Default. The default surcharge regime for VAT is unlike the normal penalty charging rules for other taxes. You go into default if you either submit a VAT return after the due date or pay all or some of the VAT shown on the return late. The good news is that a default surcharge penalty is only based on the tax unpaid by the due date, so there will be no penalty if the VAT return shows a repayment or in situations where you have paid the tax by the due date but for some reason have not submitted the return.
Percentages. On the first occasion of a default HMRC will issue a surcharge liability notice, warning that if you default again within the next twelve months, you will incur a default surcharge of 2% of the unpaid tax. This percentage rises to 5%, 10% and 15% each period until the business has a clean record for a full twelve-month period. It then reverts to the beginning again, i.e. you will receive a surcharge liability notice in the event of a default. If a surcharge is less than £400 for either the 2% or 5% period, then it is waived.
Case. So how did this company end up with a huge penalty the first time it was late paying? The problem was that whilst it had always paid on time, it was in default (at the 10% level) due to its haphazard filing history. So even though it had never paid late, its late returns meant a surcharge applied as soon as it did. The tax due was an eye-watering £3 million – hence the huge penalty.
Lesson. It is crucial to understand that the surcharge regime is triggered by either late filing or late payment – there aren’t two regimes for each type of default. You can avoid a penalty whilst you are in the regime by making sure you pay on time. However, the best way to avoid a penalty is to establish good filing habits, and putting aside cash for paying the VAT each quarter. Tip. If cash flow is a problem, consider the cash accounting scheme.