Nearly 2.4 million VAT-registered businesses in the UK are now operating under a penalty system that replaced the old default surcharge regime in January 2023. Yet around one in five of those businesses still report difficulties submitting their returns on time, according to HMRC research published in 2026. The same research found that 22% struggle to pay what they owe on time, typically because of cash flow pressure or limited administrative capacity.
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This article is general information only and does not constitute professional advice. For your specific situation, consult a qualified professional.
The system is not static. From April 2026, Making Tax Digital for VAT becomes mandatory for every VAT-registered business, not just those above the threshold. New digital channels for the option to tax are coming before the end of 2026. And the government is consulting on making Direct Debit the mandatory payment method for VAT liabilities. Each change adds a layer of process that businesses that are already stretched have to absorb.
Here’s what you actually need to know.
Understanding the New VAT Penalty Landscape
Before January 2023, a late VAT submission triggered a default surcharge that escalated with each subsequent failure. That system has been replaced by a points-based approach. Each late submission earns a penalty point. Reach a threshold of points — four for quarterly filers, five for annual filers — and you receive a fixed £200 penalty. Additional late submissions while at the threshold add more £200 penalties. The points reset only after a period of compliant filing — typically 12 months of submitting on time.
Late payment penalties work differently. They are calculated as a percentage of the VAT owed, starting at 2% on day 15, rising to 4% on day 30, and then 4% per annum on the outstanding amount. What I tend to notice is that businesses often confuse the two systems. The points system is about submission timing. The percentage system is about payment timing. They run in parallel, and you can trigger both at once without realising it.
The Real Cost of Getting VAT Wrong
The financial exposure is not abstract. A business that files its VAT return late and pays late faces both a fixed penalty under the points system and a percentage penalty on the payment. For a business with a £20,000 quarterly VAT bill, a 30-day delay in payment alone triggers a 4% penalty — £800. Add the late submission penalty on top, and the cost climbs quickly.
The research also found that 52% of businesses preferred the old late payment penalty system, compared with only 31% who prefer the new regime. That tells you something about how the new system feels on the ground. It is not necessarily easier — it is more structured, but also more rigid. For businesses that are already dealing with cash flow pressure from inflation and rising costs, an unexpected VAT penalty can compound existing strain.
There is also the reputational dimension. Persistent non-compliance can trigger more frequent HMRC compliance checks, which take time and attention away from running the business.
Where Businesses Slip Up on VAT Compliance
Not understanding the difference between submission and payment penalties
Many businesses treat a late VAT return as a minor administrative slip. Under the points system, one late submission puts you one point closer to a £200 fixed penalty. But the late payment penalty is calculated on the amount you owe, not on a fixed basis. A business that submits on time but pays a week late still faces a 2% penalty on the full amount. The two systems operate independently, and both can hit in the same quarter.
Assuming the old rules still apply
HMRC research found that 44% of VAT-registered businesses were not aware that the penalty system changed in January 2023. That is a large proportion of the 2.4 million businesses affected. If you are operating on the assumption that a late return triggers a warning letter followed by a surcharge, you are missing the fact that the points system accumulates silently. By the time you realise you have reached the threshold, you may already have triggered multiple penalties.
Ignoring the appeals process
Fewer than 1 in 6 businesses that received a penalty used the appeal process, according to the same HMRC research. Among those who did not appeal, 34% said they had difficulty finding support or understanding why the penalty was applied in the first place. The online appeals process is something you can do yourself, but if you do not understand the reason for the penalty, it is hard to know what to challenge. Keeping a clear record of your submission dates and payment confirmations makes a significant difference here.
Overlooking the digital transition
From 1 April 2026, Making Tax Digital for VAT is mandatory for every VAT-registered business, regardless of turnover. That means you must use MTD-compatible software and maintain digital links between your records and your VAT returns. The government is also exploring the use of supplementary VAT data beyond the current nine-box return format, according to MHA insights on the 2026 Tax Update. If your accounting system is still paper-based or relies on manual data entry, the transition period is shorter than you might think.
What You Need to Do About VAT in 2026
Get MTD-compatible software in place before April 2026
Mandatory MTD for all VAT-registered businesses starts on 1 April 2026. If you are not already using MTD-compatible software, you need to choose one and set it up. The software must be able to keep digital records and submit VAT returns directly to HMRC through the MTD pathway. This is not optional. If you are using spreadsheets, you will need bridging software that links your data to the HMRC system. Many accounting platforms already offer MTD-compatible features, so check whether your current setup qualifies.
