Research and analysis

Impacts of penalty reform on VAT-registered businesses

Published 15 May 2025

1. Executive summary

From 1 January 2023, HM Revenue and Customs (HMRC) introduced a new penalty regime for the approximately 2.4 million VAT-registered businesses in the UK. Key changes included a points-based system for late submissions, a revised penalty structure for late payments, and a new method for calculating late payment interest.

The aim of this research was to assess the early effects of these changes, focusing on customers’ awareness, perceptions of fairness, and perceived impacts on behaviour. The intention was for this research to identify areas for further investigation and potentially inform the future roll out of reforms to penalties for other taxes.

This qualitative study comprised 48 in-depth interviews with VAT-registered small businesses, each having turnover below £10 million and fewer than 20 employees. The customers interviewed were all responsible for managing their businesses’ VAT obligations, including filing and penalties. Participants were selected from HMRC-provided sample, with recruitment quotas ensuring coverage across 5 categories of penalty experience under the current regime, including some that had not been penalised, and others who had been penalised under the previous regime. Secondary quotas included turnover, sector, VAT registration length, and geographic location.

1.1 Small businesses’ views of HMRC and VAT

The research explored customers’ attitudes towards HMRC and VAT as context to their views about penalty reform. Those with negative views towards HMRC often had difficult experiences with penalties, citing ‘punitive’ notices or overlooked extenuating circumstances. In contrast, those with positive views mentioned HMRC rectifying errors, waiving penalties, or showing leniency, and appreciated improved communications over time. Compliant customers viewed VAT compliance as routine, leading to a more indifferent outlook on interactions with HMRC.

VAT was viewed by customers in the context of cash flow management and tax handling methods. Customers claimed that managing VAT was harder for small businesses as they are more vulnerable to cash flow fluctuations and lack in-house tax expertise, compared to larger businesses. There was a general sense that small businesses should receive greater HMRC support and flexibility in meeting their VAT obligations.

1.2 Awareness of the new regime

Customers expressed low awareness and understanding of the new penalty regime. They knew they could be penalised for non-compliance but lacked detailed knowledge of the regime's specifics. For penalised customers, the late submission points system was the most easily recalled aspect, seen as intuitive by some, although overall comprehension of penalties and appeals processes remained limited. There was a lack of interest in learning more, particularly among penalised participants who believed their non-compliance was beyond their control. These participants felt that a more detailed understanding of the penalty regime was unlikely to help them address their compliance challenges.

1.3 Perceived impact on compliant behaviour

Experiences of receiving penalty notifications prompted varied reactions among participants. Initial responses ranged from proactive efforts to resolve issues promptly to passive acceptance due to perceived inability to effect change or uncertainty about HMRC support. Those who engaged with HMRC described mixed experiences with helpline services, citing long wait times and inconsistent adviser support. Digital channel usage was minimal in the sample, with few participants using online tools for penalty management or appeals.

Participants reported mixed impacts of receiving a penalty under the new penalty regime on their future compliance. Some described no conscious behaviour change, typically attributing their non-compliance to financial difficulties or significant life events that took precedence over VAT obligations. This subset of customers felt these factors were beyond their control, rendering penalties ineffective in influencing their behaviour. Similarly, compliant customers perceived penalties as unlikely to affect them, unable to foresee scenarios where they would be non-compliant.

Those that did describe specific behaviour changes included individuals who had received penalty points for late submissions. These changes included setting reminders and taking personal responsibility for deadlines. More substantial impacts were described by customers who had received late payment penalties. These included customers changing how they managed VAT, such as setting up direct debit payments, putting money aside, switching to an accountant or software, or shifting to flat rate or cash accounting.

1.4 Prompted views about key changes under the new regime

When participants were given more detailed information about 4 key changes under the new penalty regime (late submission penalty points, late payment penalties, late payment interest, repayment interest), they had mixed reactions. The points-based system for late submissions stood out as the most straightforward and well-received. Participants found it intuitive and compared it favourably to other points systems, although there was confusion regarding the points thresholds and their duration. However, broader scepticism towards HMRC and perceptions of the regime's overall fairness influenced some customers' views. This was especially true for those who felt the regime remained overly punitive, particularly for businesses filing nil returns.

Understanding late payment penalties and interest rates proved challenging for many customers, and there was limited grasp of the differences between the old and new regimes. The grace period and ability to arrange payment plans were welcomed, although individuals facing financial difficulties struggled to move beyond a sense that penalties were unfair. The complexity of late payment interest calculations further confused some, although more financially confident customers accepted the changes due to perceived alignment with standard interest charges in their industry.

Overall, while the new regime was generally welcomed for its increased fairness and improved proportionality, there was a call for greater simplicity and flexibility to accommodate cash flow issues. This concern was particularly noted among participants who were unaware of Time to Pay arrangements or were sceptical about the ease of setting them up.

1.5 How to encourage compliance

Customers had limited suggestions for improving timely VAT filing, primarily attributing responsibility to businesses to integrate reminders into their operational routines. For timely VAT payments, customers focused on HMRC's role in supporting small businesses facing financial difficulties. They expressed a preference for HMRC to adopt a more supportive rather than punitive approach to VAT, emphasising the need for proactive assistance and flexibility in penalty enforcement, particularly for businesses facing financial difficulties. These difficulties included cash flow challenges caused by clients’ long payment terms, as well as the need to prioritise paying staff and suppliers over paying VAT on time.

2. Introduction

This section sets out the background to the research, the research aims and methodology.

2.1 Background to the research

The new penalty regime came into effect for VAT periods starting on or after 1 January 2023. Approximately 2.4 million VAT registered businesses are impacted by these changes.

