Policy paper

Interest harmonisation and penalties for late payment and late submission

Updated 6 March 2024

Who is likely to be affected

This measure will affect those who are required to submit either a VAT Return or an Income Tax Self Assessment (ITSA) Return (or both) and who fail to submit returns on time or fail to pay on time. It will also affect anyone working on behalf of taxpayers such as agents.

General description of the measure

Late submission

This measure introduces a new points-based penalty regime for regular tax return submission obligations, which replaces existing penalties for VAT and ITSA.

Late payment

There is no late payment penalty if the taxpayer pays the tax late but within 15 days of the due date.

The first penalty is set at 2% of the outstanding amount if they pay between 16 days and 30 days after the due date.

If there is any tax left unpaid 30 days after the due date it is set at 2% of the outstanding amount at day 15 plus 2% of the outstanding amount at day 30. In most instances this will amount to a 4% charge at day 30.

A second late payment penalty is charged at a rate of 4% per annum, calculated on a daily basis on the total unpaid tax incurred from day 31.

To avoid a penalty or penalties, the taxpayer will need to either pay or approach HMRC to agree a ‘time to pay’ arrangement.

Find out more about the effect of making payments or approaching HMRC to agree a ‘time to pay’ arrangement.

Interest harmonisation

The VAT interest rules will change and will be similar to those that currently exist in ITSA. The measure will make the following changes to interest payments in VAT:

• when an amount is not paid by the due date, late payment interest will be charged to the taxpayer from the date that payment was due, until the date the payment is received
• HMRC will pay repayment interest on either any overpaid tax or tax refunds (or both) due to be repaid

Policy objective

The new penalty regime is designed to make sanctions for failing to file or pay on time simple, fair and effective to protect public finances by incentivising compliance and to strengthen confidence in the tax system.

It will penalise the small minority who persistently do not comply by missing filing and payment deadlines, while being more lenient on those who make the occasional slip-up.

The current penalty regimes for late submission and late payment and interest are inconsistent across major taxes, meaning HMRC penalises the same behaviour in different ways.

The reform introduces a common approach across VAT and ITSA, providing greater consistency, fairness and certainty in the system, making it easier for taxpayers to comply with their submission and payment obligations and making late payment penalties more proportionate to the lateness of payment.

For Making Tax Digital (MTD) ITSA taxpayers, the penalties will provide a sanction to encourage compliance with their new quarterly and End of Period Statement obligations. However, as the late submission penalties are points-based they also take a proportionate approach by not applying a financial penalty to every missed obligation.

MTD taxpayers would have to miss four quarterly submission deadlines before incurring a financial penalty.

The new regime is designed so that it can be applied to other taxes with payment and regular submission obligations, to provide a clear, transparent and consistent approach for taxpayers and HMRC.

Background to the measure

This new approach assures the compliant majority that an occasional failure in the context of overall good compliance will not be treated in the same way as persistent poor compliance.

This measure has been developed through three consultations. The first Making Tax Digital: Tax Administration ran from August to November 2016.

This consultation proposed models for a late submission penalty, as well as options for a separate late payment penalty. Initial comments were also sought in this consultation for alignment of the HMRC interest rules.

The second consultation Making Tax Digital: sanctions for late submission and late payment ran from March to June 2017. Here, further models were proposed for a late submissions penalty and a late payment penalty.

The third consultation Making Tax Digital: interest harmonisation and sanctions for late payment ran from December 2017 to March 2018.

This consultation focused on aligning interest for monies owed to and by HMRC as well as proposing another model for the late payment penalty.

Responses to all of these consultations have helped to shape the details of the new penalty regime.

Detailed proposal

Operative date

Penalty Reform will replace existing penalties and will come into effect as follows:

• VAT customers for accounting periods beginning on or after 1 January 2023
• ITSA customers with business or property income over £50,000 per year from the tax year beginning 6 April 2026
• ITSA customers with business or property income over £30,000 per year from the tax year beginning 6 April 2027

For all other ITSA customers outside the scope of MTD, the changes will apply after the introduction for MTD taxpayers.

