Penalties for VAT Errors and Wrongdoing

Introduction

If HMRC finds errors or wrongdoing in your VAT Returns, you may face financial penalties in addition to paying the tax you owe. The severity of penalties depends on whether errors were careless, deliberate, or involved dishonesty, and how much you cooperate with any investigation. Understanding how these penalties work and how they can be reduced is essential for any VAT-registered business.

Types of VAT Wrongdoing

HMRC distinguishes between different types of errors and wrongdoing when deciding what penalties to charge:

Inaccurate VAT Returns occur when you submit a return that understates your VAT liability or overstates your entitlement to a refund. These errors can range from genuine mistakes to deliberate understatements.

Dishonest conduct is the most serious category. Under Section 60(1) of the VAT Act 1994, HMRC may impose a penalty where you do something (or fail to do something) for the purpose of evading tax, and your conduct involves dishonesty. This doesn't necessarily mean your actions would lead to criminal liability, but there must be an element of dishonesty involved.

HMRC investigates VAT affairs across all categories of VAT-registered traders, including those who should be registered but have failed to do so.

How VAT Penalties Are Calculated

When HMRC imposes a penalty for dishonest conduct, the law allows them to charge up to 100% of the tax that was evaded. This means if you evaded £10,000 in VAT, the maximum penalty could be £10,000 on top of the tax itself.

However, you can significantly reduce this penalty through your actions during an investigation. The penalty is worked out as a percentage of the underdeclared tax, and this percentage can be substantially lowered based on three key factors.

Reducing Your Penalty Through Cooperation

HMRC offers considerable penalty reductions for businesses that cooperate during investigations. These reductions are structured around three specific areas:

Disclosure — You can reduce your penalty by up to 40% if you provide an early and truthful explanation about why the arrears arose and the full extent of them. The officer will consider how much information you provided, how quickly you provided it, and how it helped settle the investigation.

Cooperation — A further reduction of up to 25% is available if you cooperate fully throughout the investigation. This means supplying information promptly, attending interviews, answering questions honestly and accurately, and providing relevant facts to establish your true VAT liability.

Providing records and attending interviews — An additional reduction of up to 10% can be gained by attending interviews and producing records and information as required.

In total, the maximum reduction normally available is 75% of the undeclared tax. In exceptional circumstances, HMRC may consider further reductions, particularly where you make a full and unprompted voluntary disclosure before any investigation begins.

What Reduces Your Penalty Reduction

You may receive little or no reduction if you:

• Delay supplying information
• Avoid attending interviews
• Give untrue answers to questions
• Do nothing until formal action is taken against you
• Generally obstruct the course of the investigation

The extent to which your cooperation saves official time and resources will be considered when applying penalty reductions.

The Civil Evasion Penalty Investigation Process

When HMRC suspects dishonest conduct under the Civil Evasion Penalty (CEP) Notice 730 procedure, an investigating officer will:

• Interview you (or your adviser)
• Explain the CEP Notice 730 procedure
• Explain why they believe the under-declaration arises from dishonest conduct
• Ask you to cooperate in establishing your true VAT liability

You should know that you are under no obligation to speak to investigating officers or provide information. You are free to leave an interview at any time. However, any information you do provide may be used in assessing your liability to tax or to a penalty.

The investigation is not conducted with a criminal prosecution in mind. HMRC will not use information gathered in a civil investigation to pursue a criminal prosecution of the same offence, though they may prosecute if you make a false disclosure to investigating officers.

If you provide a satisfactory explanation for any discrepancy, a civil evasion penalty will not be imposed.

What Happens After the Investigation

Once the arrears have been established or agreed, you will receive:

• An assessment notifying you of the tax arrears and any interest chargeable
• A penalty assessment
• A letter showing how much mitigation (reduction) has been allowed

If you cannot pay the full amount immediately, it may be possible to pay by instalments. You will be expected to make a significant down payment, with the balance paid by agreed instalments over a short period. Failure to pay may result in civil recovery proceedings.

If You Disagree With a Penalty

If you disagree with the tax assessment or penalty, you can ask the issuing office for a reconsideration of the matter. If you remain dissatisfied with the outcome, you have the right of appeal to a VAT and Duties Tribunal.

You should inform the investigating officer of any matters you believe may affect the level of penalty.

Important Note About This Information

For investigations started after 31 January 2012, the CEP Notice 730 procedure described here has been superseded by Code of Practice 9 (COP9), which applies where HMRC suspects fraud.

Sources

• Compliance checks: penalties for VAT and excise wrongdoing — CC/FS12
• Compliance checks: VAT dishonest conduct penalties — CC/FS20
• Civil penalty investigations statement of practice (VAT Notice 730)

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.