As part of its Making Tax Digital initiative, HMRC is modernising the UK tax system — and that includes changes to how penalties work.
If you’re a sole trader, landlord, or small business owner, it’s important to understand the new rules and how they impact your taxes. And while it might feel complex and overwhelming at first, the new system is actually designed to be fairer and more consistent than the old one.
So, how do Making Tax Digital penalties work and what do these changes mean for you?
We’ll break it down step by step and show you exactly how to stay compliant.
MTD for VAT vs. MTD for Income Tax (ITSA)
Before we consider how the new Making Tax Digital penalties work, it’s important to understand where and how they apply to different groups of taxpayers.
The new penalty system is the same for both VAT and Income Tax, but the rollout timelines are different and your penalties for each tax stream are tracked separately.
MTD for VAT is already fully in place, which means that all VAT-registered businesses must be compliant — and are subject to all Making Tax Digital penalties that we’ll cover in this guide.
From April 2026 onwards, Making Tax Digital (and MTD penalties) will extend to Income Tax Self Assessment (ITSA) for sole traders and landlords with £50,000+ in qualifying income, and from April 2027, to sole traders and landlords with £30,000+ in qualifying income.
The most important point to note here is that although the same penalty structure applies to both VAT and ITSA, your points and / or penalties do not carry over between the two categories. So, for example, you could have penalty points on your VAT account and none on your Income Tax account, because HMRC treats each system independently.
With that in mind, let’s take a look at how the new MTD penalty system works.
The new MTD penalty system explained
The new penalty system replaces the VAT default surcharge (which could escalate quickly and was often criticised for being unpredictable) with a more proportionate points and percentage-based structure.
Crucially, it separates the act of filing late from paying late, and it applies penalties in a way that reflects both the frequency of your submissions and the length of any delay in payment.
Within this new system, there are three types of Making Tax Digital penalties to be aware of:
Late submission penalties (a points-based system)
Late payment penalties (percentage-based charges plus interest)
Record-keeping penalties (for non-compliant software or missing digital links)
We’ll explain each in detail now.
Late submission penalties and the points-based system
Under the new MTD system, filing late no longer triggers an automatic fine. Instead, HMRC now uses a points-based model: every time you miss a submission deadline, you receive one penalty point. Once you reach your points threshold, HMRC issues a £200 penalty, and every further late submission results in an additional £200 charge.
Your points threshold depends on how often you need to submit returns. Annual filers receive a penalty at two points, quarterly filers at four points, and monthly filers at five points. This makes the system more proportionate — businesses that file more frequently have more opportunities to make mistakes, so their threshold is higher.
Importantly, penalty points don’t stay on your record forever. They expire after a period of good compliance (as long as you’ve also submitted any outstanding returns).
What counts as a period of good compliance also varies based on how often you’re required to submit your tax returns. If you file annual tax returns, you’ll need to file on time for 24 months to wipe the slate clean. Quarterly filers must file on time for 12 months, and monthly filers must file on time for 6 months.
Overall, the new system is designed to be more forgiving of one-off mistakes while still taking persistent lateness seriously.
MTD late submission penalties at a glance
Filing frequency | Points threshold (number of points that will trigger a £200 fine) | Good compliance period (to reset points) |
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Late payment penalties and percentage-based fines
Under the new MTD system, you can also be penalised for late payments (separate from late submissions). Here, HMRC applies percentage-based charges that increase the longer a tax bill goes unpaid.
If you pay your tax bill within 15 days of the deadline, you won’t receive a fine. However, it’s important to note that you’ll start to accrue daily interest on your unpaid tax bill from the day after payment is due. So you’ve got a 15-day grace period where no penalty is applied, but you’ll still be racking up interest.
If your tax bill remains unpaid after 15 days, HMRC then applies a penalty which is calculated at 3% of the outstanding amount. Once the delay reaches 30 days, a second 3% penalty is added — bringing the total penalty to 6% (with interest still being accrued at the same time).
From Day 31 onwards, HMRC’s late payment interest rate (currently 10% per year) accrues until the tax is paid in full. This can add up quickly, especially if the balance remains outstanding for some time.
Making Tax Digital late payment penalties: example calculation
Let’s say you’ve got a tax bill of £4,000 which is due on 7 May. If you paid it on 20 May (13 days late), you’d escape a penalty but you’d still pay interest for each day beyond the deadline.
If you paid it on 25 May (18 days late), you’d get a penalty calculated at 3% of the whole bill — so, in this case, £120 — plus any interest accrued.
If you still hadn’t paid your bill by 7 June (31 days after the deadline), you’d receive another 3% penalty — so another £120 fine (amounting to a total penalty of £240) — plus daily interest calculated at a rate of 10% p.a.
You can see just how quickly the charges escalate once you pass the 15-day and 30-day thresholds, so it’s crucial to keep on top of your payment deadlines.
If you’re having cash-flow issues, it’s worth contacting HMRC as early as possible. You can arrange a Time to Pay plan before penalties are triggered, which usually prevents them from being charged. This is an extremely useful option if you know you’re going to be late with payment.
