On top of that, HMRC charges late payment interest at the Bank of England base rate plus 4% from day one. The single most useful move if you can't pay is to call HMRC and propose a Time to Pay arrangement before day 15: stick to it, and the penalty clock stops (interest keeps running).
- Confusing late filing and late payment. These are two parallel regimes since January 2023. Late filing uses points and a £200 fixed penalty. Late payment uses percentages of the unpaid VAT. You can be late on one without being late on the other, and each has its own appeal route.
- Reading the first penalty as a single 6% charge. It isn't. It's two separate 3% charges: 3% of the balance at day 15, and another 3% of the balance at day 30. Pay even a partial amount before day 15 and the first penalty is calculated on the smaller balance.
- Assuming Time to Pay stops the interest. It doesn't. A Time to Pay arrangement, agreed before day 15, freezes the penalty accrual. Interest at base rate plus 4% keeps running on the unpaid balance throughout the arrangement.
- Waiting until day 14 to call HMRC. Time to Pay only protects you if the arrangement is in place before the relevant trigger date. HMRC's processing isn't instant. If you already know cash will be tight, call early, even before the deadline.
- Mixing up the old and new rates. VAT periods that started before 1 April 2025 are still on the old 2% / 2% / 4% rates. Periods that started on or after 1 April 2025 are on the new 3% / 3% / 10% rates. The penalty assessment should specify, but always check against the period start date.
The two-stage penalty structure for late VAT payments
The rules sit in Schedule 26 of the Finance Act 2021 and apply to VAT accounting periods starting on or after 1 January 2023. They replaced the old default surcharge regime (sections 59 to 59B of the Value Added Tax Act 1994), which charged a single percentage based on the total VAT due regardless of how late the payment was. The new system is calibrated to the delay, with two distinct penalty stages and daily interest running alongside.
In practice, the penalty clock starts at day 15 and not before:
- Day 1 to day 14: no penalty (but late payment interest is already running, daily, from day one)
- Day 15: a first late payment penalty of 3% of the VAT outstanding at that date
- Day 30: a further 3% of the VAT still outstanding at day 30 (so a total first penalty of up to 6% of the original debt if you've paid nothing by then)
- Day 31 onwards: a second penalty accruing daily at an annualised rate of 10% on the outstanding balance, every day until you pay in full
The rates above are the ones in force since 31 May 2025, following SI 2025/589. For VAT accounting periods that started before 1 April 2025, the old rates apply (2% at day 15, 2% at day 30, 4% per year daily from day 31). If you're being assessed for a period that straddles the change, check which rate set is correct, because the difference is substantial.
An example: £15,000 of VAT paid 51 days late
HMRC's own guidance uses this scenario. Imagine a VAT-registered retailer owes £15,000 in VAT, due on 7 March 2025 (assume an accounting period starting on or after 1 April 2025 for the new rates to apply). The return was filed on time, but the payment was missed.
The company pays nothing for 51 days. Here's what HMRC charges:
- First penalty, day 15: 3% × £15,000 = £450
- First penalty, day 30: 3% × £15,000 = £450 (the debt is still £15,000 in full)
- Second penalty, days 31 to 51 (21 days): £15,000 × 10% × 21 ÷ 365 = £86.30
Total penalty charged: £986.30, on top of the original £15,000 VAT, and on top of the late payment interest that's been accruing daily since 8 March. For a single late payment of a single quarter's VAT, that's a meaningful number. For a business that lets two or three quarters slip, the numbers compound quickly.
Late payment interest, on top of the penalties
Penalties and interest are two distinct charges, and both apply. Late payment interest is set in legislation at the Bank of England base rate plus 4%, since 6 April 2025 (the previous formula was base rate plus 2.5%). With the Bank of England base rate at 3.75% from 18 December 2025, the current late payment interest rate on unpaid VAT is 7.75% per year, recalculated whenever the base rate moves.
Two practical points the rates above hide. First, interest starts on day one after the due date, not day 15, so even a payment that lands within the 14-day grace period has accrued a small amount of interest. Second, interest keeps running even when you've agreed a Time to Pay arrangement: the arrangement only stops the penalties, not the interest. We see this catch business owners off-guard when the final HMRC statement arrives.