Current law

Late submission penalty

For VAT, there is currently no standalone late submission penalty. Instead, the Default Surcharge is provided for at sections 59, 59A and 59B of the Value Added Tax Act (VATA) 1994. Default Surcharge is a combined late submission and late payment sanction. It will be replaced by the new late submission penalties at the same time as the related interest harmonisation and sanctions for late payment reforms.

For ITSA, late submission penalties are set out at paragraphs 1 to 6 of schedule 55 to Finance Act (FA) 2009 (with paragraphs 6(3)(a) and (4)(a) providing a higher penalty for deliberate withholding). A penalty of £100 becomes chargeable as soon as a return is late.

A £10 daily penalty becomes chargeable when a return remains outstanding 3 months after the deadline. A penalty of £300 or 5% of the tax liability (whichever is greater) becomes chargeable where a return is outstanding 6 months after the deadline and again at 12 months. A higher penalty can be charged for 12 months’ delay if the taxpayer deliberately withholds information by not submitting the return.

Late payment penalty

Current law for late payment penalties in ITSA is contained in FA 2009 schedule 56, table items 1, 12 and 17 to 19, and paragraphs 3 and 9 to 17.

For VAT there is currently no standalone late payment penalty. Instead Default Surcharge applies at sections 59, 59A and 59B of the Value Added Tax Act 1994, which is a combined sanction for late submission and late payment penalty.

Interest

In ITSA, the current law on late payment and repayment interest is contained in FA 2009, sections 101 to 103 and schedule 53 and schedule 54.

Interest in VAT includes charges to taxpayers (default interest) and payments to taxpayers (repayment supplement and official error). Current law is contained in the Value Added Tax Act 1994, section 73 to 74 and section 78 to 79 respectively.

Proposed revisions

Late submission penalties

When a taxpayer misses a submission deadline they will incur a point. Points accrue separately for VAT and for ITSA.

A taxpayer becomes liable to a fixed financial penalty of £200 only after they have reached the points threshold.

The level of points threshold depends on the taxpayer’s submission frequency:

• annually — 2 points
• quarterly — 4 points
• monthly — 5 points

Total points can be reset to zero at any time once a customer has met the following two conditions:

1) Submission of returns on or before the due date, for a period of time based on their submission frequency:

• annually — 24 months
• quarterly — 12 months
• monthly — 6 months

2) All returns that were due within the preceding 24 months have been received.

If the taxpayer continues to miss submission deadlines after they have reached the points threshold and have been issued with a penalty, they will become liable for a further fixed rate penalty for each additional missed obligation. This is the case even if they have paid the fixed rate penalty.

In common with other tax penalties, a taxpayer will not be liable to a point or penalty if they had a reasonable excuse for not making the relevant submission on time and will have a right to appeal against both points and penalties.

Legislation will be introduced in Finance Bill 2021 to create 2 new schedules.

The first schedule will provide for the new points-based late submission penalty regime for VAT and ITSA. This legislation will set the financial penalty at £200.

The second schedule will replace the deliberate withholding penalty for ITSA (currently set out in paragraphs 6(3)(a) and (4)(a) of schedule 55 to Finance Act (FA) 2009) so it works effectively with the new points-based regime.

It will not, at this stage, apply to VAT where the immediate intention is to continue to apply the current VAT civil evasion penalty in s.60 VATA 1994, though this may be reviewed in future.

Other taxes and occasional obligations will continue to be dealt with under existing legislation.

Late payment penalties

Legislation will align the late payment penalty regimes across the main taxes. Current late payment sanctions will be replaced.

The new late payment penalty will consist of 2 separate charges. The first charge will become payable 30 days after the payment due date and will be based on a set percentage of the balance outstanding.

