VAT Update – Spring 2026

Welcome to our Spring VAT update for 2026.

In this edition Paula Mason, VAT Manager covers everything you need to know about VAT penalties. From when they apply, to examples of how the numbers work out, and details of what you can do to reduce them. She also shares the most recent updates to VAT caselaw.

VAT Penalties

Penalties for failure to register for VAT

If your taxable turnover exceeds the VAT registration threshold of £90,000, HMRC need to be informed within 30 days.  If you fail to notify HMRC or do not notify on time, then HMRC may charge a Failure to Notify Penalty.

The penalty is not charged if there is a , it was not deliberate and HMRC are notified without unreasonable delay after the reasonable excuse has ended.

Penalties for unprompted disclosures, where your disclosure is made to HMRC before they discover the failure to notify,  will result in a lower minimum penalty than prompted disclosures.

Penalties may also be reduced based on HMRC’s view of whether you’re helpful in assisting them with their enquiries after making a disclosure.

Any penalty imposed is calculated in 8 stages:

1. The penalty is a percentage of the Potential Lost Revenue, i.e. the amount that arises as a result of the failure to notify.
2. Behaviour of the taxpayer – whether Non-Deliberate, Deliberate but not Concealed or Deliberate and Concealed.
3. Whether the disclosure was Unprompted or Prompted.
4. The penalty range is then based on points 2 and 3 above and the time lapsed since the VAT was due. For example, if behaviour is Non-Deliberate and the disclosure is Unprompted and made within 12 months of the VAT being due, the penalty range is 0-30% of the Potential Lost Revenue.
5. Reductions are given for providing assistance and length of time taken for the disclosure to be made.
6. The penalty percentage rate is calculated using points 4 and 5 above.
7. The amount of the penalty is calculated by multiplying point 1 by point 6.
8. Any other applicable reductions are then added.

Penalties for late submission of VAT returns

If returns are submitted late, i.e. more than one month and 7 days after the VAT period ends, late submission penalties apply according to a points-based system.

For each VAT return submitted late a penalty point will be applied until the penalty point threshold is reached.

The penalty point thresholds are as follows:

For Monthly Returns              5

For Quarterly Returns            4

For Annual Returns                2

Different rules apply for non-standard accounting periods and adjustments are made if VAT periods are changed.

When the penalty point threshold is reached, a penalty of £200 is then applied, with a further £200 penalty applied for each subsequent return submitted late.

If the penalty threshold has not been reached, individual points expire automatically, usually 24 months after the deadline missed.

Even if the threshold has been reached, all points can be removed by meeting two conditions:

1) Completing a period of compliance (submitting all returns on time) and

2) Submitting all outstanding returns for the previous 24 months (which includes the period of compliance).  This can result in all the points being removed quicker.

Example:

ABC Limited submits quarterly VAT returns.

Having submitted their returns late for the quarters ending 31 March 2023, 30 June 2023, 30 September 2023 and 31 December 2023, they reach their penalty threshold of 4 points.

To remove these points they can meet the first condition by submitting 12 months of VAT returns on time.

This period of compliance starts the first day of the month following the day after the missed deadline for the VAT period. So in this case, the period of compliance starts on 1 March 2024, as the first day of the month following the missed deadline of 7 February 2024.

They therefore have to submit the returns due between 1 March 2024 and 28 February 2025 on time in order to meet the first condition.

To meet the second condition, the Company has to submit all outstanding VAT returns due in the previous 24 months, including the period of compliance. So this would be 1 March 2023 to 28 February 2025.  If they do this their penalty points will then reduce to zero on 28 February 2025.

Late Payment of VAT 

If any VAT payment is paid late, late payment interest will be charged from the day after the payment is due until payment is made.  The interest is calculated at the Bank of England base rate plus 4%.

Example:

ABC Limited submits quarterly VAT returns.

Their VAT return for the quarter ending 31 December 2025 was due to be submitted by 7 February 2026.  They submitted the VAT return on time but did not pay the VAT due of £5,000 until 20 February 2026.

Therefore the late payment interest charged using the current Bank of England base rate of 3.75% will be:

£5,000 x 7.75% x 13/365 days = £13.80

Additionally, late payment penalties apply to VAT returns, amendments/corrections to VAT returns and VAT assessments issued by HMRC once payment is overdue by 16 days.  They do not apply to VAT payments on account or instalments under the VAT Annual Accounting Scheme.

For payments made between 16 and 30 days overdue, a first late payment penalty applies which is calculated as 3% of the VAT owed at day 15.

For payments made after being more than 31 days overdue, a first late payment penalty applies which is calculated as 3% of the VAT owed at day 15 plus 3% of what is outstanding at day 30.

A second late payment penalty also applies which is calculated at a daily rate of 10% per year on the outstanding balance and this is charged daily from day 31 until paid in full.