Received a late payment penalty notice or HMRC chasing letter? Our Urgent VAT Advisory gives you a senior specialist's read on your options.
How Time to Pay can stop the penalty clock
Time to Pay is the single most useful lever in this regime, and it's underused. Under paragraph 6(1) of Schedule 26, if you propose a Time to Pay arrangement to HMRC before day 15 and the agreement is made (whether or not it's finalised before day 15), the 15-day condition is met and no first penalty applies. Paragraph 6(2) extends a similar logic to the 30-day window, so a TTP proposed between days 15 and 30 can still spare you the additional 3% at day 30. From day 31, the daily second penalty is suspended for as long as you stick to the arrangement (the suspension follows from how the "further penalty period" is defined in paragraph 8(4) and (5)).
The catch sits in paragraphs 7 and 9: if you break the Time to Pay arrangement (a missed instalment, an unmet condition), HMRC can charge both the first and the second penalty as if the arrangement had never had effect, retroactively. So the protection only holds while you keep to the agreed schedule. Time to Pay can be proposed via HMRC's online services or by calling the Payment Support Service. You don't need a complete payment plan worked out before you make contact; starting the conversation early is what protects you.
When a late payment penalty can be cancelled
Two routes exist for cancellation or reduction, and they sit in different paragraphs of Schedule 26.
The first is reasonable excuse, in paragraph 12. If something genuinely beyond your control prevented payment, HMRC can cancel the penalty entirely. The threshold is set by the legislation and developed by tribunal case law: serious illness, bereavement, verified HMRC system outages at the relevant date, and similar circumstances generally qualify. A simple shortage of cash does not, although the case law (notably the Steptoe principle) recognises that an insufficiency of funds caused by exceptional events outside the trader's control can itself amount to a reasonable excuse. Recent First-tier Tribunal decisions, including ESC Studios Ltd v HMRC [2025] UKFTT 747 (TC), have applied that principle where HMRC was withholding a larger repayment that would have funded the VAT payment.
The second is special reduction, in paragraph 13: HMRC has a discretionary power to reduce the penalty for "special circumstances". The legislation explicitly excludes ability to pay and the existence of a balancing overpayment from "special circumstances", so this route is narrower than it sounds. On appeal, the tribunal reviews HMRC's decision on judicial review principles, asking whether the decision was flawed rather than substituting its own view.
The appeal window is 30 days from the penalty decision letter. HMRC will offer an internal review first; the next step is the First-tier Tribunal (Tax Chamber).
What you need to do, step by step
- Confirm the period start date. If your VAT period started before 1 April 2025, the old 2% / 2% / 4% rates apply. If on or after, the new 3% / 3% / 10% rates apply. The penalty calculation flows from this.
- Check the calculation against the dates. The first penalty is based on the balance outstanding at day 15 and at day 30. Cross-check the figures on the assessment against your actual payment dates and amounts.
- If you can't pay, call HMRC immediately. Propose a Time to Pay arrangement before day 15 to avoid the first penalty entirely. Even between day 15 and day 30, an arrangement avoids the additional 3% and freezes daily accrual from day 31.
- If you have a reasonable excuse, document it. Medical records, evidence of HMRC outages, bank confirmations of failed transactions, anything that demonstrates circumstances beyond your control at the relevant date.
- If you want to appeal, act within 30 days of the penalty decision letter. Start with HMRC's internal review (free), then the First-tier Tribunal if needed.
When you might need expert VAT advisory
The late payment regime is mechanically simple, but the way it interacts with cash flow and business operations rarely is. In practice, the situations below are where a senior specialist's read meaningfully changes the outcome:
- You've received a late payment penalty notice and aren't sure whether to pay, appeal, or propose Time to Pay
- You're struggling with cash flow on the current quarter and want to know how Time to Pay actually works, and what it costs
- You're staring at two or three quarters of unpaid VAT with penalties stacking, and need a clear-eyed view of where you stand
- You think you may have a reasonable excuse and want a sense-check on whether HMRC and a tribunal would accept it
- You're being chased on an old VAT period and aren't sure which set of rates applies (the April 2025 change caused real confusion)
- You're an accountant with a client facing a penalty notice and want a senior specialist's read before drafting the response
Whether you're a business owner or an accountant working on a client case, we focus on the VAT questions where extra expertise pays off, and we work in plain English.