The changes include:

• the introduction of a points-based system for late submission penalties, meaning that businesses are not financially penalised for occasional mistakes but for repeatedly failing to submit on time

• a new penalty regime for late payments, meaning penalties now reflect how overdue a payment is and more time is provided to pay VAT or set up a ‘time to pay’ arrangement before receiving a penalty

• a new approach to late payment interest, meaning businesses who pay VAT or penalties late are charged interest on the outstanding amount (previously, interest was only charged on VAT assessments)

• changes to repayment interest meaning all businesses will be compensated for late repayments from HMRC (instead of the few that experience longer delays, as under the previous regime) and compensation is in the form of an interest payment rather than a fixed percentage

HMRC identified the need for evidence on how the changes are working and to potentially inform the future roll out of reforms to penalties for other taxes. HMRC’s intention is to standardise the approach to penalties across tax regimes.

2.2 Research aims

The aim of this research was to explore the early impacts of penalty reforms on VAT registered businesses, looking at customers’ understanding and experience of the changes, perceptions of fairness and any behavioural impacts of the reform.

The research questions covered 3 areas: awareness, perceptions and perceived impact.

• awareness: for customers aware of the reforms, how did they become aware? If via HMRC, what are their views about the information provided? What is their awareness (and experience, where relevant) of appeals?

• perceptions: what are customers’ views about the new penalty regime (focusing on each of the changes)? How does it compare to the previous regime? What are their views about the fairness and proportionality of the new regime? What are their views about the ease and value of using HMRC’s digital channels in relation to understanding or managing penalties and appeals (e.g. Business Tax Account (BTA), Agents Services Account), as well as use of wider channels to help understand the new regimes?

• perceived impact: what are the early impacts of the new regime on customers’ compliance behaviour? Does the late submission points system encourage customers to submit even if they cannot pay? What impact does the points system have on submission behaviour around timeliness, repeat offending and care taken to meet deadlines? Are there unintended consequences such as late submission when customers are not at the penalty threshold? Is the points system more re-assuring than the previous system? What is the impact on their trust in HMRC? Do customers have an improved understanding of penalties?

2.3 Methodology

The research involved 48 qualitative interviews with VAT-registered businesses, all of whom were small businesses with turnover below £10 million and fewer than 20 employees. All interviews took place with the person responsible for fulfilling the business’s VAT obligations, including penalties. This tended to be the business director or finance lead. Interviews lasted up to 60 minutes and took place over telephone or video call (according to the participants’ preference).

Participants were recruited from HMRC-provided sample. Recruitment quotas were set to achieve a spread across 5 categories of penalty experience under the current regime, including those that had not experienced any penalties under the new regime, as well as a mix of experience of receiving a penalty under the previous regime (see table below).

2.4 Table 2.3 Primary variables

Penalty status:	Businesses with one penalty point for late VAT submission	Businesses with more than one penalty point for late VAT submission	Businesses with a penalty for late VAT payment	Businesses charged late payment interest	Compliant businesses (not received a penalty under the new regime)	Total
	8	8	9	14	9	48
Of which, penalised under previous regime:	5	7	7	4	5

Note that while businesses were recruited to meet quotas for specific categories of penalty experience, a proportion had received multiple penalties under the current regime. For example, a business may have received a late payment penalty and late payment interest for the same late payment. Participants were prompted to discuss all elements of the new penalty regime regardless of any experience they had of the regime.

Secondary recruitment variables were also set to ensure diversity in business turnover, sector, VAT registration duration and location. A full breakdown of achieved sampling criteria is included in appendix 7.1.

The findings presented in this report are based on qualitative research methods and are intended to provide in-depth insights into participants' experiences and perspectives. The sample size and selection methods used in this study do not allow for quantitative analysis or generalisation of results across the population of interest. Readers are advised to interpret the findings within the context of qualitative research and consider them as illustrative rather than representative.

Throughout the report, quotes and pen portraits are used to illustrate key points. Quotes are taken verbatim from participant interviews and are attributed to the specific penalty status for which the participant was recruited (note that participants may have received multiple penalties). Pen portraits provide a concise summary of individual participants, including their background, how they manage VAT and the perceived impact of the new penalty regime. Names and any other identifying information have been changed to protect participant confidentiality.

3. Businesses’ contextual views about HMRC and VAT

This section examines participants’ views about HMRC and VAT, providing context for their views and experiences with the penalty regime.

3.1 Views about HMRC

When asked about their attitudes towards HMRC, customers expressed a wide range of views. Individuals who described neutral or positive attitudes towards HMRC generally attributed this to a sense of HMRC acting fairly. For example, positive interactions described by participants included instances where HMRC had corrected errors, written off penalties, or issued late submission points rather than a penalty.

“I think they’re fairly flexible. They work with you. If there are any issues, they are willing to sort it.” (Customer recruited for late submission points)

Others appreciated perceived improvements in the tone of HMRC communications over time or simply accepted tax as a routine aspect of doing business. These participants tended to feel relatively calm or indifferent about interacting with HMRC.

"[I feel] indifferent really. [HMRC] have got a job to do, I've got a job to do, I don’t really have any feelings towards them one way or another” (Customer recruited for late submission points)

Those with negative views expressed these views more strongly, typically attributing their dissatisfaction to adverse interactions with HMRC, often related to a recent penalty experience. For example, participants described receiving penalty-related correspondence they found overly punitive in tone or were frustrated that their ‘extenuating circumstances’ had not been considered by HMRC.

