Policy paper

Penalties for late payment and interest harmonisation

Updated 17 November 2023

Introduction

The Government is reforming sanctions for late submission and late payment to make them fairer and more consistent across taxes. The changes will initially apply to VAT and Income Tax Self Assessment (ITSA). As part of this reform, interest charges and repayment interest will be harmonised to bring VAT in line with other tax regimes, including ITSA.

The changes now apply to VAT customers for accounting periods beginning on or after 1 January 2023.

For ITSA customers, the changes will apply as customers become mandated to Making Tax Digital (MTD). This means:

• for businesses, self-employed individuals and landlords with income over £50,000 per year from the tax year beginning 6 April 2026
• for businesses, self-employed individuals and landlords with income over £30,000 per year from the tax year beginning 6 April 2027

For all other ITSA customers outside the scope of MTD, the changes will apply after the introduction for MTD taxpayers.

This technical note accompanies the draft legislation and explanatory note for the new late payment penalties and interest harmonisation and should be read in conjunction with the accompanying technical note for new late submission penalties.

Late payment penalties

The new late payment penalties will apply to payments due from VAT businesses and ITSA taxpayers. For ITSA taxpayers, the new regime will replace the current late payment penalties in schedule 56 of the Finance Act 2009 (schedule 56 of FA 09). For VAT businesses, it will replace the Default Surcharge, which served as a combined late submission and late payment sanction.

Overview of how the new late payment penalties work

There are two late payment penalties that may apply; a first penalty and then an additional or second penalty, with an annualised penalty rate. All taxpayers, regardless of the tax regime, have a legal obligation to pay their tax by the due date for that tax.

First penalty

The taxpayer will not incur a penalty if the outstanding tax is paid within the first 15 days after the due date. If tax remains unpaid after day 15, the taxpayer incurs the first penalty. This penalty is set at 2% of the tax outstanding after day 15. If any of this tax is still unpaid after day 30, the penalty will be calculated as 2% of the tax outstanding after day 15 plus 2% of the tax outstanding at day 30. In most instances this will amount to a 4% charge at day 30.

Additional or second penalty

If tax remains unpaid on day 31, the taxpayer will begin to incur an additional penalty on the tax that remains outstanding. It accrues on a daily basis, at a rate of 4% per annum on the outstanding amount. This additional penalty will stop accruing when the taxpayer pays the tax that is due.

Time-to-Pay arrangements

HMRC will offer taxpayers the option of requesting Time-to-Pay (TTP) arrangement. This enables a taxpayer to stop a penalty from accruing any further by approaching HMRC and agreeing a schedule for paying their outstanding tax. A TTP arrangement, if agreed, has the same effect of paying the tax and stops penalties accruing from the day the taxpayer approaches HMRC to agree it, as long as the taxpayer continues to honour the terms of the TTP agreement. The examples below illustrate how TTPs work, and the effect of a TTP is shown in this chart:

Days after payment due date	Action by customer	Penalty
0-15	Payments made or TTP is proposed by day 15 and then agreed	No penalty is payable
16-30	Payments made or TTP is proposed by day 30 and then agreed	Penalty will be calculated at half the full percentage rate (2%)
Day 30	Some tax is still unpaid, no TTP agreed	Penalty will be calculated at the full percentage rate (4%)

If tax is still unpaid on day 31 a second, additional penalty will start to accrue at 4% per annum.

Example 1

The taxpayer owes £1,000, which they fail to pay on the due date. They approach HMRC asking for a TTP arrangement on day 11 and they subsequently agree with HMRC a schedule to pay off the debt.

By approaching HMRC for a TTP arrangement, and subsequently agreeing one, the taxpayer enjoys the same benefit of paying their tax on day 11. Their position is the same as it would be if they had paid their tax on day 11 — there will be no penalty. Late payment interest will continue to accrue on any outstanding amounts.

Example 2

Again, the taxpayer owes £1,000 and fails to pay by the due date. By day 15 they have already incurred the first penalty at 2% — £20. They approach HMRC asking for a TTP arrangement on day 20 and subsequently agree with HMRC a schedule for paying off their debt.

By agreeing a TTP arrangement, the taxpayer enjoys the same benefit of paying their tax on day 20. Their position is the same as it would be if they had paid it on day 20; the penalty is charged at 2%. Late payment interest will continue to accrue on any outstanding amounts.

