payment due to unexpected cash flow issues was a reasonable excuse, leading to a change in HMRC policy. This case was something of a David v Goliath – David won, as he should.
Key changes of the new HMRC VAT penalty rules
Changes to the late submission and payment of VAT returns saw a simplification in the system but resulted in more penalties being issued.
The new system introduced a penalty points system for late submissions and flat rate penalties and interest charges for late payments.
The penalty regime was expanded to include repayment traders, who were previously exempt.
The new regime also saw a change to interest payments. These are not penalties but in theory compensation for the loss of the use of money. HMRC did not charge interest if the recipient of the supply could recover VAT charged as there was no loss to the Treasury. This has changed, and HMRC now state this was a discretion exercised by the Commissioners that is no longer allowed.
Application of VAT penalties
HMRC are levying penalties for late submissions or payments, where they did not before. This impacts repayment businesses and is a burden for VAT register organisations. However, we understand and agree submission is mandatory and needs to be compliant.
HMRC are currently applying a generous touch to the application of misdeclaration penalties – and allowing suspension – often unpromoted. This is welcome.
Areas of concern
Interest charges
This is meaningful. If there is no net loss to the Treasury, a one-sided charge is inappropriate.
Misdirection
VAT-registered businesses, acting as unpaid tax collectors, previously had some protections, but these have been withdrawn. Businesses can only rely on the EU principle of legitimate expectation, which HMRC often frustrates through heavily caveated rulings.
You can only make a request for a ruling if HMRC believes the published guidance does not provide clarification. But if you rely on the published guidance, this is unlikely (or never in our experience) to be accepted by HMRC as something you are entitled to rely on.
Where does this leave businesses?
HMRC require businesses to exercise reasonable care in VAT compliance, which is difficult to deny that is the appropriate approach. Management are unlikely to do anything less.
However, given the complexity of VAT, businesses need to ensure the VAT treatment applied is appropriate. HMRC provide advice and guidance, which should be used and a record should be kept of all ‘advice’ given.
Any penalties can be challenged. The potential to suspend penalties is welcomed, but they need to be correct in the first instance.
UHY view
Compliance is important and there must be penalties for non-compliance to enforce this. However, they must be fair and appropriate.
There must be responsibility and culpability on the authorities if their guidance is unclear, incorrect or ambiguous. If HMRC provides a ruling, it should come with appropriate caveats rather than leaving businesses exposed to unexpected fines.
Tax only works if it is fair and administered properly – this is crystal clear if we look at history. Fair administration encourages tax compliance and penalties are a last resort.
The next step
If you require help navigating VAT, please get in touch with Sean Glancy at s.glancy@uhy-uk.com or your usual UHY VAT adviser.
