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July 2023

VAT Errors and Interest Penalties – Commercial Restitution

By VAT news

Although the changes to penalties relating to the late filing and payment of VAT returns at the beginning of 2023 received lots of publicity, there seems to have been less attention paid to another change to VAT penalties which will lead to increased costs for fully taxable businesses. Historically, if a business underdeclared VAT but this VAT would have been fully recoverable by the recipient of the goods or services if charged, HMRC were able to inhibit the default interest charge on the basis there was no overall loss of VAT to the Revenue as a result of the error. This position has now changed and HMRC no longer have the discretion to do this. Default interest therefore applies regardless.

This is a significant change the profile of VAT errors for a business. Historically, if a business discovered an error in relation to a VAT exclusive contract with a fully taxable customer, disclosing the error simply presented the business with a potential cashflow disadvantage whilst the VAT was paid to HMRC and the payment of the VAT from the customer was awaited. The default interest that will now apply will form a cost to the business and this could be significant in value given VAT errors have to be disclosed going back 4 years.

This change re-enforces the need for businesses to have robust controls in place for VAT, with particular attention paid to the following high risk transaction types when carried out with fully taxable counterparts:

  • domestic intercompany transactions;
  • errors in VAT liability of revenues – treating revenue as zero rated or exempt when it should be standard rated;
  • recharges of costs incurred on behalf of a 3rd party

HMRC updated their internal manuals on this in March but the public notice on default interest (VAT notice 700/43 remains unchanged on this point).