Example 3

This time the taxpayer has failed to pay their tax by day 30 and has already incurred the first penalty amounting to £40 (or 4%). They have still not paid by day 40 and have incurred 10 days’ worth of the additional or second penalty at 4% per annum. They approach HMRC on day 40 and agree a schedule for paying off their debt.

By agreeing a TTP arrangement, the taxpayer enjoys the same benefit of paying their tax on day 40. The second penalty stops accruing and they are only charged the additional penalty for days 31 to 40. Late payment interest will continue to accrue on any outstanding amounts.

Where HMRC might not assess a late payment penalty

HMRC has discretionary power to reduce or not to charge a penalty for late payment if it considers that appropriate in the circumstances. This will include where there are special circumstances that cause a taxpayer to pay their tax late.

HMRC recognises that moving to the new system of late payment penalties is a significant change for some customers, especially those who might have more difficulty in getting in contact with HMRC within 15 days of missing a payment to begin agreeing a Time-to-Pay arrangement. HMRC will therefore take a light-touch approach to the initial 2% late payment penalty for customers in the first year of operation of the new system under both VAT and ITSA.

Where a taxpayer is doing their best to comply, HMRC will not assess the first penalty at 2% after 15 days, allowing taxpayers 30 days to approach HMRC in the first year before HMRC charges a penalty. However, if a taxpayer has not approached HMRC by the end of day 30 and there is still an amount of tax outstanding, the first penalty will be charged according to 2% of the amount outstanding at day 15 plus 2% of what is still outstanding at day 30. In most instances this will amount to a 4% penalty.

Additionally, there is no penalty due if the taxpayer has a reasonable excuse for late payment. If HMRC is satisfied a taxpayer has a reasonable excuse HMRC will agree not to assess. This will prevent the taxpayer from unnecessarily having to appeal.

HMRC also has discretionary power to reduce or not to charge a penalty for late payment if it considers that appropriate in the circumstances. This will include where there are special circumstances that cause a taxpayer to pay their tax late. HMRC will actively consider all cases where this might be the case.

If HMRC decides not to use its discretionary power or does not agree that a taxpayer has a reasonable excuse for late payment, the taxpayer must use the appeals and review process to challenge a penalty. Where the reasonable excuse for late payment comes to an end, the taxpayer will not incur a late payment penalty if they then pay the tax promptly.

Reviews and appeals

A taxpayer will have the right to appeal against each late payment penalty that is assessed. They can challenge an assessment both through an internal HMRC review process and also by an appeal to the courts (the First Tier Tax Tribunal). The grounds for appeal may vary and include having a reasonable excuse for missing a filing deadline. The appeal process will be the same as the appeal process against an assessment of the tax on which the penalty is based.

Interest harmonisation

HMRC charges late payment interest as a form of recompense for the use of money that is owed, ensuring fairness by preventing those who do not pay on time from gaining financial advantage over those who do. Similarly, where amounts have been overpaid, HMRC pays interest on that overpayment.

Interest harmonisation provides a set of rules that ensures interest is consistently and automatically charged and paid in all cases where amounts are paid late or where amounts have been overpaid, bringing VAT in line with other tax regimes, including ITSA.

How the new late payment and repayment interest charges work

HMRC will charge late payment interest on tax that is outstanding after the due date, irrespective of whether any late payment penalties have also been charged. The late payment interest will apply from the date the payment was due until the date on which it is received by HMRC. Late payment interest will be calculated as simple interest at a rate of 2.5% plus the Bank of England base rate.

Where a taxpayer has overpaid tax, HMRC will pay Repayment Interest (RPI) on any tax due to be repaid (the difference between the amount due and the amount paid) either from the last day the payment was due to be received or the day it was received, whichever is later, until the date of repayment. RPI will be paid at the Bank of England base rate less 1% (with a minimum rate of 0.5%).

Late payment interest and Time-to Pay arrangements

Late payment interest is charged when tax is paid late. HMRC will always try to help taxpayers in temporary financial difficulty to manage payment of their debt. Late payment interest will continue to accrue on amounts not paid on time even if those amounts are included in Time-to-Pay arrangement.