The amount of that charge will depend on payments made or time to pay arrangements that are agreed during those first 30 days.

First charge

Days after payment due date	Action by taxpayer	Penalty
0 to 15	Payments made or taxpayer proposes a time to pay that is eventually agreed.	No penalty is payable.
16 to 30	Payments made or the taxpayer proposes a time to pay that is eventually agreed.	The penalty will be calculated at half the full percentage rate (2%).
Day 31	No payment made, no time to pay agreed.	2% of what was due at day 15, plus 2% of what was due at day 30.

Second charge

A second charge will also become payable from day 31 and will accrue on a daily basis, based on amounts outstanding. As with the first charge, the taxpayer can agree a time to pay with HMRC.

If the time to pay is agreed, the penalty will stop accruing from the date the taxpayer proposes it.

Notice of penalty

Both the first charge and second charge will be notified to the taxpayer and any amounts shown as payable on the notice will be required to be paid, or appealed, within 30 days of the date of that notice.

In common with other tax penalties, a taxpayer will not incur a late payment penalty if they had a reasonable excuse for not making the payment on time and will have a right to appeal against late payment penalties.

Interest harmonisation

Legislation will align the interest rules for VAT to make sure they follow similar rules to those for ITSA. Provisions similar to the current FA 2009 S101, S102, schedules 53 and 54 will be enacted to apply to VAT accounting periods starting after January 2023.

The measure will make sure that in VAT, where a payment is made after the due date, late payment interest will be payable from the date that payment became due until the date it is received by HMRC.

Late payment interest will also apply to VAT returns, VAT amendments and assessments and VAT payments on account.

Additionally, repayment interest will be payable in VAT either from the last day the payment was due to be received or the day it was received, whichever is later, until the date the repayment to the taxpayer is authorised or offset. Where a VAT repayment return has been received HMRC will not pay interest where:

• there are any outstanding returns for other prescribed accounting periods
• security has been requested and not provided

Summary of impacts

Exchequer impact (£ million)

2020 to 2021	2021 to 2022	2022 to 2023	2023 to 2024	2024 to 2025	2025 to 2026
—	—	+5	+90	+155	+155

These figures are set out in Table 2.1 of Budget 2021 and have been certified by the Office for Budget Responsibility. More details can be found in the policy costings document published alongside Budget 2021.

Economic impact

This measure is not expected to have significant macroeconomic impacts.

Impact on individuals, households and families

This measure is expected to affect individuals who submit a Self Assessment tax return and who are either non-compliant with payment or submission deadlines, or both.

There are currently about 4 million individuals who are within the ITSA regime who will benefit from the replacement of flat rate penalties with a points-based regime. This will allow ITSA taxpayers to make one-off failures to file returns on time without a financial penalty, unlike now.

Late payment penalties will directly link to the tax amount owed and the length of time outstanding to encourage payment sooner. Over time it is expected that the new regime will influence compliance and reduce the overall number of penalties.

In the short-term, taxpayer experience may worsen given the need for familiarisation with the new late payment and late submission penalty regimes. HMRC will aim to reduce this impact by carrying out pre-implementation publicity and where a taxpayer has a Digital Tax Account, providing interactive guidance.

HMRC recognise that moving to the new system of late payment penalties is a significant change for some taxpayers, especially those who might have more difficulty in getting in contact with HMRC within 15 days of missing a payment to begin arranging a Time-to-Pay agreement.

HMRC will therefore take a light-touch approach to the initial 2% late payment penalty for taxpayers in the first year of operation of the new system under both VAT and ITSA. In the first year, HMRC will not assess the first penalty at 2% after 15 days, allowing taxpayers 30 days to approach HMRC before HMRC charges a penalty.

If any tax is still outstanding at 30 days, the first penalty charged will be charged at 2% of the outstanding amount at day 15 plus 2% of the outstanding amount at day 30. In most instances this will amount to a 4% charge at day 30.

