A new system of penalties for late submission and payment of income tax is being introduced alongside Making Tax Digital (MTD) for income tax. ICAEW’s Tax Faculty explains the new rules and the other penalties that may need to be considered in the context of MTD income tax.
A new system of penalties for late submission of tax returns was introduced by Finance Act 2021 (s116 and Schs 24 and 25). Finance Act 2021 also introduced new penalties for late payment (s117 and Sch 26).
The legislation comes into force on a date to be appointed in further regulations. The rules have applied to VAT since January 2023. The rules apply to those who sign up to MTD income tax (s37, Finance Act 2024) whether they do so voluntarily or, in due course, because they are mandated to do so. The new rules are expected to apply to all income tax self assessment taxpayers in the future.
It is worth noting that the new penalty rules generally apply to any taxpayer who signs up to MTD income tax, even if they subsequently opt out. The trigger is whether HMRC has migrated the taxpayer’s record from the Computerised Environment for Self Assessment (CESA), the income tax self assessment system, to the new Enterprise Tax Management Platform (ETMP) that is used for MTD income tax. This usually takes place once the taxpayer signs up to MTD income tax but there can be a short delay.
An HMRC policy paper explains that the new rules apply to those that volunteer for MTD income tax beta testing but only in respect of the annual filing obligation (final tax return). Late submission penalties do not apply to quarterly updates during the 2024/25 and 2025/26 testing periods.
Late submission penalties
The new late submission penalties are points based.
If the submission frequency is annual, once the taxpayer reaches two points, they will be charged a £200 penalty. A further £200 penalty will be charged if another annual tax return is submitted late.
During the MTD income tax testing period, a penalty point is issued for each annual tax return submitted late. After signing up to MTD income tax, penalty points do not apply to self assessment returns for earlier tax years (ie, outside of MTD income tax) that are submitted late. Those years remain subject to the current late submission rules.
Penalty points will not be issued for late quarterly updates during the testing phase (as taxpayers are submitting quarterly updates voluntarily to test the system).
Once a taxpayer is mandated to use MTD income tax and is required to make quarterly submissions, a £200 penalty is applied once they have received four points.
Post mandation, those that comply voluntarily will also not be charged penalty points in relation to quarterly updates. Points are only issued for mandatory submission obligations.
Points are reset to zero if:
- all submissions have been made on or before the due date for the following periods:
- 24 months for taxpayers with an annual filing obligation; or
- 12 months for taxpayers with a quarterly filing obligation; and
- all submissions that were due in the preceding 24 months have been received by HMRC.
The penalty points for income tax are separate from the penalty points for VAT. The late submission penalty rules in the new regime are generally less harsh as they allow at least one deadline to be missed before a financial penalty is incurred.
Late payment penalties
A late payment penalty will be charged where a balancing payment or an amount due following an amendment or assessment is paid more than 15 days late. This is a shorter timeframe than the current regime. Late payment penalties are not charged in respect of payments on account.
The penalty is equal to 3% of the tax outstanding 15 days after the due date (day 15). If the payment is not made by day 30, a further penalty equal to 3% of the amount due at that point is charged. A further penalty is charged at the rate of 10% per year for every day tax is unpaid after day 30.
These penalties are charged on top of interest and are very harsh. However, they can be avoided by having a time to pay arrangement in place by the relevant date.
The current late payment penalty rules continue to apply to late payment of self assessment liabilities for earlier tax years (ie, outside of MTD income tax).
Appeals
HMRC will send a penalty decision letter when a penalty is charged. The taxpayer may appeal against the penalty. It is also possible to appeal against penalty points.
Record keeping penalties
No change has been made to record keeping penalties. EM4650 - Penalties: Failure to Keep or Preserve Records: Approach applies to MTD income tax. A £3,000 penalty is available to HMRC for a failure to keep digital records or for a break in digital links within functional compatible software but there is no mechanism to charge these penalties automatically.
Inaccuracy penalties
Inaccuracy penalties do not apply to MTD income tax quarterly updates. They do apply to the annual tax return in MTD income tax in the same way that they apply to income tax self assessment returns.
Failure to notify penalties
MTD income tax will apply to only some of the self assessment population. Failure to notify penalties will continue to be charged as now to those that fail to notify HMRC and register for income tax self assessment. HMRC’s sanction for failure to sign up to MTD income tax is late submission penalty points rather than failure to notify penalties.