Those with negative views of HMRC also included customers who had struggled to communicate with HMRC to resolve an issue. This included those having difficulty reaching an adviser via the helpline and receiving what they felt was unsatisfactory service when they did.

“My penalties could have been avoided if I could have spoken to somebody… I can't sit for 20 minutes a day on the phone waiting for someone to answer [the HMRC helpline]" (Customer recruited for late submission points)

3.2 Views about VAT

Participants’ attitudes towards VAT varied widely and were influenced by their attitude towards cash flow issues, how they handled tax obligations, and specific business circumstances. For example, participants who described VAT as ‘scary’ or ‘difficult’ were typically relatively conscientious customers. These customers worried about whether financial difficulties, including cash flow issues caused by their clients’ delayed payments or long payment terms, would impede their ability to pay VAT.

This contrasted with more relaxed customers who described VAT as ‘simple’ or ‘straightforward’. These individuals either did not anticipate any difficulty paying VAT (because they had filed a nil VAT return or believed they had sufficient money to pay) or were resigned to their inability to pay (see pen portrait 1). For the latter group, cash flow issues were considered beyond their control, therefore VAT payment was not something they devoted time or energy to until they were able to pay.

These customers included ‘reluctant’ participants who described disengaging from interactions with HMRC related to penalties. For this group, VAT payment difficulties were considered a relatively minor part of doing business and interacting with HMRC was not considered worthwhile. For example, one customer described disengaging from the penalty process until debts were transferred to a third-party debt collector. They perceived this to be more straightforward to incorporate into their business processes than interacting with HMRC.

How participants handled their tax obligations also affected their attitude towards VAT. Those using accountants or software packages to manage VAT were more likely to describe it as straightforward, compared to unrepresented customers and those using paper records or manually updating spreadsheets. Despite this split, both groups included customers who simply struggled to remember deadlines for VAT reporting and payment.

The third influence on attitudes towards VAT was businesses’ specific circumstances. For example, a customer working in hospitality described challenges managing VAT due to variable VAT rates on their goods and transactions, while a customer importing beauty products from South Korea into the UK via the Republic of Ireland found the different rates between multiple jurisdictions complex.

There was also a sense among participants that managing VAT was harder for smaller businesses, compared to larger businesses. This was for 2 reasons. First, the perception that smaller businesses were less likely to have in-house tax expertise or the resource to pay for external tax support.

A second reason was that smaller businesses were felt to be more susceptible to cash flow issues. Relative financial instability and being subject to clients’ long payment terms were repeatedly described as a challenge for managing VAT. For example, businesses reported seeing more clients requesting 90-day payment terms, meaning they were sometimes required to pay VAT to HMRC before they had been paid by their clients. Other financial demands, such as paying staff and suppliers, were considered more critical to keeping businesses running and were prioritised ahead of paying VAT on time. These challenges prompted a desire for small businesses to receive more support or leniency from HMRC in relation to fulfilling their VAT obligations.

"It feels like you are handling someone else's money for them and having to deal with the stress of the cash flow with that, when it's become particularly hand to mouth since Covid." (Customer recruited for late submission penalties)

3.3 Pen portrait 1: VAT seen as straightforward, but cash flow issues affect ability to pay

Louis is the CEO of a product design business. The business's clients tend to have long payment terms, causing cash flow issues (as described above) and ultimately leading to failure to pay VAT on time. 

He has experienced penalties under both the current and previous regime. Louis understands and agrees with the premise of having penalties for non-compliance but has had a negative experience communicating with an HMRC helpline advisor. This caused him issues relating to his late payments, as the advice he received regarding how best to pay off the late payments led to him receiving further penalties. He also feels he should have been shown some leniency by HMRC, due to having a track record of compliance.

Managing VAT: Louis has an accountant but tends not to use them for VAT administration as he finds this relatively straightforward and has no issues filing on time. His book-keeping is done via online software and he submits the VAT return automatically to HMRC. Louis's accountant placed him on accrual VAT accounting, which exacerbated the business’s cash flow issues. He must wait until he receives payment from clients and then pay his VAT bill, even if this means paying late and receiving penalties.

Impact of the new regime:  Since receiving a late payment penalty Louis has recently switched to cash accounting to be better able to manage cash flow. He tries to be even more meticulous in ensuring he meets payment deadlines. His experience of the penalty has improved his understanding of how penalties are calculated, but he does not feel his experience has had any negative impact on the business. 

Names and any other identifying information have been changed to protect participant confidentiality.

4. Experiences and impact of the current penalty regime

This section details participants’ experiences of the current penalty regime and its perceived impact on their future compliance behaviour and views of HMRC.

4.1 Awareness of the penalty regime

Awareness of the penalty regime was low. While customers were aware they could be or had been penalised for non-compliance, very few in the sample had more than a vague awareness or understanding about the regime itself. Awareness and understanding of the appeals process was also poor (see section 3.3).

"We know that there's going to be penalties if we have late payment, but we don't really know that much about it" (Customer recruited for late payment interest)

Those with little or no awareness were not motivated to learn more. This was for several reasons. For example, customers who felt they had been unintentionally non-compliant cited circumstances beyond their control or simply overlooking a deadline. Consequently, they perceived information about the penalty regime as irrelevant to their situation.

Relatively relaxed customers either lacked interest or were cynical about their ability to influence the penalty process. These customers felt there was little point in trying to learn more. This included participants who were more generally disengaged from HMRC communications, claiming they would not actively seek information unless they thought it absolutely necessary to do so.

Participants with some awareness of the regime typically described learning about it via a penalty notification letter. There were some vague recollections of wider HMRC communications about the penalty regime changes, but no one in the sample was able to recall specific details. Those with a finance background also described hearing about the changes from industry sources, but again awareness of details of the current regime were limited.

