What happens if a business doesn’t comply with MTD for VAT

Making Tax Digital for VAT is no longer a future requirement – it’s the default. For VAT registered businesses, failing to comply with MTD for VAT doesn’t usually lead to dramatic consequences overnight, but it does create a steady build-up of risk, penalties and admin that can quickly become expensive and distracting. Over 1.8 million businesses are benefitting from MTD, with more than 19 million tax returns filed through the service already.

Here’s what actually happens if a business doesn’t meet its MTD obligations – and how most issues arise in practice. If businesses are finding it difficult to switch to Making Tax Digital, there is plenty of support on the government website to help with the transition to digital VAT returns.

The Help to Grow: Digital scheme offers up to 50 percent off the price of compatible digital accounting software for businesses facing financial difficulties.

What HMRC expects under MTD for VAT

Under Making Tax Digital, VAT registered businesses must:

• Keep records digitally in an electronic account using MTD compatible software
• Use MTD compatible software or functional compatible software
• File VAT returns digitally via an application programming interface (API)
• Maintain digital links between business records and submissions

Using an electronic account within MTD-compatible accounting software ensures VAT records are securely stored and facilitates online filing.

This applies regardless of turnover once a business is VAT registered – the VAT registration threshold determines registration, not MTD compliance.

Using paper records, re-typing figures into a VAT online account, or filing annual VAT returns manually all fall outside MTD regulations. Businesses that do not keep digital records can be charged daily penalties ranging from £5 to £15 until compliance is achieved.

Digital links are essential for transferring data between systems. Transferring data manually, rather than using digital links, can result in daily penalties. Using checking functions within accounting software helps catch errors before filing VAT returns, reducing the risk of penalties.

The most common ways businesses fall out of compliance

Most MTD compliance failures aren’t deliberate. They usually happen when a business hasn’t moved onto Making Tax Digital for businesses software or when it:

• Uses non-compliant accounting software or spreadsheets without bridging software
• Breaks digital links by manually re-entering figures
• Submits a VAT return late because systems aren’t joined up
• Misses quarterly submissions, annual submissions, or quarterly updates required by HMRC
• Fails to meet the VAT return deadline for a VAT period
• Keeps business records outside a digital accounting system
• Assumes filing and payment are the same thing.

Late filing of VAT returns for a VAT period or missing the VAT return deadline can result in penalties. Regularly checking each update before submission helps catch small errors and avoid penalties.

Even where tax remains unpaid or no VAT is due, the obligation to submit VAT returns on time still applies.

The points-based penalty system explained

MTD for VAT operates under HMRC’s points based penalty system, also known as the points system, which tracks late submissions and enforces penalties, making it crucial to use robust Making Tax Digital (MTD) software and guidance to stay organised. Each late VAT return earns one penalty point. For quarterly submissions, one point is added for each late filing, and reaching four points triggers a £200 fine. Monthly filers accumulate 5 points, quarterly filers 4 points, and annual filers 2 points before fines are incurred. Penalty points for late submissions stay on a business’s record for two years. When a business reaches its penalty threshold, HMRC charges a fixed £200 penalty for each additional late submission while at the threshold. HMRC can charge a maximum penalty of up to £3,000 per quarter for non-compliance with MTD requirements.

New penalties for late payment and late submission of VAT returns were introduced from January 2023, replacing the previous surcharge regime. Penalties for late payment and interest on unpaid VAT are charged from the day the payment becomes overdue, and if a VAT payment is more than 15 days overdue, first and second late payment penalties apply. VAT late submission penalties and MTD for VAT penalties are enforced through this system, and HMRC will charge penalties for late filings and late payments accordingly. The final declaration is the last submission required at the end of the tax year, consolidating all income and expenditure reports.

It’s also important to note that penalty points don’t disappear immediately. A business must submit VAT returns on time for a set compliance period before points are reset.

Late payment penalties and interest

Late submission penalties are separate from late payment penalties, and similar digital rules will apply under MTD for Income Tax software. If VAT remains unpaid after the filing deadline:

• Interest accrues from the due date if you pay late
• Penalties for late payment may apply
• HMRC may request a payment plan or pay agreement

Penalties for late payment can apply if VAT owed is not paid on time. If a business files a return that contains errors, HMRC may charge a penalty of up to 100 percent of the VAT owed. HMRC offers a Time to Pay service, allowing businesses to set up a payment schedule to pay off their debt in instalments over 12 months without receiving further penalties. Contacting HMRC early if you are unable to pay on time provides more options to avoid penalties.

This can affect cash flow quickly, especially for small businesses or sole traders managing tight margins.

What happens if issues continue

Ongoing non-compliance with Making Tax Digital penalties can lead to more work and risk for accountants as well as their clients, which is why many firms now use dedicated Making Tax Digital for accountants tools. Ongoing non-compliance with Making Tax Digital penalties can lead to:

• Escalating fines under the new penalty system
• Increased scrutiny of tax affairs
• Restrictions within the VAT online account
• More time spent resolving HMRC queries.

In extreme cases – such as insolvency procedures or persistent failure – HMRC may intervene more directly.

Reasonable excuse and exemptions

HMRC does recognise limited reasonable excuse and exemption criteria. These may apply where it’s not reasonably practicable to use digital tools due to age, disability, location or other genuine barriers.

Exemptions aren’t automatic, though. They must be requested and approved, and most VAT registered businesses are expected to comply.

Why compliance is usually simpler than businesses expect

For most businesses, avoiding MTD penalties comes down to systems rather than effort. Using the right MTD-compliant accounting software, maintaining digital record keeping, and submitting VAT returns through MTD compliant software dramatically reduces the risk of:

• Late submission
• Broken digital links
• Manual errors
• Missed payment dates.

Timely and accurate digital record-keeping is essential to avoid penalties, not just for VAT but also for income tax returns under Making Tax Digital (MTD). Using checking functions within specialised MTD for VAT software helps avoid penalties by catching errors before submission. Making tax digital mtd compliance is supported by using compatible software and regular checks.

It also makes it easier to spot issues early and reduce errors, before they become costly.

MTD for VAT is often the first step into digital tax compliance. Many businesses affected by MTD for income tax or corporation tax later already have the foundations in place if VAT reporting is handled properly. Good digital records today reduce friction across future tax years, and firms can draw on dedicated Making Tax Digital resources and guides to keep up with evolving rules.

Staying compliant with MTD for VAT

Failing to comply with MTD for VAT doesn’t necessarily cause instant problems – but over time it increases penalties, admin and stress. Failing to comply with MTD for VAT can result in daily penalties being issued by HMRC until compliance is achieved. The good news is that most compliance issues are preventable with the right tools and processes. MTD for VAT penalties can be avoided by keeping digital records and filing VAT returns on time.

If you want to reduce risk and avoid fines, Capium’s MTD-ready VAT software helps businesses keep digital VAT records, submit VAT returns directly to HMRC, and stay fully compliant with MTD requirements – without overcomplicating everyday accounting, especially when paired with structured tools like a free MTD readiness checklist.