Understand the points threshold and how to reset it
For quarterly filers, four late submissions trigger a £200 penalty. For annual filers, the threshold is five. The points reset only after 12 months of on-time submissions — not after paying the penalty. That means a business that receives a penalty in March cannot simply pay it and move on. It must file every subsequent return on time for a full year to reset its points total. Missing one return during that period keeps the clock running.
→ Scroll right to see all columns
| Penalty Type | Old System (pre-2023) | New System (from Jan 2023) |
|---|---|---|
| Late submission | Escalating surcharge (2% to 15%) based on previous defaults | Points-based system: fixed £200 penalty after 4 points (quarterly) or 5 points (annual) |
| Late payment | Escalating surcharge on unpaid VAT | 2% at day 15, 4% at day 30, then 4% per annum |
| Reset mechanism | No automatic reset; surcharge rate carried forward | Points reset after 12 months of on-time submissions |
Prepare for the option to tax going digital
The option to tax process — which allows businesses to charge VAT on otherwise exempt commercial property transactions — is moving from paper-based submission to a digital channel. HMRC expects the new system to be live before the end of 2026, according to Crowe’s analysis of the 2026 Tax Update. If you deal with property transactions, you will need to submit option to tax notifications and revocations through the new digital portal. Bulk uploads will be supported, which is useful for businesses with multiple properties.
E-invoicing is coming, but not yet
E-invoicing using the Peppol network will be mandated from 2029, with a detailed roadmap expected at the Autumn Budget. The government is also exploring Continuous Transaction Controls (CTC), which would require real-time or near-real-time transaction data to be submitted to HMRC. That is unlikely before 2030, according to the Crowe guidance, but the direction of travel is clear. VAT data is moving from periodic returns to continuous reporting. If you are choosing accounting software now, it is worth selecting a platform that supports Peppol e-invoicing or can be upgraded to do so.
Review payment controls for the mandatory Direct Debit proposal
The government is consulting on making Direct Debit the mandatory payment method for VAT liabilities, with a consultation running until 16 August 2026. If this goes ahead, businesses that currently pay by bank transfer or cheque will need to set up a Direct Debit mandate. This is still under consultation, so no action is required yet, but it is worth checking whether your business bank account supports Direct Debit for HMRC payments. If you are already using MTD-compatible software, the payment process can often be integrated directly.
Frequently Asked Questions About VAT Compliance
What happens if I miss the VAT registration threshold by one month? ▾
Can I appeal a late submission penalty? ▾
Do I need MTD-compatible software if I file my VAT return manually? ▾
What is the difference between a late submission penalty and a late payment penalty? ▾
What if my business is seasonal and I only trade for part of the year? ▾
Will the VAT registration threshold change in 2026? ▾
The Digital Shift Is Not Optional
The 2026 changes are not a one-off adjustment. The combination of mandatory MTD, digital option to tax, e-invoicing from 2029, and the potential move to Continuous Transaction Controls means that VAT compliance is moving from a quarterly event to a continuous digital process. Businesses that treat VAT as a four-times-a-year task will find the gap between their current process and the required standard widening each year.
If you are still using paper records, spreadsheets without bridging software, or manual payment methods, the practical work of switching needs to start now. The cost of upgrading accounting software, reviewing data quality, and setting up Direct Debit is real, but it is smaller than the cumulative cost of penalties from a system you did not fully understand.
Remember: this article is general information only. For advice on your specific situation, speak to a qualified professional.
If this was useful, you might also want to read Managing Excessive Overhead Expenses in UK Businesses.
Sources and Further Reading
The Inflation Crisis: Strategies for UK SMEs to Survive and Thrive — Explores how rising costs including VAT compliance burdens affect small business cash flow.
UK Businesses Face Legal Turmoil Amid Challenges — Covers the regulatory and legal landscape UK businesses need to navigate, including tax compliance risks.
HMRC (2026). Tax Update 2026: Simplification, Modernisation and Fairness — Summary. 🔗
MHA (2026). HMRC Tax Update 2026: VAT and customs changes businesses should prepare for. 🔗
Crowe (2026). UK Tax Update: VAT Measures. 🔗
TAJ Accountants (2026). VAT in the UK 2026: A Step-by-Step Guide for Businesses. 🔗