When asked to describe what they understood about the current penalty regime, customers struggled to recall anything beyond basic details of their own experiences. There was limited understanding of how penalties worked or indeed how they had changed from the previous regime. Among those that were aware of the penalty system, the late submission points system was the easiest element of the current regime to recall, with participants describing this as intuitive and likening it to other penalty systems (see section 4.2).

4.2 Experiences of receiving a penalty or point

Recall of penalty experiences was low. Researchers used customer journey mapping techniques to help participants recall experiences of their most recent penalty or point under the current regime. Using these prompts, customers could explain why they were penalised but typically struggled to understand reasons for a particular amount or type of penalty. This lack of understanding was not viewed as problematic, and participants were not particularly curious to learn more.

"There's not enough hours in the day [to engage with penalty information]. I work 7 days a week and there's no time to sit and read this stuff." (Customer recruited for late payment penalty)

Participants were divided between those who anticipated receiving a penalty before being informed by HMRC and those who were unaware until they received a penalty notice. The former group tended to be conscientious customers who tried to stay on top of their tax position. They either knew they would be unable to pay VAT when they submitted a return or realised they had missed a deadline or made an error when it was too late to take corrective action.

Customers who only became aware when they received a penalty notice typically had a more chaotic or relaxed approach towards VAT. They either lacked knowledge about how to manage their VAT obligations or were focused on other priorities. For example, this included customers facing a change in circumstance, such as moving to a new accounting system, growing or shrinking their business, or dealing with a personal life event. These factors were prioritised over their VAT obligations.

On receiving a penalty notice, participants described a mix of active and passive responses. Responses were driven by their attitude towards managing VAT generally. Customers who immediately took action included conscientious customers who wanted to resolve the issue quickly (if they had not done so already). They did this by submitting a late return or payment or contacting HMRC to arrange a payment plan.

This group also included customers who felt they had been unfairly penalised and wanted to challenge the sanction received. These participants typically described calling the HMRC helpline to explain what had happened with the aim of getting the penalty adjusted or removed.

Customers who took no action were those who felt unable or unsure how to resolve the issue. This included customers with low expectations of HMRC support, either in terms of reaching someone via the helpline or of receiving effective assistance. This group also included those who lacked the funds to pay VAT and believed nothing could change their circumstances. They intended to pay when they were able.

4.3 Experiences of HMRC support and appeals

Customers in the sample who sought support from HMRC about their penalty typically used the helpline. They described calling HMRC to either arrange a payment plan or challenge the penalty. There was limited interest in using the helpline to seek information about why they had been penalised or to understand the penalty itself.

Experiences of using the helpline were mixed. Customers described frustration with long waiting times to get through to an adviser and aborted calls. Views about helpline advisers were particularly mixed, with contrasting experiences of both ‘helpful’ and ‘aggressive’ call handlers.

“I felt they [HMRC] really turned a corner and they were available and rang you back and gave you reminders. HMRC were very helpful” (Customer recruited for late submission points)

"[HMRC is] a fortress…They think they provide mechanisms to communicate with customers but actually they don't. Not ones that are accessible anyway. Unless you have a spare hour to wait. Each time you talk to someone you get a different version of the truth which is not consistent. Also, they don't really know what's going on. A lot of stuff seems to go into a black hole." (Late payment interest)

Use of HMRC’s digital channels was limited in the sample. When prompted, a small number of participants described using their online account to check the penalty amount. In these examples, customers reported that the information provided via these channels was clear. Only one participant in the sample had attempted to set up a payment plan online. However, they ultimately discovered this was not possible due to having an existing plan in place.

As noted previously, customers’ awareness of the appeals process for penalties was low. Those who were unaware had either given it no thought or assumed there was some recourse but had no awareness of what it involved. When prompted, participants assumed more information would be available in the penalty notification letter, but this was not something participants had looked into. In part, this reflected a sense that the appeals process would be laborious and unproductive, and therefore not something this group felt would be worthwhile exploring.

"Do I really want to put an appeal in when I know they don't care?” (Customer recruited for late submission point)

Those who had used the appeals process (a small portion of the sample) reported negative experiences. This included experiences of submitting an appeal and not receiving a response or finding the process complex and unsatisfactory. For example, one business whose appeal was escalated to a tribunal and ultimately dismissed felt the experience was disproportionately burdensome and excessively lengthy compared to the nature of the non-compliance.

“I can’t treat my customers like this [tribunal process] and I don’t think [HMRC] should because I’m actually acting effectively as a servant collecting taxes for [HMRC]” (Customer recruited for late payment penalty)

"It becomes a blur, you just know you're going to get shafted every time by HMRC so you don't take much notice.” (Customer recruited for late payment interest)

4.4 Impact on future compliance

When asked about the perceived impact of receiving a penalty on future compliance behaviour, participants’ responses ranged from little or no impact to substantial changes. The extent of the impact varied depending on the penalty type and whether participants felt in control of their circumstances.

Those who described no impact typically felt their non-compliance had been out of their control, rendering penalties ineffective in influencing their behaviour. For example, financial difficulties or significant life or business events had affected their ability to pay or submit a return. As described previously, these customers felt they needed to prioritise immediate business needs over VAT compliance. Penalties played little part in this decision (see pen portrait 2).

"The penalty regime has no impact on my behaviour because it's not like I'm actively avoiding paying or not wanting to pay. It's just that I can't pay.” (Customer recruited for late submission points)

4.5 Pen portrait 2: No impact of penalties due to perceived lack of control

John has recently taken on the role of managing a pub. He has a negative perception of HMRC, finding the department to be insensitive to the current economic environment and difficult to contact for support. John understands the purpose of VAT and wants to comply, but financial difficulties make it difficult to keep the business afloat whilst meeting VAT obligations.

