Making Tax Digital for VAT: Treating Small Businesses Fairly Contents

Chapter 6: The Making Tax Digital penalty and interest regime

104.This chapter assesses the Government’s proposed penalty and interest regime which would apply to Making Tax Digital. The regime is provided for in clauses 30–32 of and Schedules 11–13 to the draft Finance Bill 2018–19. In the Budget on 29 October 2018 the Government announced that the clauses would not be included in the 2018–19 Finance Bill; they would be included in the 2019–20 Finance Bill instead. We nevertheless present the evidence we received on these clauses below, to inform the drafting of the provisions for the 2019–20 Finance Bill.

The current penalty and interest regime

105.For income tax late filing penalties start at a fixed £100, increasing by £10 per day for 90 days and then increasing again by £300 or five per cent of the tax due, whichever is the greater, and regardless of whether tax is payable for the year concerned. Late payment of tax is penalised by an additional five per cent of tax due at each of 30 days, six months and 12 months, as well as late payment interest.

106.For corporation tax late filing penalties also start with a fixed £100, increasing by a further £200 at 90 days then a further 10 per cent of the tax due if the return is filed up to a year late, or 20 per cent if later. A third late filing year increases the fixed penalties to £500 and £1,000. There is no late payment penalty—only late payment interest.

107.For VAT there is a combined late return and late payment sanction: the VAT Default Surcharge. Each payment default gives rise to an escalating penalty, from 2–15 per cent, within a 12-month rolling default period on the amount of VAT due, with late returns extending the 12-month default calculation period.

Consultation process

108.The proposed penalties for failure to submit returns and failure to make payments on time have each been developed through three stages of consultation. The key principles in the design of the new regime were simplicity and proportionality. Three models were considered for late returns penalties and a points-based system won most support. The Government announced in December 2017 that it would proceed with the points-based system. The proposals on VAT repayment interest were the subject of a two-stage consultation. Draft clauses for all areas were published on 6 July 2018.

109.The evidence we received demonstrated widespread support for the proposals.66 This is a strong example of the benefits of the ‘new approach to tax policy making’.67

110.We commend the consultation process which underlies these proposals, which was key in achieving broad support. This demonstrates the value of the ‘new approach to tax policy making’ when it is used effectively.

Draft legislation on penalties

111.Under the points-based approach each failure to submit a return by the due date attracts a point. Points accumulate up to a certain threshold after which penalties are applied to subsequent failures. Points are removed after a period of good compliance or two years. There is a shorter penalty period for deliberately withholding information from HMRC by failing to file at all, which links with the new escalating penalties for late filing.

112.There are different points models for each tax and the points for different filing frequencies (monthly, quarterly etc.) will accrue or be removed at different levels, to ensure proportionality. In order for points to accrue HMRC must notify the taxpayer promptly, so that the failure can be remedied before further points accrue.

113.Late payments will not be penalised for the first 15 days; half a penalty will be charged where payment is made between 16 and 30 days. A full penalty applies thereafter until full payment is made with an additional daily penalty. If a taxpayer contacts HMRC to make payments before the relevant dates, penalties will not be charged.

114.An appeal system, based on providing a reasonable excuse or failure to file or pay, provides a taxpayer safeguard.

115.The Government planned to introduce the new penalties regime in 2020–21 at the earliest, one year after the implementation of MTD for VAT, although the effect of the one-year delay to the Finance Bill clauses is not yet clear. The penalty levels and a final impact assessment have yet to be published. As a result we could not hear evidence on the impact on taxpayers of the complete package nor assess its likely effectiveness.

Impact of the penalty reforms

116.Most witnesses agreed that a points-based system is more proportionate in relating penalties to non-compliant behaviours and differentiating between innocent errors and deliberate or persistent non-compliance.68 The Association of Accounting Technicians (AAT) wrote: “This penalty system avoids the imposition of a penalty in circumstances where, in the words of one senior HMRC officer, ‘life just got in the way’ at the same as providing strong encouragement to the willingly non-compliant to avoid repetition of their failure.”69 But timely notification of failures is needed to support this.70

117.Witnesses held mixed views about aligning penalty regimes across taxes. However even those who welcome it as a simplification are concerned that the legislative provisions for the points-based system are complex,71 particularly around transition to the new regime, and may be difficult for taxpayers to understand. There was agreement that clear communications from HMRC will be important to prepare taxpayers for the new system.

118.Witnesses raised concerns about the detail of the penalties legislation. First, some witnesses considered the two-year time limit for HMRC to undertake a penalty assessment too long. The Low Incomes Tax Reform Group (LITRG) said this limit “runs counter to one of the key aims of the new system which is to encourage non-compliant taxpayers to become compliant again as quickly as possible”.72 The Association of Taxation Technicians (ATT) said: “Two years seems excessive when all that HMRC’s computer system will have to do will be to tot up the number of penalty points that a taxpayer has accrued.”73

119.Second, witnesses stated that the 15-day limit before a late payment penalty was charged was too short to allow for understandable delays, such as for post and processing, and should be extended to 30 days74 Mike Cherry OBE, National Chairman of the Federation of Small Businesses, told us the time limit “presupposes that the business owner would never go on holiday”.75 The Association of Accounting Technicians (AAT) said: “It is disappointing to note that, in contrast to the views of the clear majority of respondents to the previous consultation, HMRC is proceeding with an unnecessarily short penalty period … HMRC should not impose late payment penalties until 30 days have elapsed.” They also regarded the “compromise” solution, involving no penalty in the first 15 days and half the penalty being payable between 16 and 30 days, as introducing “unnecessary complexity”.76

120.The penalties regime could be fairer and better encourage taxpayers to remedy defaults promptly by giving taxpayers a longer grace period before penalties for late payment are applied, and ensuring taxpayers are aware of their exposure sooner.

