A massive change in VAT and PAYE is coming as HMRC consults on plan to require all payments to be made by direct debit rather than by bank transfer, card or even cheque, except for the largest businesses
The move will affect an enormous 2.4 million companies, sole traders and employers, HMRC said, with only the largest businesses outside the rules due to the limitations of direct debit.
Currently only 330,000 business – a paltry 13% of the 2.73m businesses registered for PAYE and VAT – use direct debit payments. The scale of this proposal cannot be underestimated.
As part of its digitisation programme HMRC is also getting rid of some of the many paper-based forms used for VAT compliance with a move to online submission options for various VAT items by December.
On the direct debit issue, HMRC has been trying to persuade VAT and PAYE paying businesses, sole traders and individuals to pay their bills by direct debit and updated the guidance earlier this year to say it was the 'primary method' for payment.
But this approach did not work and made little difference to the volume of payments being made by direct debit, HMRC and the government's preferred payment method as it has more control. There are still 2.4m VAT and PAYE payers not using direct debit.
In fact, in the consultation document on the issue, released this week at the same time as 13 other significant proposals, HMRC admits that despite updating the guidance, 'this has not led to a material increase in payment by direct debit'.
Most VAT payments are made by bank transfer, debit or corporate credit card, standing order and even cheque and cash at banks and building societies approved to make paper returns using an HMRC paying in slip.
With VAT accounting for 20% of the massive tax gap at an estimated nearly £20bn in unpaid VAT in 2023-24 tax year, HMRC is under pressure to improve compliance rates. It is trying to couch the move to direct debit as beneficial for taxpayers, claiming it is a 'way to reduce unnecessary administrative burdens and avoidable costs' for businesses.
Under the new proposals, direct debit will be the 'required' method of paying VAT and PAYE, with only very limited 'necessary exceptions.
Once a direct debit is set up through the VAT online account, HMRC collects the payment three days after the due date and then notifies businesses of the date and amount of the direct debit payment no later than three working days before the payment is collected.
But for larger businesses, direct debit will not work as payments are limited to £20m by the BACS payments scheme. So, if HMRC introduces mandatory use of direct debit for VAT payments, payments over a certain threshold will have to be excepted. 'Other methods of electronic payment would remain available' for these larger organisations, HMRC confirmed.
From HMRC's perspective, the advantages are clear; it would be automating payment after a return is submitted using direct debit removing taxpayers from the process as they would not have to set up each payment or enter payment references, helping reduce avoidable late and incorrectly allocated payments. On the plus side, this might mean less penalties for businesses too.
The direct debit proposals also cover payments on account (POA) for businesses with annual VAT liability more than £2.3m, but obviously below the £20m figure cut-off.
For those UK based businesses and individuals without a bank account, HMRC said they would have to open an account, and warned business bank account holders could face additional bank charges for processing direct debits.
It is important to note that the UK direct debit scheme can only be used with UK bank accounts. Businesses without a UK bank account, including those based overseas, would have to use existing payment arrangements. HMRC confirmed 'other methods of electronic payment would remain available for those affected'. This may begin to feel like a not so level playing field.
For those excepted from online filing, HMRC said the impact on this group would be reviewed as part of the consultation but did not clarify whether the exceptions would remain. The consultation does ask for feedback on any group 'disproportionately affected' by the proposed direct debit mandating.
Harsh penalties
While the government is wanting to improve its cashflow and raise more VAT through better compliance as the pesky VAT gap remains, it is also considering the penalty regime for non-compliance.
One of the options is a penalty for failure to pay by direct debit 'even if the payment is otherwise made in full and on time'. There may also be 'timing incentive' removing current payment deadline extensions for everyone except those paying by direct debit.
With only eight weeks until 18 August to respond to these proposals, it is definitely worth reviewing the consultation – see links below for full document. This will likely be confirmed at the Budget this autumn as the timing is perfect for an announcement at that time.
Interesting, the impact assessment is blank, raising initial questions about the rationale for this decision if it is not to raise billions for the Exchequer.
If it slashes the VAT and PAYE tax gap, it makes sense for HMRC, but if not ,with the overwhelming majority of affected businesses not paying with direct debit, it seems as yet another onerous demand for the majority of tax compliant businesses being battered by record high tax bills and rising employment costs, not to mention increasingly complicated tax rules.
End of paper forms for option to tax notifications
In another move to modernise, HMRC confirmed it will replace legacy paper forms with new online tools to submit option to tax notifications and revocations, replacing existing paper-based processes by the end of 2026.
This is designed to improve accuracy, reduce processing times and help agents and companies file in a more 20th century way, rather than having to use paper forms as no other system is provided by HMRC.
The new digital methods will incorporate industry requirements, including bulk uploads, for option to tax notifications, revocations and VAT registration cancellations, HMRC stressed.
Also on the VAT front, the government is considering whether it can change the law to allow it to access to businesses' digital accounting systems.
This appears to be an incredible reach, but in a major tax update released by HMRC on Tuesday, the government argued 'VAT data that businesses already hold in their digital accounting systems could help HMRC work more efficiently'.
In other words, HMRC wants more access to confidential financial information from companies to help it reduce the ever-growing tax gap. It appears likely a future consultation will address this issue, with the government stating: 'Engagement with stakeholders will inform any future decisions.'
The eight-week VAT direct debit consultation closes for comment on 16 August 2026.
HMRC consultation, Requiring payment of VAT and PAYE by Direct Debit