Managing VAT: John cannot afford an accountant or book-keeper, so is responsible for managing the business's VAT administration himself using an online software package. He also keeps hard copies of receipts and invoices. He is not confident about managing VAT obligations and has been unable to access any support from HMRC.

As a result of the business's financial difficulties, he has received 2 late payment penalties under the current regime. He has tried to be proactive and establish a payment plan but was unable to do so online through HMRC. In the end, John found it easier to communicate with the debt collector employed by HMRC to retrieve the payment, rather than with HMRC themselves.

Impact of the new regime: As John's compliance is based on having the ability to pay, rather than the penalty system itself, his experience of penalties has not had any impact on his behaviour. "It's [penalties] not made any difference at all." . He believes the only thing that would have an impact is a VAT freeze, as he cannot afford to pay both his staff and the VAT bill. If he continues to struggle with paying VAT, he may have to close his business.

Names and any other identifying information have been changed to protect participant confidentiality.

Compliant customers also reported that penalties were unlikely to influence their behaviour. These customers could not visualise circumstances in which they would be non-compliant, and therefore how penalties might affect them (see pen portrait 3).

4.6 Pen portrait 3: No impact of penalties due to lack of perceived relevance

Charlie is the director of an accountancy firm. He is responsible for submitting VAT returns and paying VAT. The business has not received any penalties under the new regime, but he is aware there have been changes to interest rules, as well as the introduction of the penalty points system.

He does not have strong opinions about VAT specifically, but finds communicating with HMRC, particularly via telephone or webchat, to be ”frustrating” and ”stressful”.

Managing VAT: Charlie finds that VAT administration runs smoothly providing he keeps on top of bookkeeping. He uses HMRC-compatible software for record-keeping and invoicing clients, making it easy to submit VAT returns. He makes payment via direct debit once the return has been submitted, and his record-keeping software provides reminders when payments are due. 

The business’s main challenge is ensuring there is sufficient funds to make the payment at the end of the quarter. However, the business has not experienced issues with this so far.

Impact of the new regime: Whilst Charlie is aware of some of the changes to the penalty regime, he does not think this will have an impact on his behaviour. He already knows when returns and payments are due, so it is simply a case of remembering to file and pay on time.

The penalty regime changes have had no impact on his perceptions of HMRC. He understands that HMRC are trying to make VAT processes more efficient, but doubts the penalty reform will affect how they deal with tax-related queries and problems faced by customers, which is his main challenge. "The issue is with problems and queries...that's my major problem with HMRC."

Names and any other identifying information have been changed to protect participant confidentiality.

Customers who had received penalty points for late submissions described some small-scale impact on their behaviour. Examples included setting reminders for submission and payment deadlines (see pen portraits 4 and 5). They also included being “more diligent” over deadlines, setting aside money, taking personal responsibility for filing and paying rather than delegating, and acknowledging the need for help with business management. For example, one participant, who felt their ADHD diagnosis affected their VAT compliance, described the penalty experience as a catalyst for seeking support to improve their financial management.

"This new regime has helped to change my behaviour. As soon as I realised I'd got 2 points and if I could get up to 4 points for being late, I thought I'd better sort myself out, so I put it in my diary, made sure I know exactly when the quarter end is coming up." (Customer recruited for late payment interest)

4.7 Pen portrait 4: Impact of late submission points on compliance behaviour

Harry is the director of a tech startup company that has not yet started trading. He is a qualified accountant so is very confident dealing with business finances. He has a positive perception of HMRC, particularly in relation to how Making Tax Digital has been delivered. He finds the HMRC webpages easy to use, which has made it much easier for him to submit VAT returns. 

Managing VAT: Harry keeps records using digital spreadsheets and uses an add-on that allows him to submit directly to HMRC, making VAT administration straightforward to do. His biggest challenge is remembering to submit the return, which has led to him receiving multiple penalty points for late submission. This is because the business only submits nil returns, which have no financial impact, making it harder to remember to file on time.

Impact of the new regime: The new regime, particularly the penalty points system, has influenced Harry's views on HMRC, now viewing the department as more understanding. The regime has also had an impact on his behaviour. He now adds VAT submission deadlines to his diary so he does not forget to file in the future. 

Names and any other identifying information have been changed to protect participant confidentiality.

More substantial impacts were described by participants who had received late payment penalties. These impacts included customers changing how they managed their tax affairs. For instance, they began setting up direct debit payments, putting money aside in a dedicated account, or switching to an accountant or software packages to manage their VAT obligations.

“I was doing manual payment up until the last one [payment] but now it’s all set up, so it does it automatically.” (Customer recruited for late payment penalty)

This group also included customers who changed their VAT approach due to being penalised, by shifting to flat rate or cash accounting (see pen portrait 1). There were also participants in the sample who, since receiving penalties, said they were exploring deregistering from VAT or considering closing their business. These participants felt that the benefits of being VAT-registered did not outweigh the stress associated with ensuring timely payment of VAT.

4.8 Impact on perceptions of HMRC

The impact of receiving a penalty on customers’ perception of HMRC varied according to how fairly they felt they had been treated.

Those who felt fairly treated typically understood and accepted the reasons for their penalty and had positive interactions with HMRC during the process. This was often via the helpline when arranging a payment plan or resolving penalty charges. This group also included customers who had received late submission points, which they interpreted as HMRC showing leniency. These experiences led participants to believe that HMRC had become more understanding of the challenges facing small businesses over time.