In addition, there is no penalty due if the taxpayer has a reasonable excuse for late payment. If HMRC is satisfied a taxpayer has a reasonable excuse it will agree not to assess. This will prevent the taxpayer from unnecessarily having to appeal.

HMRC also has discretionary power to reduce or not to charge a penalty for late payment if it considers that appropriate in the circumstances.

These will include where there are special circumstances that cause a taxpayer to pay their tax late. HMRC will actively consider all cases where this might be the case.

In the longer term, taxpayer experience is expected to improve as the change brings the ITSA and VAT penalty regimes into closer alignment reducing complexity for taxpayers.

There could be an impact on family formation, stability and breakdown if individuals receive a penalty that they are unable to pay. Some individuals could be more affected than others depending on their income levels and family circumstances.

However, ‘time to pay’ arrangements and ‘reasonable excuse’ provisions will help those individuals who have trouble paying all at once or are unable to meet their payment obligations respectively.

Equalities impacts

HMRC does not hold equalities information on those who currently receive late submission and payment penalties, but this measure will make the application of penalties fairer and simpler to understand.

‘Time to pay arrangements’ and ‘reasonable excuse’ provisions for late filing and payment will cover those unable to meet their obligations. This will protect taxpayers in vulnerable circumstances who, for example, may have suffered a bereavement or a serious illness.

Further ‘reasonable adjustments’ may apply to groups with protected characteristics who may, because of their circumstances, be less able to meet their obligations. HMRC will also provide support for the digitally excluded.

Impact on business including civil society organisations

This measure is expected to have an impact on an estimated 2.5 million VAT and 7 million ITSA businesses and civil society organisations who will need to familiarise themselves with the change to the VAT or ITSA regimes respectively (and some businesses will need to learn about both changes).

In the short-term, taxpayer experience may worsen given the need for familiarisation with the new late payment and late submission penalty regimes. HMRC will aim to reduce this impact by carrying out pre-implementation publicity and where a taxpayer has a Digital Tax Account, providing interactive guidance.

In the longer term, taxpayer experience is expected to improve as the change brings the ITSA and VAT penalty regimes into closer alignment reducing complexity for taxpayers.

For VAT-registered businesses, the current combined penalty for late filing and late payment (VAT default surcharge) will be replaced with the new penalties. This means that for the first time there will be a specific penalty for late filing, although only for repeated late filing.

One-off costs include familiarisation with the new late payment and late submission penalty regimes, and the new rules for interest in VAT. HMRC will aim to reduce these costs by carrying out pre-implementation publicity and providing interactive guidance in a taxpayer’s Digital Tax Account.

It is not expected that there will be any continuing costs for compliant businesses.

Estimated one-off impact on administrative burden (£ million)

One-off impact	(£ million)
Costs	39
Savings	—

Estimated continuing impact on administrative burden (£ million)

One-off impact	(£ million)
Costs	—
Savings	—
Net impact on annual administrative burden	—

The measure also replaces the complex and unpopular default surcharge regime for VAT. In addition, the new late submission penalties will not penalise ITSA taxpayers for occasional slip-ups, such as one-off failures to file returns on time.

Operational impact (£ million) (HMRC or other)

The operational impact to HMRC for ‘Penalty Reform’ in total is estimated to be in the region of £34 million. This includes IT development, business readiness and communications to explain changes to taxpayers.

There may be some longer-term efficiencies to be realised through the automated application of penalties but it has not been possible to quantify these.

Other impacts

A Justice Impact Test will be sent to the Ministry of Justice.

Other impacts have been considered and none has been identified.

Monitoring and evaluation

This measure will be monitored through information collected from HMRC’s systems including data on the issuing of penalties, points accrued and appeals and reviews.

HMRC will monitor implementation closely, collecting stakeholder feedback, and use this to inform any future changes that may be necessary.

Further advice

If you have any questions about this change, contact Christopher Jennings on Telephone: 07471 027634 or email: [email protected].