The penalty surcharges imposed when VAT is paid late can have a perverse effect, as they encourage the taxpayer to pay VAT owing for later periods in preference to paying debts outstanding for earlier periods. However, the HMRC computer automatically allocates payments against the oldest debt first, which can disadvantage the taxpayer.
The rate of surcharge increases with every late payment, but each surcharge issued relates to a specific quarter’s debt, not the whole amount of VAT outstanding. The surcharge starts at nil for one late payment, and increases to 2%, 5%,10% and finally 15% for 5 or 6 late payments within the surcharge period.
There is £400 minimum floor for the surcharge for the second and third late payments, so the taxpayer may not receive a bill until the penalty has reached 5% or 10%. Small businesses with annual turnover of no more than £150,000 are permitted two late payments before surcharges apply.
A taxpayer is due to pay £10,000 for each VAT quarter, and has paid VAT late once in the last 12 months. The VAT due for quarter 2 is outstanding and has attracted a surcharge of 2%: £200. The VAT due for quarter 3 is payable by 7 July 2017. If the taxpayer pays £10,000 on 30 June 2017 it will be allocated against the quarter 2 debt, and a surcharge for quarter 3 of 5%: £500 will be raised. However, if the payment on 30 June was allocated against the VAT due to be paid by 7 July, the 5% surcharge would not be issued.
This is the situation that QN Hotels found itself in; facing a potential surcharge of 15% if the VAT for the current period was not paid on time. HMRC argued that it could not accept payment of VAT for the current period until the due date for that period’s VAT return and payment had been reached. HMRC was thus entitled to allocate the VAT paid “on account” to an earlier period, causing the 15% surcharge to arise.
QN Hotels won its appeal against this surcharge, and the Upper Tribunal held that HMRC’s allocation of the payments to earlier periods was “plainly unfair”.
To avoid such difficulties the taxpayer should request that VAT payments be allocated to specific debts. Alternatively, if a surcharge has not yet been imposed, try to come to a time to pay agreement with HMRC (call 0300 200 3835). This will avoid a surcharge being raised, and gives the taxpayer certainty as to the payment arrangements.