MTD late payment penalties at a glance
Payment timing (in relation to deadline) | Penalty incurred | Notes |
|---|
| | |
| 3% of outstanding tax bill | Interest continues to accrue despite penalty |
| Additional 3% (total penalty of 6%) | Plus daily interest at HMRC’s late payment rate |
| Penalties are usually halted | Must be agreed with HMRC before penalties apply |
Other penalties: record-keeping and inaccuracy
Alongside late submissions and late payments, HMRC may also issue penalties for poor record-keeping or providing incorrect information.
Penalties for failing to maintain digital records
Under the new Making Tax Digital initiative, you’re required to keep all records in a fully digital format, and you must use HMRC-compatible software to store, update, and submit your tax information. You must also maintain digital links between any systems you use — you can’t manually copy and paste data from one spreadsheet or platform to another.
Failure to comply with these new rules may incur a fine of up to £3,000. However, such penalties aren’t triggered immediately by a single mistake; HMRC looks at the overall severity of the failure and can reduce or waive the penalty depending on the circumstances.
Penalties for inaccurate reporting
Inaccuracy penalties apply when incorrect information is submitted to HMRC, and the penalty is based on both taxpayer behaviour and the amount of ‘potential lost revenue’.
HMRC categorises behaviour into four types:
Reasonable care: No penalty if you can show you took reasonable care but still made an error.
Careless: 0% to 30% of the lost revenue.
Deliberate: 20% to 70% of the lost revenue.
Deliberate and concealed: 30% to 100% of the lost revenue.
The final penalty can be significantly reduced if you make an unprompted disclosure (i.e. telling HMRC about the error before they discover it).
Good to know: For MTD for Income Tax, inaccuracy penalties do not apply to the quarterly updates. They apply only to the Final Declaration, which is where your full tax liability is confirmed.
How to avoid Making Tax Digital penalties
With the right tools and habits in place, MTD penalties are entirely avoidable. Here are three key steps for compliance.
Use HMRC-recognised, compatible software
The single most important step for avoiding Making Tax Digital penalties is to use software that’s fully recognised by HMRC. This ensures that you’re correctly managing your digital records, keeping all data properly linked, and that you’re able to submit directly to HMRC in the required format.
With Tide, you can combine straightforward business banking with fully MTD-compatible accounting software all in one platform. That means no jumping between tools or reconciling data manually — just one connected system that keeps your records accurate, saves time and admin, and keeps you compliant year-round.
Maintain accurate digital records
Be diligent about maintaining clean digital records throughout the year. This reduces the risk of inaccuracies and protects you from record-keeping penalties.
Aim to update your books regularly rather than waiting until just before a deadline. This makes errors easier to spot and ensures that your quarterly or annual submissions are based on accurate, complete information. Wherever possible, rely on integrated tools rather than bridging software, which can increase the risk of broken digital links or inconsistent data.
Understand and stick to all deadlines
Most Making Tax Digital penalties arise from timing issues, so get ahead of all your filing and payment deadlines. If you’re not sure what’s due when, refer to our guide on Making Tax Digital deadlines.
From there, set up recurring reminders in your calendar — leaving plenty of buffer time ahead of each deadline. Aim to review your books a week or two before each submission to reduce last-minute pressure and give you time to resolve any issues before penalties apply.
Are you ready for MTD? Learn exactly what the upcoming changes mean for you and prepare to tackle Making Tax Digital for Income Tax with Tide.
Can you appeal a Making Tax Digital penalty?
It is possible to appeal Making Tax Digital penalties if you believe they’ve been applied incorrectly, or under extenuating circumstances. HMRC allows appeals where you can prove a reasonable excuse such as a serious illness, bereavement, major software failure, or an unexpected service outage that prevented you from filing or paying on time.
Appeals must be submitted within 30 days of receiving the penalty notice, and you’ll need to explain what happened, how it affected your ability to comply, and when you put things right. If HMRC accepts your explanation, the penalty may be reduced or cancelled.
Wrapping up
The new Making Tax Digital penalties system may feel like a big change, but it’s designed to be more proportionate than the old rules. And, once you’ve got to grips with it, it should offer more consistency and clarity in terms of how penalties are applied.
Here’s a recap of what’s new:
The same penalty framework applies to both VAT and Income Tax, although your points are tracked separately for each.
Late submission penalties use a points-based model, with a £200 fine applied once you reach your points threshold.
Late payment penalties follow a percentage-based structure, with charges increasing the longer a bill goes unpaid.
Rules around record-keeping and accuracy add an extra layer of responsibility, so it’s more important than ever to keep your digital records complete, connected, and up to date.
To stay on track, make sure you’re clear on all deadlines that apply to your business, set yourself up with HMRC-recognised tools like Tide’s accounting software, and build a reliable process that helps you keep on top of your submissions and payments.
Photo by Wesley Tingey on Unsplash
