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  • Writer's pictureInchmead

Reducing the risk of VAT penalties

The points-based system of penalties for VAT errors and non-compliance makes it essential to keep on top of payments, warns Liz Maher, indirect tax director, Xeinadin Group



VAT has always been an administrative burden to businesses and the system remains more complex than it should. Similarly, because VAT processes and controls are not covered by the requirements of an annual audit, it is often a risk area that is overlooked.


As a consequence, more businesses than ever are being issued penalties at the hands of HMRC for VAT inaccuracies thanks to errors driven by complexity.

Financial penalties over VAT inaccuracies are now commonplace. HMRC issued over 66,000 penalties for inaccuracies on VAT in the tax year 2021-22, a 66% increase on the previous year and a 63% increase on 2019-20. The collective value of penalties issued was over £159m – a 26% increase on the previous year and a 32% rise on 2019-20.


Following the latest HMRC tax gap figures showing that £42bn of taxes had not been collected last year – 5% of the UK’s tax burden – HMRC said that it would hire 2,500 more staff to support its compliance teams to investigate non-payment, and prioritise the collection of unpaid taxes.


The risk of penalties is on the up for businesses as HMRC devotes more resources to closing the tax gap for VAT, a revenue generation priority for HMRC. Businesses are at a heightened risk of paying substantial penalties as a result of errors made.


Increasing complexity

HMRC’s management of VAT compliance has changed over the years. VAT is a hugely complex part of the UK tax regime, that has been made more complex by Brexit, which has changed the UK’s cross-border relationships and given the country the power to vary VAT in a way it could not previously do.


Just this January, the VAT default surcharge regime was replaced by a new penalty system that imposes separate penalties for late submission of VAT returns and late payment of VAT.


In addition to this, VAT risk is often further elevated in challenging economic times by business owners often being driven into more diverse lines of business.

Businesses, and organisations in the not-for-profit sector, the majority of which do not have their own tax departments to work on their returns and ensure accuracy, struggle with the complexity of VAT and therefore risk being penalised for late payments and errors.


Of course, as VAT advisors know, being able to demonstrate that they have exercised reasonable care in managing their VAT processes is a positive step that can reduce this financial exposure. But there is not much available on the market to help businesses do this.


Having seen the growing risk to clients and businesses, Xeinadin has developed a new behaviour-based VAT risk evalution tool to help businesses protect themselves and manage VAT risk.


VAT risk assessment tool

The new tool has been piloted with some of our clients and assesses companies’ attitude to VAT risk – the thought they put into it and processes they have adopted to ensure compliance in their organisation. It is designed to provide VAT registered organisations with robust supporting evidence to demonstrate to HMRC that they have exercised reasonable care.


As penalties are behaviour-based, they can be mitigated if the VAT registered entity can demonstrate that they have taken reasonable care to get the right tax declared at the right time. This includes putting processes in place for training their staff or ensuring sound checking steps exist in the production of VAT data for the return submission.


One client had a particularly positive response from their external auditors when sharing the output from our VAT risk review which saved management time from additional audit scrutiny and informed their own development plans for a new accounting system – a double benefit.


We believe this kind of tool will become increasingly important in helping businesses reduce their VAT risk. While errors are something businesses clearly aim to avoid, the ever-increasing complexity of VAT will continue to make them inevitable, particularly for smaller businesses with fewer resources. These businesses therefore need to change their mindset in how they approach their VAT risk, taking proactive steps to demonstrate the care they have taken and mitigate any potential penalties.


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