Being an entrepreneur comes with many responsibilities, with tasks ranging from attending networking events and developing a marketing strategy to ensuring you hire the right people and having your finances in order.

External factors such as stock market crashes, a pandemic, inflation, and recessions can be detrimental to a business’ success. But so too can internal mistakes, such as not keeping payroll information up-to-date, not paying employees on time or even errors related to Value Added Tax (VAT). Errors related to VAT can be disastrous for business owners.

That’s why in this post we’ll explore what the VAT penalties are and how to avoid them, so you stay out of trouble.

What is VAT?

First let’s start with some basics, namely what exactly VAT is. The standard VAT rate is 20% — tax that’s tacked on to the purchase price of certain goods, services, and other taxable supplies within the UK. For some health, energy, heating, and protective products and services this rate is 5%. Finally, some sectors like public transport, publishing, and essential goods and services are zero-rated, meaning they don’t have an added VAT rate.

When to register for VAT

If your business has an annual taxable turnover of more than £85,000, you must register for VAT and may be fined if you don’t. Businesses with an annual taxable turnover of less than £85,000 can choose to register for VAT. Lastly, businesses that sell only VAT-exempt goods and services are not allowed to register for VAT.

VAT registration requires a National Insurance (NI) number or your tax identifier — Unique Taxpayer Reference (UTR), as well as information about other businesses you’ve owned within the past two years, and your business bank account details. If you purchased an existing business, you’ll have to provide the sales record.

Making Tax Digital for VAT

This all ties into Making Tax Digital (MTD), which is Her Majesty’s Revenue and Customs (HMRC)’s initiative to create a more effective and efficient tax system in the UK. Essentially, HMRC’s goal is to “become one of the most digitally advanced tax administrations in the world.” That’s because taxpayers will be providing HMRC details of their revenue and costs using accounting software on a quarterly basis, rather than completing an annual return.

Common VAT errors

Now that you have an overview of what VAT is, it’s important to comply with the regulations in order to avoid costly mistakes.

Here are some common VAT errors that businesses make:

  • Poorly maintained records (e.g. missing sales from your returns, late filing of returns or late payments, claiming VAT without purchase invoices).
  • Deposits for goods or services — using cash accounting for sales and invoice accounting for purchases.
  • Claiming bad debts, which are loans or outstanding balances that a business deems uncollectible, too early. These can’t be claimed until six months past the due date.
  • Claiming VAT for entertainment purposes not related to staff of the business, such as taking a client out for lunch.
  • Non-standard business transactions, such as cash sales, supplies of staff, and cross-border transactions.
  • VAT related to property is extremely complex and businesses should seek professional advice for matters like property purchases, and construction services and building.

It can be really easy for entrepreneurs to make honest errors given that there are so many rules related to VAT.

VAT Penalties

HMRC will record a “default” on your account if you miss the deadline for submitting your VAT return. Once this occurs, you’ll be in a 12-month “surcharge period.” During this time, if you default again, HMRC could apply a surcharge to your VAT payment and will extend your surcharge period for an additional 12 months.

Late payment penalties for VAT returns vary depending on the defaults within a surcharge period and your annual turnover. Surcharges start at 2% (if annual turnover is £150,000) for the second default within 12 months and goes up to 15% or £30 (whichever is more) for six or more defaults within 12 months.

You won’t have to pay a surcharge for submitting a late return if you:

  • Pay your VAT in full by the deadline.
  • Don’t have any tax to pay.
  • You’re owed a VAT repayment.

Additionally, HMRC can apply the following penalties to your VAT return:

  • £400 if you submit a paper return instead of submitting one online.
  • 30% of an assessment if HMRC isn’t informed (within 30 days) of a discrepancy involving a VAT assessment that is less than the VAT liability.
  • 100% of any tax under-stated or over-claimed if an inaccurate return is submitted, whether it’s deliberate or by accident.
  • 5%-15% penalty for not properly registering your business for VAT on time.

You may be charged 4.75% interest if you:

  • Report less VAT than you charge, or reclaim more than you pay.
  • Pay an assessment that HMRC later finds was too low.
  • You owe HMRC VAT due to an error on your VAT return.

How to avoid VAT Penalties

Given how strict HMRC is with compliance, it’s important to understand the rules and ensure you have good business practices in place to avoid financial penalties. Ensure your bookkeeping is accurate, clear, and up-to-date at all times to avoid incorrect VAT returns. For example, businesses should be keeping records of sales and purchases and issue correct VAT invoices.

VAT-registered businesses must use compatible payroll software. Look for software that can provide HMRC with information and VAT returns from the data stored in digital records, can receive information from HMRC, and can store digital records.

Speaking of records that are stored digitally — these should include information like your business name, address, and VAT registration number, adjustments from calculations you make outside your software for any VAT accounting schemes you use, any adjustments you make to a return, and your reverse charge transactions.

Late submission penalties can easily be avoided, so just be aware of deadlines for VAT returns. For most businesses this equates to quarterly returns.

Don’t make a costly mistake

As a business owner, the last thing you want is to be hit with financial penalties because you submitted incorrect VAT returns, missed a crucial deadline, or weren’t using compatible software with HMRC. You can easily avoid VAT penalties by understanding the rules and regulations, maintaining digital records, and using functional accounting software.

Keep your head above water with an accountant

Before making careless mistakes with your VAT return and facing financial consequences, seek assistance. To help ensure you’re remaining compliant and submitting your VAT return on time, start by requesting a consultation right here from one of our London accountants. Having one less thing to worry about will help you focus on other aspects of your business.