Understanding the Making Tax Digital Penalties System

HMRC’s penalty system for Making Tax Digital (MTD) uses a points-based model, similar to penalty points on a driving licence. Instead of an immediate fine for a single error, small slip-ups accumulate over time.

The system is already in place for VAT and is scheduled to be implemented for ITSA in April 2026. This change from a default surcharge to a cumulative points model necessitates a new compliance approach.

This guide explains how the points-based system works, the key differences between VAT and Income Tax, and the common mistakes that put firms and their clients at risk.

Why HMRC Introduced a New Penalty System

Before January 2023, the penalty systems for VAT and Income Tax were more rigid. For VAT, a ‘default surcharge’ regime applied escalating penalties for late submissions or payments, often punishing businesses harshly for minor delays. For Income Tax, late Self Assessment returns triggered an immediate £100 penalty, which could quickly increase with daily charges.

HMRC recognised that these older models were complex and often disproportionate, especially for businesses making genuine, one-off mistakes. As Making Tax Digital introduced more frequent reporting deadlines, applying the old rules would have resulted in higher fines under the Making Tax Digital regime. The new points-based system was designed to be fairer, encouraging compliance by penalising persistent non-compliance rather than isolated errors.

What are the new Making Tax Digital Penalties?

The new regime applies penalties for the following actions:

1. Late Submission Penalties: A Points-Based System

For every missed submission deadline, a business receives one penalty point. A fine is only triggered once the business accumulates a certain number of points (the ‘penalty threshold’).

The penalty amount for late submission is £200 per offence for both MTD VAT and Income Tax.

The points threshold varies depending on the submission frequency:

• VAT & MTD for ITSA Quarterly Updates: 4 points
• MTD for ITSA Annual Submissions (e.g., Final Declaration): 2 points
• Monthly filers (VAT): 5 points

The penalty points have a two-year shelf life. If you have reached the threshold and received a fine, you can reset your points to zero by:

• Meeting all your deadlines for 12 months (for quarterly filers)
• Submitting any outstanding returns from the previous 24 months

If you miss another deadline after reaching the threshold, it will result in an additional point and incur an immediate fine.

For businesses voluntarily testing the new system, HMRC has confirmed that penalty points will not be issued for late quarterly updates during this initial phase.

2. Late Payment Penalties

These penalties are separate from the points system and are based on the amount of tax owed and the extent of the late payment. This structure is the same for both MTD for VAT and MTD for ITSA.

The penalty is structured in two stages:

• First Penalty: If the tax is unpaid 15 days after the due date, a first penalty of 2% of the outstanding amount is charged.
• Second Penalty: If the tax is still unpaid 30 days after the due date, a second penalty of 2% of the outstanding amount is charged. This is an additional charge, bringing the total penalty to 4% of the tax that was due on day 1. HMRC also charges late payment interest. This is a separate charge that starts from the first day the payment is late (the due date) and accrues daily until the tax is paid in full.

3. Penalties for Inaccurate Reporting

Beyond timeliness, significant penalties can apply for providing incorrect information. These are not based on points but on the taxpayer’s behaviour and are calculated as a percentage of the ‘potential lost revenue’.

HMRC defines behaviour in four ways:

• Reasonable Care: No penalty is charged if you can show you took reasonable care but still made a mistake.
• Careless: A penalty of 0% to 30% of the lost revenue can be charged.
• Deliberate: If you knowingly submit an inaccurate return, the penalty is between 20% and 70%.
• Deliberate and Concealed: If you actively try to hide an inaccuracy, the penalty rises to between 30% and 100%.

The final penalty can be significantly reduced if you provide an ‘unprompted disclosure’ by telling HMRC about the error before they discover it.

For MTD for Income Tax, it is important to know that inaccuracy penalties do not apply to the quarterly updates. They only apply to the Final Declaration, where liability is declared.

4. Penalty for Failure to Maintain Digital Records

Under MTD, failure to maintain the required digital records can lead to a separate penalty. This is not a straight penalty for a single missing transaction; rather, it applies to a more fundamental failure to keep and preserve records as required by law.

According to HMRC’s internal guidance, the penalty is determined by the severity of the record-keeping failure. The maximum penalty can be up to £3,000, but HMRC has the discretion to reduce or not charge a penalty depending on the circumstances.

How to Avoid MTD Penalties

Avoiding Making Tax Digital penalties depends on two things: proactive compliance and understanding the grounds for an appeal. The most effective strategy is to prevent errors from happening in the first place.

1. Adopt Proactive Digital Habits

Using MTD-compliant software is essential, but effective compliance extends beyond that. Tools like Receipt Bot can automate the management of digital records, ensuring every transaction is captured accurately and digitally linked. This not only streamlines submissions but also provides a clear audit trail, which is your first line of defence against record-keeping penalties. Pairing this with a system of automated reminders helps you get the necessary data from clients well before the deadline, preventing the accumulation of late submission points.

2. Use Time to Pay for Payment Delays

If you or your client cannot pay on time, acting fast is critical. You can prevent late payment penalties by agreeing to a Time to Pay (TTP) arrangement with HMRC. This must be done within the first 15 days of the payment due date. While a TTP arrangement prevents penalties from being applied, it is essential to note that late payment interest will still accrue on the outstanding amount.

3. Appeal with a ‘Reasonable Excuse’

If a penalty has already been issued, it can be appealed if there is a ‘reasonable excuse’. The core of this argument is proving that you or your client took reasonable care to meet tax obligations but were prevented by exceptional, often unforeseeable, circumstances.

Valid examples include:

• Unexpected Serious Illness: A sudden, life-threatening condition or emergency hospitalisation affecting you or your agent can be a valid excuse.
• Bereavement: The death of a close family member or partner shortly before a deadline.
• Reliance on a Third Party: This may apply if your client received incorrect advice from a seemingly qualified adviser or if there were unavoidable delays in receiving essential information from a previous agent.

In all cases, you must be prepared to provide clear evidence, such as medical notes or correspondence, to support your appeal.

Final Thoughts

The shift to the new Making Tax Digital penalty system is clear: HMRC is rewarding consistent, proactive compliance and penalising persistent errors.

Manual data entry and chasing paper records are the biggest risks in this new environment. They open the door to missed deadlines, inaccurate calculations, and incomplete digital links—the very issues that the MTD penalty system is designed to catch. The most practical way to stay compliant is to automate your processes with MTD-compatible software that handles the details for you.

Don’t let manual errors compromise your compliance. Receipt Bot streamlines the entire process by directly connecting to HMRC, automatically extracting VAT data from invoices, and ensuring that every submission is fully made-to-date (MTD)-compliant. Minimise the risk of penalties and manage your tax obligations with confidence.

Ensure you submit your VAT accurately and remain compliant with Receipt Bot. Start your free trial today!