Do You Charge VAT on Late Payment Interest and Compensation? (UK)
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No. You do not charge VAT on statutory late payment interest, or on the fixed compensation you are entitled to under the Late Payment of Commercial Debts (Interest) Act 1998. HMRC treats both as compensation for being paid late, not as payment for a good or service, so they sit outside the scope of VAT. The VAT on your original invoice is unaffected. This guide explains why, with a worked example.
1. The short answer
Late payment interest and statutory compensation are outside the scope of VAT. HMRC's VAT manual states plainly that no tax is due on interest for late payment, because it is compensation for delayed payment rather than consideration for a supply. The same principle covers the fixed £40, £70, or £100 compensation.
In practice, you add these amounts to what the client owes and charge no VAT on top. The only VAT anywhere in the transaction is the VAT on the original goods or services, at their normal rate.
HMRC's VAT Supply and Consideration manual says: "No tax is due, however, on any interest awarded or agreed because of the late payment. This is outside the scope of VAT as compensation for payment being delayed." See VATSC06810.
2. Why interest and compensation sit outside VAT
VAT is a tax on the supply of goods and services. It applies to the consideration, meaning the payment given in return for that supply. Interest and compensation for late payment are not paid in return for anything. Nothing new is supplied when a client simply pays late.
HMRC's test is whether there is a direct link between a payment and something supplied in return for it. A late payment charge fails that test, because it compensates you for being kept out of your money rather than buying anything. That is why statutory interest and the fixed compensation both fall outside the scope of VAT.
There is one area of nuance worth knowing. HMRC has tightened its treatment of some payments described as "compensation" since 2022, and certain fees, such as early contract termination charges, are now often treated as consideration that does carry VAT. Genuine late payment interest and statutory compensation on an existing debt are not affected by that shift. If you set your own contractual late fee, it usually follows the same outside-scope treatment when it genuinely compensates for late payment, but confirm anything unusual with your accountant.
3. Does this affect the VAT on your original invoice?
No. The VAT on the original supply is fixed when you make the supply and issue the invoice. Being paid late does not change it, and you still account for that output VAT as normal in the VAT period it belongs to.
The interest and compensation are separate amounts added on top of the debt. They do not alter, reduce, or add to the VAT already charged on the goods or services themselves.
4. What if you're not VAT registered?
If you are not VAT registered, you do not add VAT to anything, not to the invoice, the interest, or the compensation, so the question never arises. Your right to charge statutory interest and compensation is completely separate from VAT.
Every UK business can claim statutory interest and compensation on a late commercial debt under the Act, whether or not it is VAT registered. The entitlement depends on the debt being a business-to-business one, not on your VAT status.
5. Worked example
Say you invoice £2,000 plus 20% VAT, a gross debt of £2,400, and the client pays 40 days late. You charge the £400 VAT on the work exactly as you always would. On top of the unpaid debt you add statutory interest and a fixed compensation sum, and neither of those carries VAT.
| Item | Amount | VAT treatment |
|---|---|---|
| Original work (net) | £2,000 | Standard 20% VAT applies |
| VAT on the original work | £400 | Accounted for as normal output VAT |
| Statutory interest (40 days late, 11.75% a year) | £30.90 | Outside the scope of VAT |
| Fixed compensation (debt £1,000 to £9,999.99) | £70 | Outside the scope of VAT |
| Total the client now owes | £2,500.90 | Only the £400 is VAT |
Statutory interest runs on the full VAT-inclusive debt of £2,400. At the current statutory rate of 11.75% a year (the Bank of England base rate of 3.75% plus 8%, checked 5 July 2026), 40 days works out at about £30.90. Our late payment interest calculator does this for you, and the base rate can change, so confirm the current figure before quoting it.
The fixed compensation for a debt in that band is £70. Add it all together and the client owes £2,500.90, of which the only VAT is the original £400. For how to actually apply interest and word it to a client, see our guide to charging interest on overdue invoices, and for what you can claim under each heading, our guide to statutory interest and compensation.
6. FAQ
NudgeBadger works out the statutory interest and compensation you're owed and builds it into a properly worded letter, free to try.
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