There is a two-year assessment time limit that applies to late payments of VAT which means that if the outstanding balance is still unpaid before this time limit expires, HMRC will charge a second late payment penalty at 10% from day 31 to the date when the penalty is assessed by them.

Late payment interest also applies to late payment and late submission penalties.

Examples:

Using the same amount due as in the example above:

If payment is made 25 days after the date due:

First Late Penalty:

£5,000 x 3% = £150.00

Plus

Late Payment Interest:

£5,000 x 7.75% x 25/365 days = £26.54

If payment is made 50 days after the date due:

First Late Penalty:

£5,000 x 3% = £150.00 (amount owed at day 15) + £5,000 x 3% = £150.00 (amounted owed at day 30) = £300.00

Plus

Second Late Penalty:

£5,000 x 10% x 20/365 days = £27.39

Plus

Late Payment Interest:

£5,000 x 7.75% x 50/365 days = £53.08

If payment remains unpaid at 1 February 2028:

First Late Penalty:

£5,000 x 3% = £150.00 (amount owed at day 15) + £5,000 x 3% = £150.00 (amounted owed at day 30) = £300.00

Plus

Second Late Penalty:

£5,000 x 10% x 694/365 (10 March 2026 to 1 February 2028) = £950.68

Plus

Late Payment Interest (assuming paid on 7 February 2028)

£5,000 x 7.75% x 730/365 = £775.00

How to reduce VAT penalties

A Time to Pay arrangement can be put in place at any time if you’re unable to pay what is owing.  This is flexible and individual to the business’ circumstances and can result in lower or no payment penalties.  It can also cover payments, penalties and interest.

Late payment interest will still be charged however, until the amount owing is paid in full. If the conditions of the arrangement are not met at any time, the arrangement can be cancelled and penalties can be charged as if it never existed.

Late payment penalties are conveyed by HMRC in a decision letter.  An offer is made in the letter for a review to be made and if this is taken up, a review officer will complete a review within around 45 days, unless you’re advised it will take longer.  Once the review has been completed, the decision may either be upheld, varied or cancelled.  If you disagree with the result of the review, an appeal can be made to a tax tribunal, usually within 30 days of the review date.  No payment needs to be made before the review or appeal decision is made.

It is also possible to challenge a penalty if you have a reasonable excuse, for example, if a close relative died shortly before the VAT return or payment deadline.

VAT Caselaw Update

Aspire in the Community Services Limited (“ACSL”) v HMRC [2026] TC09789

Background:

ACSL is the representative member of a VAT Group with Aspire in the Community Ltd (“ACL”) being a Group member.  The VAT Group was registered with effect from 1 May 2021.

ACL was regulated by the CQC and had provided exempt welfare services since 2009 to clients including local authorities and clinical commissioning groups.  ACSL was incorporated in 2011.  ACSL became the supplier to these local authorities and clinical commissioning groups from November 2021 (before that making no taxable supplies) and, as they were not regulated by the CQC, their supplies were standard rated rather than exempt.  The VAT Group was therefore partially exempt.

In their first VAT return for the period ending July 2021, the VAT Group included a claim for input tax incurred both before and after the effective date of registration (“EDR”).  This included a claim for a proportion of VAT incurred on goods on hand at the EDR, a proportion of VAT incurred on services up to six months prior to the EDR, and a proportion of VAT incurred on purchases made after the EDR.  The proportions calculated were based on a use-based method and compared funding received from public bodies to the total value of funding received giving them a recovery rate of 76%.

HMRC disputed their calculations and proposed that:

Regarding goods on hand, a two-stage calculation was used whereby the value of the goods at the EDR was depreciated based on an economic life of 5 years. A recovery rate based on projected taxable supplies over the 4 years after the EDR was then applied to these depreciated values to work out the deductible input tax.

Regarding services purchased up to six months prior to the EDR, these were given economic lives of 5 or 10 years and deduction was allowed using the same recovery rates as for the goods on hand.

Regarding VAT incurred on goods purchased made post EDR, a recovery rate of 77% based on projected taxable use.

Regarding VAT incurred on services post EDR, these were disallowed on the basis that the costs were revenue costs and had been consumed in making exempt supplies before 1 November 2021.

ACSL disagreed with HMRC and appealed to the First Tier Tribunal.

First Tier Tribunal (“FTT”)

The FTT allowed the appeal finding that once identified, pre-registration input tax is treated as incurred in the first VAT return after registration and that the use based partial exemption recovery rate should be based on the intended future use of the goods or services, i.e. any pre-registration use should be disregarded.

Comments

This decision has a significant impact on businesses that switch from providing exempt services to taxable services and how pre-registration input tax is calculated. There are several other appeals by businesses in the care sector raising similar issues relating to pre-registration VAT either postponed or waiting behind this appeal so it wouldn’t be surprising to see HMRC appeal the decision.

We’re here to help

For more information and support on VAT penalties speak to Paula or one of the team by calling  0330 058 6559 or email hello@scrutton.bland.co.uk