Unfair rules: HMRC charges interest even when no tax is due

The interest rate on late payment of tax is due to increase by a further 1.5% in April, with no equivalent increase in interest on overpaid tax. The CIOT is urging the government to re-introduce rules which enable HMRC to waive interest on underpaid VAT when no actual tax loss to the Exchequer occurs.

This power was omitted from the new VAT interest regime which came into effect for VAT return periods starting on or after 1 January 2023. The exposure to interest where there is no tax loss is due to the unique operation of the VAT regime.

Richard Wild, CIOT’s Head of Tax Technical, said:

“It is possible for a taxpayer to under-declare an amount of VAT due to HMRC, in circumstances where that VAT is reclaimable by a third party, such as the taxpayer’s customer. Under the previous interest regime¹ the principle of commercial restitution could be applied, providing HMRC with discretion not to charge interest in these circumstances, because there had been no loss to the Exchequer.

“Under the present system, HMRC no longer has statutory discretion to not charge interest in these circumstances. So, interest is now being charged in situations where there is no net loss of tax.

“We do not understand this to be a deliberate decision on the previous government’s part, but it is vital that this unfairness is removed and commercial restitution reinstated.”

Richard Wild explained:

“Imagine a scenario where HMRC decide Business A should have charged VAT on services provided to Business B over the last four years. HMRC assess Business A for the VAT owed on those past supplies and charge interest at 2.5% above the base rate on the VAT it has underdeclared. Business A issues a VAT-only invoice to Business B for the VAT previously underdeclared.

“Business B uses this VAT-only invoice to reclaim the VAT from HMRC. However, the earliest it can do this is after receiving the invoice. Business B is not entitled to any interest from HMRC (at 1% below the base rate or any other rates).

“So, while no tax has been lost, the government is enriched by four years' worth of interest, payable by Business A.”

The Institute also argues that the imbalance between repayment and late payment interest rates, particularly when late payment penalties are factored in, is unfair. This imbalance will be further exacerbated by the increase in late payment interest rates from April 2025, meaning that the rate of interest that HMRC pays taxpayers on money it owes them will be 5% lower than the rate taxpayers are charged on money that they owe to HMRC².  

Richard Wild continued:

”We are calling on the government to consult on the rate and approach to repayment interest on overpaid tax.³ It is vital to ensure that repayment interest provides adequate and fair recompense for the loss of the use of the monies by the business or individual concerned, and an adequate incentive for HMRC to process repayments in a timely fashion.”

Notes for editors:

1. The previous interest regime applied to VAT return periods starting on or before 31 December 2022, with the new interest regime applying to VAT return periods starting on or after 1 January 2023.
2. If HMRC fails to make tax repayments on time, or makes errors leading to taxpayer refunds, it pays interest at the Bank of England base rate minus 1%. If a taxpayer fails to make a tax payment in time, or makes errors leading to an underpayment of tax, HMRC charges interest at the Bank of England base rate plus 2.5%. From April 2025, the rate of interest payable to HMRC on overdue tax will be increased by 1.5% to the Bank of England base rate plus 4%, thus increasing this differential even further. Penalty interest or other late payment penalties may also be charged on the taxpayer, but not HMRC.
3. See https://www.tax.org.uk/ref1361