This is the second blog in our VAT series, following an initial post on VAT compliance. Here, we explore when HMRC can issue VAT penalties, common compliance errors, and how penalties are calculated. Whether due to late registration, incorrect documentation, or misreported VAT, understanding these issues is key to avoiding costly penalties. 

When can HMRC issue a VAT penalty?

HMRC has the power to issue penalties to taxpayers who fail to comply with the complex reporting and filing requirements of UK VAT legislation.

Common examples of UK VAT compliance failures include:

• Not registering or deregistering at the correct date.
• Not keeping VAT receipts or reclaiming input VAT without the appropriate VAT documentation.
• Reclaiming input VAT incorrectly e.g., VAT on business entertainment or motor cars available for private travel.
• Reclaiming input VAT on non-business expenditure.
• Failing to apply a partial exemption restriction on “exempt” input VAT recovery correctly.
• Failing to retain sufficient export evidence to justify zero rating of export sales.
• Accounting for the wrong rate of VAT on sales.
• Reclaiming import VAT in the absence of a C79 certificate.
• Failing to confirm if a property sale should be concluded as a transfer of going concern.  

How can I correct a VAT error?

HMRC allows for most minor VAT errors to be corrected on a VAT return in the VAT accounting period in which they are found. However, VAT errors above a certain threshold must be separately disclosed to HMRC. A mandatory VAT error disclosure is required:

• When the net value of total errors found on previous returns is between £10,000 and £50,000 and exceeds 1% of the box 6 (net outputs) VAT Return declaration due for the current return period (during which the error was discovered);
• When the net value of errors found on previous returns is greater than £50,000; or
• When errors on previous returns were made deliberately.

How is the VAT penalty calculated?

A penalty will be considered when a VAT error has resulted in a financial loss to HMRC. If the VAT error is in the taxpayer’s favour (and results in a VAT reclaim) it is unlikely to be penalised.

Where HMRC has suffered a financial loss, the penalty value will be based on the value of the error and their assessment of the taxpayer’s actions in the creation and disclosure of the error. The penalty will be confirmed as a percentage of the value of the VAT error.  

HMRC will typically apply penalties as below:    

Careless errors

Most VAT errors will fall into this category. HMRC appreciate that errors can still be made despite the best efforts of the taxpayer.

If HMRC identifies the error rather than a taxpayer, the penalty range is likely to be assessed as 15-30% of the value of the VAT error.

If a taxpayer discloses a careless error to HMRC, and provides full information to HMRC, the penalty is likely to be assessed more favourably. Early notification and cooperation with HMRC will usually be rewarded by a reduced penalty (down to as low as 0%), or even result in the penalty being cancelled altogether.

Deliberate errors

The burden of proof to demonstrate that a taxpayer’s behaviour has been deliberate lies with HMRC, and such behaviour will be penalised more severely than a careless error.  

In the absence of any mitigating behaviour, should HMRC determine that a VAT error is both deliberate and intentionally concealed, a maximum penalty of 100% of the value of the VAT error is within its discretion.

Can VAT penalties be appealed?

If a taxpayer disagrees with the imposition of a penalty, they have the right to:

1. Request a statutory review of the decision by someone at HMRC who was not involved in the original decision.
2. Appeal to a tax tribunal. The tribunal will decide for itself if a penalty is due and has power to cancel or reduce it.

The taxpayer can appeal directly to the tax tribunal or do so following a statutory review – but it is important to do so within the time limits advised by HMRC on their penalty notification letter (or review conclusion letter, if a review was requested). Late appeals are possible but are at the discretion of the Tribunal and will largely depend on the length of the delay and the reason for it.

The taxpayer can also apply for the Alternative Dispute Resolution (ADR) procedure either instead of an appeal or once an appeal to the tax tribunal has been lodged. This involves an HMRC mediator working with both parties to seek resolution of the dispute in a more informal setting and therefore, potentially avoid the costs of a Tribunal hearing.

If a “reasonable excuse” is accepted by HMRC (or on appeal, by the Tribunal) as the reason for a VAT error being made, the penalty must be cancelled. HMRC should be informed if a VAT error may have been due to:

• Personal bereavement or illness.
• Accounting software failure.
• Serious business disruption (e.g. fire or flood).

In the absence of a “reasonable excuse”, providing more information to HMRC may still enable them to re-assess an error from being “deliberate” to “careless” and/or reduce the value of the resulting penalty.

HMRC also has the power to reduce a penalty if they determine that there are “special circumstances” that warrant such a decision. They can also suspend a penalty. Such actions will be prompted by their review of the circumstances involved in individual cases.   

How should I manage VAT errors?

1. Ensure that VAT transactions are reviewed by a competent member of staff or management team (and amended as required) before returns are filed.
2. Seek professional advice if unsure how VAT on transactions should be reported.
3. Consider an annual or periodic VAT “health check” from your professional advisors.
4. If VAT errors have been made on previously filed returns, identify if these can be corrected on a future return or require to be disclosed separately to HMRC.
5. If a VAT error disclosure is required, do this as soon as possible and work openly with HMRC to reduce the potential error penalty assessment.
6. Consider appealing any VAT error penalty applied by HMRC.

Can we help your business?

Our team of experienced VAT advisers at Johnston Carmichael can provide expert advice relevant to your VAT compliance and VAT errors issues. 

We can provide you with the information required to make informed decisions to help you reach the preferred VAT outcomes for your business.

Get in touch with our team of sharp minds by filling in the short form below.