MTD for VAT Penalties: What HMRC Says About Filing Without Functional Compatible Software

Key takeaways

• HMRC says it may charge a penalty of up to £400 for every VAT return filed without functional compatible software.
• “Functional compatible software” is defined by HMRC as software (or a set of programs/apps) that can keep digital records, send VAT return information to HMRC from those records, and receive information from HMRC.
• The risk HMRC describes is about how the return is filed (the MTD method), not just whether the figures are right.

The question: can HMRC penalise you for filing a VAT return without functional compatible software?

Yes. HMRC says that if you file VAT returns but do not use functional compatible software, it may charge a penalty of up to £400 for every return you file.

This statement appears in HMRC’s compliance checks factsheet for Making Tax Digital (MTD) for VAT.

What HMRC means by “functional compatible software”

HMRC defines functional compatible software as a software program (or set of software programs, products, or applications) that can:

• record and store digital records
• provide HMRC with information and VAT returns from the data held in those digital records
• receive information from HMRC

In other words, it’s not enough that you keep records “somewhere digital” — HMRC’s definition focuses on whether your setup can both maintain the required digital records and submit the VAT return to HMRC from those records, using software that can also receive HMRC information.

Why this matters (practical implications)

For VAT-registered businesses and bookkeepers, HMRC’s position means there’s a distinct compliance risk if a VAT return is filed outside the MTD process (for example, using a method that does not meet HMRC’s definition of functional compatible software).

Because HMRC frames the penalty as applying “for every return you file”, the potential exposure can repeat across VAT periods if the filing method does not meet the requirement.

Common misunderstandings to avoid

• “We used software somewhere in the process, so we’re fine.” HMRC’s definition is specific: the software must be able to store digital records, submit the VAT return information to HMRC from those records, and receive information from HMRC.

• “This only matters if HMRC opens a wider VAT enquiry.” HMRC’s factsheet describes the penalty risk specifically for filing returns without functional compatible software, as a standalone issue.

What to do if you’re unsure

If you’re not confident your current process meets HMRC’s definition, use HMRC’s guidance to sense-check whether your tools and workflow are “functional compatible” under MTD for VAT.

For the exact wording and context, see HMRC’s factsheet:

• https://www.gov.uk/government/publications/compliance-checks-how-to-avoid-penalties-for-making-tax-digital-for-vat-ccfs69/compliance-checks-how-to-avoid-penalties-for-making-tax-digital-for-vat-ccfs69

Summary

HMRC’s stated position is clear: it may charge a penalty of up to £400 for every VAT return filed without functional compatible software. HMRC also defines functional compatible software as software (or a set of apps/programs) that can keep digital records, send VAT return information to HMRC from those records, and receive information from HMRC.