"I see HMRC as a bit more understanding that a lot of people are busy and this is not done deliberately. It's a bit of admin that I'd love to outsource to an accountant but it's not really worth it. So having that leniency makes them look a bit more understanding." (Late payment interest)

In contrast, customers who felt unfairly treated typically felt their non-compliance was due to circumstances beyond their control, or resented the ‘burden’ of VAT and its perceived punitive management. For these individuals, any penalty was deemed disproportionate and unfair. This group also included participants who had struggled to access HMRC support. Customers reported experiencing long waiting periods to get through to the helpline and receiving what they felt was poor service from helpline advisers. In these cases, participants felt HMRC was unsupportive of small business and viewed the penalty regime as disproportionately punitive.

"It just feels like they're trained to get small businesses to fail. They're so quick to fine and yet they're so slow to help. Surely the fines should pay for better training from HMRC for small businesses. My company has probably paid about £15k in fines." (Customer recruited for late payment interest)

“The good will has gone. The relationship has been damaged due to receiving bad advice [via the helpline] and it has been a negative experience with no positive experience." (Customer recruited for late payment penalty)

5. Views about the current penalty regime

This section outlines participants’ reactions to prompted explanations of each of the 4 changes to the penalty regime. These include the introduction of late submission points, and changes to late payment penalties, late payment interest and repayment interest. It also captures their overall views on the new regime.

5.1 Introduction to changes

Verian described each of the changes to the VAT penalty regime to customers, seeking their reactions. This started with a high-level description of the changes and the previous regime. Where customers showed understanding and engagement with the changes, more detailed stimulus was used for deeper exploration. The stimulus used for this exercise is included in appendix 7.3.

5.2 Late submission points

Of all the changes introduced to customers, this change was the simplest for them to engage with. The newly introduced ‘points system’ made sense to participants and was compared favourably with other points systems, such as for driving licenses. The change was perceived as being more lenient and targeting those that were repeat offenders. It was also largely viewed as an effective way to encourage compliance (see pen portrait 5).

“The logic of it is hard to dispute… fair, balanced, justified by facts and there has to be rules.” (Compliant customer)

The number of points needed to incur a penalty depends on how often the customer is filing. It was not clear for most participants what the points threshold was for their frequency of filing. The length of time that points remained on someone’s record was also a topic of confusion for customers, with most not being sure exactly how long it would take to remove a point.

Where customers struggled to understand this change, this was in the context of wider challenges. The language used to describe the change was felt to be difficult for some customers to understand. There was also cynicism about why HMRC had introduced the change and for whose benefit, which affected their assessment of the new approach.

”[The description] didn't scan like [a customer benefit] for me. It felt like they were just changing the system for another reason that wasn't a benefit. If they are being more lenient that does feel more fair.” (Customer recruited for late submission points)

Customers who felt the new regime was unfair still perceived it as too punitive. They felt that any changes should instead be supportive of small businesses. Customers filing nil returns were frustrated at the possibility of receiving a late submission penalty even though they would not need to pay any VAT.

“£200 is maybe a bit high for someone who has regular nil returns.” (Customer recruited for late payment interest)

5.3 Pen portrait 5: Impact of late submission points on compliance behaviour

Alex is the director of a small telecommunications business. Although below the threshold, he chooses to register for VAT as he finds it useful to be able to claim VAT back. He does not have strong opinions on HMRC or VAT and views himself as a tax-collecting agent working on HMRC’s behalf. However, he feels that HMRC could be clearer about the penalty system, particularly around how to pay penalty charges.

Managing VAT: Alex employs an accountant for other tax-related tasks but finds the process of VAT simple and therefore does this himself online. His biggest challenge is remembering to complete the return. To find out when returns are due, he must log into his HMRC online account, which he finds difficult to access. Alex has received multiple penalty points for late VAT submission under the new system, as well as a subsequent penalty charges.

Impact of the new regime: Under the old regime, Alex would regularly submit his VAT return late and not experience any consequences. He feels that the £200 penalty charge for repeated late submissions is unfairly high, but thinks this will encourage him to submit his returns on time. This is because small businesses like his cannot afford to pay the penalty charges. "As a small business owner, I won't be going one day over now" "No one wants to be fined £200"

Names and any other identifying information have been changed to protect participant confidentiality.

5.4 Late payment penalty

Customers were not clear on what the difference between the previous and current regime was for late payment penalties. They understood the idea of having a grace period before being penalised and grasped the concept of linking the penalty to the extent of the delay. However, they struggled to understand how the penalty rates work. For example, the different rates depending on how many days after the deadline the penalty was paid caused significant confusion when presented to customers.

“Sounds like it’s a better approach now.” (Compliant customer)

The main group that viewed late payment penalties as unfair were those who felt they lacked control over their circumstances. For instance, receiving a late payment penalty when they already had cash flow problems felt like ‘salt in the wound’. The grace period was not felt to be long enough to account for customers with cash flow problems.

Customers not directly affected by late payment penalties and without cash flow issues were more likely to see the change as fair and proportionate. While the opportunity to arrange a payment plan was welcomed by customers, getting in touch with HMRC to discuss and arrange this was felt to be difficult.

“How do you come to a payment arrangement if nobody answers the phone?” (Customer recruited for late submission points)

5.5 Late payment interest

Changes to late payment interest were the hardest to grasp and led to the biggest divide in opinions on any of the changes to the penalty regime. This was also the case for customers with personal experience of late payment interest.

