Sarah Bradford highlights the penalty regime applying under making tax digital.
Making tax digital for income tax self-assessment (MTD for ITSA) will become a reality for self-employed traders and unincorporated landlords with combined trading and property income of £50,000 or more (based on 2024/25 figures) from 6 April 2026. It will be extended to traders and landlords with combined trading and property income of £30,000 from 6 April 2027 and to those with combined trading and property income of £20,000 from 6 April 2028.
Across the UK tax system, penalties apply if returns are submitted late and tax is paid late, and MTD is no exception. A penalty regime for MTD was introduced by Finance Act 2021. The penalty regime already applies for VAT purposes, and has done so since 1 January 2023. As regards MTD for ITSA, the regime will apply both to those for whom MTD for ITSA is mandatory, as well as to those who sign up voluntarily. Here, it is important to note that the penalty regime will continue to apply to anyone who signs up voluntarily and later opts out. This is because once a taxpayer signs up for MTD, their tax records are moved across to the new MTD-specific computer system.
Late submission penalty
Under MTD for ITSA, taxpayers are required to submit quarterly returns and a final declaration, which, much like the current self-assessment tax return, is the point at which the adjustments are made, reliefs are claimed, and the position for the year is finalised. Late submission penalties will apply only if the final declaration is made late; they do not apply to late quarterly returns. Further, they do not apply for 2023/24 or 2024/25 to taxpayers who have signed up voluntarily to test MTD for ITSA systems.
The new late submission penalty regime is points-based. The taxpayer receives a penalty point each time a relevant return is filed late. The point at which a penalty hits depends on the frequency of the returns. For annual returns, such as the final declaration, a penalty is levied once the taxpayer has accumulated two penalty points. For quarterly returns (such as VAT returns), the threshold is four points; for monthly returns, the threshold is five points. The penalty is set a £200.
The points expire after 24 months for taxpayers with an annual filing obligation (as for the final declaration) and after 12 months for taxpayers with a quarterly filing, where the taxpayer remains below the penalty threshold, provided that all the submissions due in the preceding 24 months have been received by HMRC. The clock is also reset once the taxpayer has reached the penalty threshold and received a penalty.
Example 1: Points mean penalties!
John is a sole trader, with trading income for 2024/25 of £70,000. He must comply with MTD for ITSA from 6 April 2026. He must submit his final declaration for 2026/27 by 31 January 2028. He does not file the return until 5 February 2028. As the return is late, he receives one penalty point. However, as he is below the penalty threshold of two points for annual returns, he does not receive a late submission penalty for the 2026/27 return.
John also misses the deadline of 31 January 2029 for the 2027/28 final declaration, filing it on 2 February 2029. He gets a further point, taking his penalty point total to two. He has reached the points threshold for annual returns of two penalty points and he receives a late submission penalty of £200.
As he has received a penalty, the clock is reset to zero. He will not receive a further late submission penalty until he once again has two penalty points, even if he files his 2028/29 final declaration late.
The new rules are less stringent than the current penalty regime for self-assessment tax returns, under which a £100 late filing penalty is charged even if the return is only a day late and regardless of whether any tax is due.
Late payment penalties
The late payment penalty regime introduced by the Finance Act 2021 will be aligned across the main taxes and will apply to taxpayers within MTD for ITSA, either compulsorily or voluntarily. However, HMRC has stated that it will apply ‘a light touch’ during the first year of operation of the new regime.
By contrast to the new late submission penalty rules, those for late payment penalties are harsher than the current rules, with the first penalty biting where a payment is made 15 days late (rather than 30 days currently). The first penalty is 3% of the tax outstanding 15 days after the due date.
If any tax remains outstanding 30 days after the due date, a further penalty is charged equal to 3% of the tax outstanding at day 30.
If the tax remains unpaid more than 30 days after the due date, a daily penalty is charged from day 31 at an annual rate of 10% of the tax outstanding on that day for each further day on which the tax is due.
The penalties are charged in addition to interest on the late paid tax.
These penalties are considerably harsher than those under the current rules, under which a penalty of 5% of the tax due is charged if tax is unpaid at the 30-day point, the six-month point and the 12-month point. The harsher penalties are no doubt designed to encourage taxpayers to pay their tax on time.
For those struggling to pay, it will be even more important to set up a ‘time to pay’ agreement in order to escape the penalties as they can quickly mount up. Interest will continue to be charged even where a time to pay arrangement is in place.
Example 2: Paying the penalty
Jane is within MTD for ITSA from 6 April 2026. For 2026/27, she has a balancing payment of £12,000 which is due by midnight on 31 January 2028. Jane is waiting for some money from a supplier. She makes a part payment on 21 February 2028 of £4,000. She pays the remaining £8,000 on 13 March 2029.
Jane falls within the scope of the late payment rules.
On day 15 (15 February 2028), she owes £12,000 in tax. She receives a late payment penalty of £360 (3% of £12,000).
On day 30 (1 March 2028), she owes £8,000 (having paid £4,000 on 21 February 2028). She receives a further penalty of £240 (3% of £8,000).
As the tax remains unpaid for a further 12 days, she receives daily penalties of £2.18 – a total of £26.16. The daily penalties are (10% x £8,000)/366).
Jane’s total penalties are £626.16.
Under the current regime, she would have paid a penalty of £400 (5% of the tax of £8,000 unpaid on day 30).
Other penalties
Under MTD for ITSA, traders and landlords must keep digital records. A penalty can be charged for a failure to maintain the prescribed records in functional compatible software.
HMRC can charge a penalty of up to £3,000 for any quarterly period.
Inaccuracy penalties
Inaccuracy penalties will apply to the final declaration in the same way as they do currently in relation to the self-assessment tax return.
However, they will not apply to the quarterly updates.
Right to appeal
Taxpayers will receive a decision letter notifying them when a penalty has been charged. They will be able to appeal against the penalty as now if they believe it to be incorrect or if they have a reasonable excuse for the late submission or the late payment.
Where penalty points are issued under the late submission rules, the taxpayer will also have a right of appeal.
Practical tip
As the start date for MTD for ITSA approaches, taxpayers who will fall within the regime from 6 April 2026 are advised to familiarise themselves with the penalty rules, so that they do not incur unnecessary penalties.
