Avoiding the costs and consequences of the updated VAT penalty regime

By Russell Gammon, Chief Solutions Officer at Tax Systems


HMRC is buckling down on the way it has been handling corporate compliance to ensure organisations get their tax right the first time. Now considering Making Tax Digital (MTD) business as usual, HMRC has introduced an updated points-based VAT penalty system, which commenced on 1st January 2023. This means tax leaders and their teams must re-evaluate MTD and make new critical compliance checks to satisfy regulations and swerve more stringent penalties.

What’s new?

In May 2022, HMRC published guidance setting out the key compliance checks VAT-registered businesses need to be aware of to avoid penalties for MTD for VAT. The key drivers for this tougher approach are to reduce the tax gap and prevent non-compliant outcomes, as HMRC figures illustrate how MTD has reduced the so-called tax gap for VAT to date – in 2022, the VAT tax gap fell from 8.5% to 7% which equates to a considerable additional tax take.

And HMRC now considers MTD for VAT a ‘business as usual’ process. The new enforcement approach in 2023 is designed to deliver accuracy in VAT calculations and submissions. This means organisations must be aware of three key areas – the new penalty types, the costs and consequences of submission errors and defaults and, critically, the role of technology in simplifying and decreasing risk on businesses’ tax returns.

  1. The two penalty types: default and behavioural
Russell Gammon

One key theme in the penalty system is that HMRC will evaluate the behaviours behind any VAT compliance failure in addition to penalties for defaulting on mandatory requirements, such as deadlines for VAT submissions and payments. HMRC cites the most significant behaviour contributing to the tax gap as failing to take reasonable care (19%), with criminal attacks, evasion and legal interpretation in complex transactions each accounting for between 15% to 17%.

The updates to the penalty regime aim to drive up more reliable and accurate VAT returns by applying default behavioural penalties, relevant to the MTD for VAT requirements, that will incentivise firms to exercise due care and attention when reporting and calculating their VAT liabilities. For example, businesses not holding digital records, or following the digital links rules, are liable to pay if found out. It’s a move designed to cut reporting errors and re-submissions, streamline HMRC’s tax administration efforts and reduce the tax gap yet further.

Organisations will need to assess the implications of these non-negotiable new compliance requirements for the systems and processes currently being used to manage VAT reporting.

  1. Penalties and requirements

From 2023, organisations will be required to file returns using digitally compatible software that can record and store digital records and exchange information to and from HMRC. The penalty for failing to do this is a flat £400 fine per return.

Ways of showing tax calculations will also be critical. Organisations must maintain detailed electronic records for all VAT-related transactions. Compliance failure will result in a £15 daily penalty. Specifically, digital links must be used to transfer data between software programmes, applications or products.

HMRC also stipulates each organisation’s software must have a checking function built in to ensure the accuracy of data in tax returns upon filing. Returning a file with errors could see a fine of up to 100% of any VAT owed.

The upgrade in compliance requirements sees HMRC addressing behaviours that lead to tax return errors. For instance, HMRC will apply fines according to lack of care, which is punishable by a fine of up to 30% of VAT owed, while a deliberate error will incur a fine of 70%. Worse still, a deliberate and concealed error will result in a business being fined an additional 100% of VAT.

Implications for businesses

The changes may seem minor, with many perhaps not considering £15 per day a high cost, but multiple compliance failures can see costs quickly rack up, especially if backdated over multiple submission periods.

Corporate groups in particular run the risk of penalties relating to multiple VAT registrations, as they claim multiple VAT rates – a compliance error within one VAT registration is replicated wherever the same processes are utilised. For example, the Box 6 split can prove particularly challenging to accurately record and report.

Businesses must start as they mean to go on with new compliance etiquette. Once a VAT compliance failure has put an organisation on HMRC’s radar, it’s likely to be under more intense scrutiny. HMRC inspectors will be checking that a compliance failure resulting from a lack of due care and attention isn’t an indicator of something more – a deliberate error or act of concealment.

Why software matters

Organisations should act now to ensure they minimise non-compliance risks, utilising solutions that offer robust checking functions to ensure returns are correct before filing. The requirement to demonstrate the use of software checks means that inspectors will request evidence that these have been applied. From an HMRC perspective, not using the checking functions contained within commercially available software will act as a red flag that there are potentially negative behaviours motivating this compliance failure.

To ensure tax returns are right the first time, specialist VAT solutions feature automated digital checks on the key elements highlighted by HMRC as being the most prone to error. The most common include VAT on business entertaining, intra-group transactions, passenger transport and leased car expenditure. Some software even enables organisations to configure checks for their own specific data sets, processes and business operations.

To prevent potential fines and avoid the scrutiny of HMRC, compliance must be a priority for businesses in 2023. Adopting specialist tax software should be part of a mindset shift in tax teams to a more strategic value-based approach to tax. Only this will truly avoid penalties for MTD for VAT and keep their business at one with its expenditure.

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