“I don't deal with this every day, only once a quarter and I make films, I don't deal with tax. It's a bit like opening your exercise book on algebra once a quarter and realising you can't remember what you did last time. The language is overly complicated and hard to understand." (Customer recruited for late submission points)

When shown details about the change, customers struggled with the term ‘VAT assessment’ and understanding how the interest rules were different to the previous regime. Several customers spontaneously said they would prefer an example based on a real case, or a visual aid to help them understand the change.

“I'm a fairly intelligent person but it went over my head. The language used is mumbo jumbo.” (Customer recruited for late submission points)

Confusion around the changes also led to a spread of views about their perceived fairness. Those that felt the changes were unfair focused on the idea of combining penalties and interest for those facing financial difficulties. Adding interest on top of the late payment penalty was viewed as especially punitive. This was similar for businesses who missed VAT payments due to one-off business circumstances (for example, due to software failure or changing bank accounts), which they felt should have been taken into consideration (see pen portrait 6).

Those who viewed the changes as fair felt they aligned with standard business practices to charge interest on late payments. They also acknowledged that the interest rates were comparable to those used in their industries. Customers who had only received late payment interest, and not a late payment penalty, were more likely to feel the changes were reasonable. In contrast, those who had received both felt that the addition of late payment interest was disproportionate.

5.6 Pen portrait 6: no impact of late payment interest

Jenny is a self-employed bookkeeper working for a law firm (among other businesses). Following recent growth, the law firm had become a limited company. The changes resulting from this transition, such as a new bank account, ultimately led to a late payment and having to pay late payment interest. 

Jenny is ambivalent towards HMRC and VAT, acknowledging that tax is a requirement of running a business and the rules must be followed. While Jenny thinks that charging interest for late VAT payment is fair and proportionate, she feels that HMRC could have been more sympathetic towards the unique circumstances leading to this business’s penalty.

Managing VAT: The company uses an online finance package to manage VAT and other finances. This is straightforward to use once established, as all invoices are recorded and a box simply has to be ticked to submit the VAT return. VAT payments are made via direct debit.

Impact of the new regime: Jenny’s experience of having to pay late payment interest had no impact on either her behaviour or attitude towards HMRC and VAT. She thinks that compliance is simply a case of ensuring records are checked and direct debits are set up. Being compliant around her VAT obligations is "a high priority anyway because you want to get it right". Jenny therefore feels that increased communication about the details of the penalty regime would be unlikely to have any impact. 

Names and any other identifying information have been changed to protect participant confidentiality.

5.7 Repayment interest

Of all the changes described, customers felt this change was the least relevant to them. Research participants initially found the description of this change confusing, struggling to understand that it related to HMRC repaying overpaid VAT and querying the lack of detail about interest rates. They took some time to understand the concept but once they did, they welcomed the idea of HMRC paying interest on repayments.

“Why can't they write it in plain English?” (Customer recruited for late submission points)

Perceptions of fairness varied according to the degree of cynicism participants had towards HMRC. Some spontaneously assumed the interest rate would be lower than for late payment interest, or that HMRC could somehow avoid paying any interest owed.

“That would be fantastic, but I don’t believe it." (Customer recruited for late submission points)

Largely, customers felt this was a reasonable change and that it was right for HMRC to be subject to the same interest rate rules as customers.

5.8 Overall views on the new regime

Reflecting on the new regime as a whole, customers largely welcomed it. However, the specific changes were not well understood, with customers feeling they needed to be written simply, in plain English. Even among more engaged groups awareness was low. The lack of clarity around what the changes signified in practice and how they differed from the previous regime encouraged criticism from some customers who interpreted the changes negatively.

“My accountant would know what you’re talking about here but not me.” (Customer recruited for late payment penalty)

The greater sense of proportionality was appreciated, particularly around the introduction of late submission points, a grace period for late payment penalties, and repayment interest. Customers facing financial difficulties were more likely to feel that late payment penalties and late payment interest were not proportionate.

Whilst it was felt that the regime was largely fair and more supportive than before January 2023, it was observed that it still does not help those struggling with financial difficulties to pay VAT. Customers thought the regime could be more flexible for this group. There was also cynicism amongst some late payment penalty customers around the lack of perceived clarity, and doubts about how the regime will work in practice.

“The devil is in the detail. Them saying they'll do this is fine but it depends on the detail.” (Customer recruited for late payment interest)

6. Views about how to encourage compliance

This section presents customers’ suggestions for encouraging timely VAT filing and payments.

6.1 Customer suggestions to encourage timely VAT filing

Customers had few suggestions for encouraging timely VAT filing. This reflected a sense that it was the customer’s responsibility to build reminders into their business processes. These customers felt that there was little HMRC could do to further encourage timely filing.

“You can’t legislate for unorganised people" (Customer recruited for late submission points)

Those who did offer suggestions largely focused on reminders. They felt that reminders such as emails or text messages from HMRC would help customers meet quarterly filing deadlines. Customers also suggested notifications on their digital tax account or accounting software would be helpful. Filing quarterly did not come naturally to some customers, as it did not align with the timeline of other business obligations, which were usually fulfilled monthly. Reminders may therefore be particularly useful for this group.

“Reminders would help. A simple text message that says, ‘it's the end of the quarter’ or 'don't forget to file your VAT return'." (Customer recruited for late payment interest)

Another suggestion for encouraging timely filing was to improve access to support from HMRC, such as through HMRC’s telephone helpline. Participants suggesting improved access to support felt this would make the process of filing VAT returns seem less onerous and mean that customers would be less likely to delay or avoid filing their returns.

