HMRC delay was a reasonable excuse for paying VAT late

The current penalty regime for late payment of VAT has been with us for two-and-a-half years now and will be familiar to many businesses and agents. However, a recent change to penalty rates may have gone under the radar, given the (understandable) focus on non-doms, employer’s national insurance contributions and inheritance tax changes. In this article, I’ll explore what the changes mean for businesses and explain why a recent taxpayer victory on reasonable excuse is worthy of attention.

Penalty regime

For VAT accounting periods starting on or after 1 January 2023, fixed and daily penalties for late payment are provided for by Schedule 26, Finance Act 2021.

At the Spring Statement 2025, the government announced increases to the rates of the penalties as part of a package of measures intended to tackle tax debt. Regulations giving effect to those changes apply with effect for VAT accounting periods beginning on or after 1 April 2025.

Penalties can be avoided if the business arranges a time to pay arrangement with HMRC before day 16/day 30 and sticks to it. It is possible to agree a time to pay arrangement online, subject to meeting a number of conditions, including that:

• the amount owed is £100,000 or less;
• the business plans to pay off the debt within the next 12 months; and
• it has filed all of its VAT returns.

If the business is unable to apply online it can call HMRC and discuss its circumstances with an adviser.

HMRC may reduce or cancel a penalty if the business has a reasonable excuse for not making the payment on time. The legislation provides that the following are not examples of a reasonable excuse:

• an insufficiency of funds, unless this is attributable to events outside the person's control; and
• reliance by the business on another person to do something, unless the business took reasonable care to avoid the failure.

HMRC’s guidance includes other examples of what may and may not constitute a reasonable excuse.

In addition, the legislation gives HMRC the power to reduce a penalty because of “special circumstances”. It is provided that the following are not special circumstances for this purpose:

• ability to pay; or
• the fact that the potential loss of revenue from the business is balanced by a potential over-payment by the business.

The case of ESC Studios Ltd

ESC Studios Ltd (ESC) is engaged in the production of films. It filed its VAT return for the quarter ended 31 March 2024 on time. As ESC had three films in production in that period, the amount of input tax was higher than usual and the return showed that it was due a repayment of £478,893. ESC anticipated that HMRC may want to check the claim before processing the repayment and that proved to be the case.

However, ESC did not anticipate that it would take more than six months for the repayment to be processed, especially as, throughout the process, it did its best to respond to HMRC’s queries in an efficient manner and made regular contact with HMRC. During that period, ESC submitted its VAT return for the quarter ended 30 June 2024, showing a VAT liability of £225,640. Due to cash-flow issues exacerbated by its delayed repayment claim, ESC failed to make the payment within 30 days of the deadline and incurred a penalty of £9,026.

Key dates

ESC appealed against the penalty to the First-tier tribunal (FTT). As there was no dispute that the VAT had been paid late and that the penalty had been correctly charged, it fell to the FTT to determine:

• if ESC had a reasonable excuse for failing to pay its VAT liability on time; and
• whether HMRC should have reduced or extinguished the penalty due to special circumstances.

Reasonable excuse

Having acknowledged that checks can be time consuming, HMRC said the delay in issuing the repayment was a matter for a possible complaint, not a basis for failing to pay other VAT on time. HMRC went on to argue that, as ESC was not entitled to the repayment until HMRC had completed its checks, it could not rely on that repayment to pay VAT falling due in the meantime. Although the FTT agreed with HMRC’s analysis, it felt it did not give the “full answer” in this case.

Referring to the decision of the Court of Appeal in HM Customs & Excise v Steptoe [1992] STC 757, the FTT said that, where a company has a VAT liability, it comes out of funds that that the trader has received from its customers in excess of the selling price of its good and services. Therefore, the general position is that the “trader’s net VAT liability should come out of funds that should not be carelessly mixed with the trader’s working capital”. Here, ESC “had to find an additional £478,893.36 from its working capital and, in effect, lend it to HMRC until such time as HMRC are able to approve the repayment”, and it was unreasonable to expect ESC to “absorb the cash-flow costs of this amount”.

Further, the FTT accepted ESC’s evidence that it had grounds to expect that the repayment would be agreed by 7 August 2024 (the date on which its VAT liability for the quarter ended 30 June 2024 was due) and that it “took every reasonable step to facilitate that outcome by assisting HMRC in their investigations”. This was the case despite ESC having failed to seek a formal deferral of the 7 August due date from HMRC, due to the level and nature of ESC’s engagement with HMRC. Therefore, the FTT found that ESC had a reasonable excuse for failing to pay its VAT liability on time and allowed its appeal against the penalty.

Special circumstances

Having decided this matter in ESC’s favour, the FTT did not need to go on and consider if there were special circumstances. However, it did so and again found for ESC. The FTT said that, although the legislation rules out an insufficiency of funds, it does not prevent HMRC from considering the reason why there was an insufficiency of funds. HMRC’s decision on special reduction was flawed, allowing the FTT to permit it to substitute its decision for that of HMRC. Had the FTT not found for ESC on the issue of a reasonable excuse, it would have found in its favour on the issue of special circumstances, and reduced the penalty to £nil.

Lessons to be learned

It’s difficult to draw hard and fast rules from a decision of the courts, as much turns on the facts. In this case, a contributing factor, acknowledged by the HMRC officer who dealt with the checks, was that the delay in issuing the repayment was due to HMRC’s risk management approach to the film industry as a whole.

However, this case does provide a good opportunity to ensure that you have procedures in place to avoid incurring interest and late payment penalties. Although my focus here has been on penalties, interest should not be forgotten. In addition to increasing the rates for late payment penalties, the government has also increased interest rates on tax paid late. The rate of interest on most overpaid tax currently stands at 8.25%.

This case is also a good reminder that, where a penalty is charged, the business should consider if it has a reasonable excuse or if there are any special circumstances. Keeping a comprehensive and contemporaneous record of contact with HMRC, for example, can only help the business’s case.

There is also food for thought for HMRC. As we explained in a recent article, tax debt has been stubbornly high in recent years and HMRC is increasing its efforts to ensure tax is paid promptly. However, in doing so, HMRC must ensure it treats taxpayers fairly. Imposing penalties in situations where HMRC’s own delays caused the late payment risks damaging trust in the tax system.

Stephen Relf, Technical Manager, Tax, ICAEW