In May 2022, HMRC published guidance setting out the key compliance checks VAT registered businesses need to be aware of to avoid penalties for Making Tax Digital (MTD) for VAT.
The new points-based VAT penalty regime comes into force on 1st January 2023, and marks the end of an extended ‘soft landing’ introductory phase for MTD. As far as HMRC is concerned, MTD for VAT is now a ‘business as usual’ process; and it’s moving forward with a new enforcement approach designed to prompt businesses to get their VAT calculations and submissions right the first time.
The changes to the penalties regime are subtle but significant. Alongside penalties for defaulting on mandatory requirements, such as deadlines for VAT submissions and payments, HMRC looks set to evaluate the behaviours behind any VAT compliance failure.
Forewarned is forearmed.
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.
The key drivers: reducing the tax gap and preventing non-compliant outcomes
Figures released by HMRC highlight how MTD has helped reduce the so-called tax-gap for VAT. This year, the VAT tax gap fell from 8.5% to 7% – a move that will have generated a sizable additional tax take.
According to HMRC, the most significant behaviours contributing to the tax gap include failing to take reasonable care (19%), with criminal attacks, evasion and legal interpretation in complex transactions each accounting for between 15% to 17%.
The new VAT penalty regime aims to drive up more reliable and accurate VAT returns by applying default behavioural penalties that will incentivise firms to exercise due care and attention when reporting and calculating their VAT liabilities. 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.
Penalties and requirements
Organisations will be required to file returns using digitally compatible software that can record and store digital records and provide and receive information to and from HMRC. Failure to do so risks a £400 fine per return.
Similarly, HMRC expects organisations to maintain detailed electronic records on all VAT related transactions (supplied and received). Failure to comply will result in up to a £15 daily penalty.
Organisations must also use digital links to transfer data between software programmes, applications or products. Using ‘cut and paste’ to select and move information is not acceptable and HMRC will apply a penalty of up to £15 a day for non-compliance with this requirement.
Finally, and significantly, HMRC stipulates that organisations must use checking functions contained within their software to ensure their returns are correct before filing. Returning a file that contains errors could potentially incur a fine of up to 100% of any VAT owed.
This final compliance requirement suggests HMRC will be assessing with interest the behaviours that lead to errors and will apply fines according to what they find or surmise. For example, lack of care is punishable by a fine of up to 30% of VAT owed, while a deliberate error will incur a fine of 70%, and a deliberate and concealed error will result in 100% of VAT being due as an extra tax.
What the new penalty regime really means for businesses
While £15 per day may seem like a relatively minor penalty, should HMRC detect multiple compliance failures that have gone unnoticed, these could all add up to a substantial amount. Especially if these fines are backdated over multiple submission periods.
Corporate groups in particular risk being hit with penalties that are applied across all their VAT registrations, since it stands to reason that a compliance error within one VAT registration will be replicated wherever the same processes are utilised. For example, organisations that claim multiple VAT rates often find the Box 6 split can prove particularly challenging to accurately record and report.
Ultimately, any VAT compliance failure that puts an organisation on HMRC’s radar will result in increased scrutiny. Once HMRC inspectors have an indication there is something to investigate, they will be looking to evaluate if a compliance failure resulted from a lack of due care and attention or is an indicator of a deliberate error or act of concealment.
When coupled with the requirement to demonstrate the use of software checks, organisations can be sure that inspectors will be requesting 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.
Complacency isn’t an option
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. Should HMRC come knocking for more information, they will be able to pull reports that demonstrate software checks have been applied.
To get tax right first time, organisations should look for specialist VAT solutions that offer automated digital checks on the key elements highlighted by HMRC as being the most prone to error: VAT on business entertaining, intra-group transactions, passenger transport and leased car expenditure. Best-in-class solutions will also provide a customisable feature that enables organisations to design checking processes around their own unique data sets, processes and business operations.
One thing is for sure, with compliance and reconciliation now a top priority, utilising integrated digital checks is the way forward for organisations that want to ensure accurate VAT calculations and avoid fines.
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Russell Gammon, Chief Solutions Officer at Tax Systems
Russel Gammon has 14 years and counting of experience in technology functions. The first ten of those years in the "Big 4", and since then he has been involved in a pre/post VC-backed business (including being instrumental in the fundraising process), and now works in a PE-backed environment (Bowmark Capital) for the market-leader in the CT space (and no, we don't just say we're "market-leading", we have 70% of the UK market...). He has undertaken a number of roles and sits most comfortably between the world of Product and Commercial operation. He understands how to build great products, yet also understands that business and customer limitations mean that the path to success is often bumpy, winding, and difficult to navigate. He has been a Chief Product Officer running product teams, ran an Innovation function looking at "the next big thing" and currently runs "Solutions", where he spends time talking strategy with some of the largest corporates and accounting firms in the UK. Ultimately, he is interested in making sure that customers get great technology, and he is not afraid to make the sometimes difficult decisions along the way to get there. Tax is embracing technology; he wants to make sure it does it the right way.
