VAT and PAYE payments to be made by direct debit

VAT and PAYE payments to be made by direct debit

HMRC has set out plans that require mandatory direct debit payments for VAT and PAYE affecting up to 87% of current registered businesses and sole traders.

This will equate to a massive change for VAT and PAYE as HMRC consults on the plan, which requires all payments to be made by direct debit rather than by bank transfer, card or even cheque, except for the largest businesses!

The move which would affect 2.4 million companies, sole traders and employers, with only the largest businesses outside the rules due to the limitations of direct debit.

At present only 330,000 businesses (which is only 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 paper-based forms used for VAT compliance with a move to online submission options for various VAT items by December 2026.

For some time, 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 made little difference to the volume of payments being made by direct debit, HMRC and the government’s preferred payment method. There are still 2.4m VAT and PAYE payers not using 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 tax gap, estimated at nearly £20bn in unpaid VAT in 2023-24 tax year, HMRC is under pressure to improve compliance rates. It is trying to expediate 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 automate 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.

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’’.

Harsh penalties

While the government is wanting to improve its cashflow and raise more VAT through better compliance as the 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 a ‘timing incentive’ removing current payment deadline extensions for everyone except those paying by direct debit.

With only eight weeks until 18 August 2026 to respond to these proposals, it is worth reviewing the consultation. This will likely be confirmed at the Budget in the autumn.

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 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.

The eight-week VAT direct debit consultation closes for comment on 16 August 2026.