121.We recommend that the two-stage late payment penalty system is amended to extend the period of grace from 15 to 30 days.

122.We recommend that the Government reduces the two-year time limit for HMRC to assess penalties to no more than one year, so that taxpayers are aware of their exposure sooner.

123.The new penalty provisions will be introduced for VAT in 2020–21 at the earliest, the year after MTD for VAT goes live. The ATT found it “disappointing that HMRC is unable to move faster to replace the current discredited provisions”.77 CIOT wrote: “this creates confusion for businesses and their agents, and indeed HMRC”78 as to which regime applies to which taxes and when.

124.Witnesses also highlighted the importance of effective communication of the new penalty regime. CIOT said: “Clear guidance will be needed, especially around the new penalty points regime for MTD taxes”.79 The Institute of Chartered Accountants in England and Wales (ICAEW) stated: “The practical application of the old and new penalty rules needs careful managing, with clear communications to business”.80

125.While we support the points-based approach for late filing of penalties we remain concerned that the complexity of the provisions, the transition process and the timescales may be confusing to taxpayers until they become familiar with the new system.

VAT default surcharge and repayment supplement, and proposed interest regime

126.At present for VAT, late payments by the taxpayer are included in the VAT default surcharge regime. Interest payments to taxpayers are made according to the VAT repayment supplement rules. These limit interest for the first 30 days. No supplement is payable for periods when a return is under inquiry, even if it is subsequently found to be correct or if there are outstanding VAT returns. The repayment supplement rate is five per cent, to recognise these features and to incentivise HMRC to make timely repayments.

127.The proposed interest regime for VAT would broadly harmonise with that for income tax, with interest payable on tax paid late and on tax overpaid, but at different rates. The different rates for corporation tax quarterly payments would be retained. However, as for VAT repayment supplement, interest would not be paid on VAT repayments where there were outstanding VAT returns, until those returns were submitted. It would also not be paid during the period of a reasonable HMRC enquiry. The date when the interest proposals would take effect has yet to be published.

128.Although broadly aligned with the rules for income tax, the proposals differ in ways which seem difficult to justify. Non-payment of interest on overpayments during VAT enquiries is inconsistent with other taxes and uncommercial. CIOT, while welcoming alignment of the interest regime across taxes, were “concerned that certain measures (such as withdrawal of the Repayment Supplement and no entitlement to repayment interest for periods of enquiry by HMRC) remove the incentive for HMRC to process VAT repayments and undertake enquiries in a timely fashion.”81

129.The absence of any incentive for HMRC to conclude VAT inquiries promptly risks taxpayers being unfairly disadvantaged by HMRC delays.

130.We recommend the draft legislation is amended to remove the restrictions on repayment interest on VAT.

Taxpayer awareness

131.Comprehensive information and guidance from HMRC will be required to support taxpayers’ understanding of the proposed changes to penalties and interest. As ICAEW noted, “penalties and sanctions only work as a deterrent if taxpayers are aware of them and understand what is required”.82

132.A recurring theme of our inquiry was that HMRC does not do enough to communicate with taxpayers about changes that affect them. Communication needs to be direct with taxpayers and backed up by accessible guidance. It will not be enough for HMRC to put information on a website or in a VAT brief. Unless taxpayers are fully aware of the regime it will not be a deterrent to non-compliance.

133.We recommend that HMRC introduces a communication and support programme to ensure that taxpayers have a clear and timely understanding of the new penalty and interest regime, including the transitional provisions.

134.We recommend that HMRC introduces a messaging system to give timely information to taxpayers of penalty points accruing, in order for the new regime to support taxpayers in timely compliance with their tax obligations.

66 QQ 1–15 (CIOT); Written evidence from CIOT (DFC0071), Association of Taxation Technicians (ATT) (DFC0061), Low Income Tax Reform Group (DFC0067), Institute of Chartered Accountants of Scotland (DFC0068)

68 Written evidence from Low Incomes Tax Reform Group (DFC0067) and Association of Taxation Technicians (DFC061)

69 Written evidence from Association of Taxation Technicians (DFC0061)

70 Q 21 (Paul Morton)

71 Q 35 (Jason Collins)

72 Written evidence from the Low Incomes Tax Reform Group (DFC0067)

73 Written evidence from the Association of Taxation Technicians (DFC0061)

74 Written evidence from the National Farmers’ Union (DFC0084) and Association of Accounting Technicians (DFC0044)

75 Q 21 (Mike Cherry)

76 Written evidence from the Association of Accounting Technicians (DFC0044)

77 Written evidence from the Association of Taxation Technicians (DFC0061)

78 Written evidence from the Chartered Institute of Taxation (DFC0071)

79 Written evidence from the Chartered Institute of Taxation (DFC0071)

80 Written evidence from the ICAEW (DFC0073)

81 Written evidence from the Chartered Institute of Taxation (DFC0071)

82 Written submission from ICAEW (DFC0073)

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