"Someone in a small business doesn't have 45 mins to wait to get through on the phone, and they should bear that in mind so that they can't just hang up on customers when they can't pass security, they need help. " (Customer recruited for late payment penalty)

Some customers also suggested offering incentives to reward timely VAT filing, in the form of prize draws, discounts on VAT payments and cancelling of penalty points. There were also suggestions to lower the £200 penalty for breaching the late submission points threshold. Participants had mixed views about whether this amount was appropriate for all types of customers. £200 was seen as too punitive for those already struggling financially but viewed as an insufficient deterrent for those choosing not to comply.

6.2 Customer suggestions to encourage timely VAT payments

Suggestions for encouraging timely VAT payment were largely focused on what HMRC could do to support small businesses whose financial struggles made it difficult to pay on time.

Customers proposed changes which would allow greater payment flexibility. For example, allowing monthly or real-time payments to help businesses better manage cash flow.

As with encouraging timely filing, customers felt that HMRC could encourage timely payment by making it easier to access support. Customers were sometimes reluctant to contact HMRC, as they found it to be a difficult and time-consuming process. Therefore, making support more accessible could make it easier for customers to set up payment plans or discuss payment difficulties with HMRC ahead of the VAT payment deadline.

Customers also reported that they would like to see HMRC take a more supportive, rather than punitive approach to VAT. They felt that HMRC should acknowledge that most businesses want to comply and should not be penalised for factors largely outside of their control. This should involve helping businesses avoid penalty charges where possible, by making it easy to set-up payment plans and providing proactive support for those facing financial difficulties.

"HMRC should be more accessible. If you have a reason for late payment, if you could contact someone to explain why. If there are genuine cases, or someone is starting on a new regime, there should be more support if you don't understand something so you can just check that you're doing it properly. I imagine most people really do want to get it right and pay their taxes fairly." (Late payment interest)

Some customers thought that HMRC should raise awareness of penalty charges and how this may impact businesses. Whilst customers acknowledged that increased awareness was likely to have minimal impact on compliance behaviour, they felt it could be helpful for businesses in determining financial priorities when they are struggling.

"It would be helpful to know how much the penalty would be. If I knew it was going to be 1% I might struggle on and pay the 1% whereas if was going to be 20% I might have to use a loan shark." (Customer recruited for late payment interest)

Finally, as with encouraging timely filing, some customers felt that there was little HMRC could do to encourage timely VAT payment. Those who had nil returns or had set up direct debits believed actions taken by HMRC to encourage timely payment would not apply to them. Businesses that had failed to pay on time typically felt their financial issues were unavoidable and there was little HMRC could do to help (see pen portrait 2).

7. Conclusion

This concluding section sets out a summary of the key findings against the research objectives and potential implications to emerge from thosefindings.

7.1 Summary of findings

The findings from this research are summarised below against each of the research aims:

• awareness: awareness and understanding of the new regime were limited in the sample, even among those who had received a penalty. There was also a sense that customers did not particularly want to engage with the penalty regime. Penalties were not something participants prioritised, and they therefore either ignored or struggled to engage with the detail. This included engaging with the summarised descriptions of the changes as presented to participants during the research.

• perceptions: perceptions of fairness and proportionality of the current penalty regime (when explained) were more favourable compared to the previous regime. When prompted, customers largely recognised that elements of the current regime were fairer and more proportionate. Specifically, they noted the fairness of the introduction of late submission penalty points, the grace period for payment penalties, and the changes to repayment interest.

  • however, concerns remained that the regime was overly punitive for those with limited control over their ability to comply (for example, due to financial difficulties or substantial life or business events). This in turn had a negative impact on these customers’ attitudes towards HMRC. Some of those with nil returns felt frustrated about late submissions being penalised but felt the newer system was fairer due to the penalty points system.

• impact: the perceived impact of the new penalty regime on behaviour varied considerably, dependent on the type of penalty received. Late submission points prompted positive small changes to improve timeliness of submissions. Late payment penalties prompted larger and more far-reaching changes for affected businesses, including setting up direct debit payments, putting money aside, switching to an accountant or software, or shifting to flat rate or cash accounting.

  • however, the findings also revealed that customers already using some of these approaches could still struggle to remember deadlines for VAT reporting and payment. This suggests there is still room for process improvements, even for those with relatively sophisticated tax management approaches.

7.2 Implications

The research findings suggest several implications for improving customer compliance, perceptions of fairness and proportionality, and awareness of the regime.

To improve customers’ compliance behaviour there are several lessons from this research that could be applied more widely. For example, promoting some of the positive behaviours that had been established by customers after receiving a penalty. This could include nudging customers to set up submission and payment reminders, direct debits for VAT payments, and savings accounts to hold VAT funds.

It may also be helpful to prompt customers to review their accounting approaches and signpost them to additional help where necessary. This could include general financial management support, or strategies to support those who may face challenges with literacy, numeracy or administrative organisation.

To improve perceptions of fairness and proportionality of the penalty regime there are potential lessons from the experiences of participants who felt they had been treated unfairly during the penalty process. This could include increasing the awareness of the appeals process and improving the accessibility, tone and consistency of helpline support.

There are also implications for supporting customers struggling with financial difficulties who are more likely to perceive penalties as disproportionately punitive. This could include signposting to support with setting up payment plans or prompting them to consider alternative VAT approaches, such as flat rate or cash accounting.

Finally, the research explored ways to improve awareness of the penalty regime. The findings indicate that customers are unlikely to engage with the regime until they are penalised, which implies that the priority for raising awareness and understanding should focus on improving penalty notifications. That said, participants did suggest that it would be helpful to enhance the clarity of language used to describe the regime and welcomed more tangible worked examples and visual guides to explain some of the concepts.