Do I add VAT to late payment interest and compensation?
The short answer
No. HMRC says no tax is due on interest awarded or agreed because of late payment1, because it compensates for the delay. The VAT goes into the sum, not onto the interest: work the interest on the invoice total with VAT in it3. HMRC's page names interest, not the £40, £70 or £100 fixed sum6, so ask your accountant about that part.
England and Wales only. WolfX is software, not a law firm.
What you can add
A £7,200 invoice, paid 59 days late
Say a software shop invoiced another business £6,000 plus £1,200 VAT: £7,200 in all, due on 31 July 2026. The customer paid on 28 September, 59 days late. It went late on 1 August, so the rate is the one fixed on 30 June 2026. That makes 11.75% a year: 8% on top of the base rate5, which was 3.75% on 30 June 20267.
The wrong way: 20%9 on £206.75 is £41.35. The shop would owe that to HMRC unless it corrected the invoice with a credit note4.
The road ahead
Five steps. Nothing to pay.
Step 3: Send a new invoice with no VAT on it
Name the unpaid invoice, show the working and add no VAT. The Commissioner's guidance is to send a new invoice3 stating the amount owed and a due date, referring to the invoice paid late.
Step 4: Tell your bookkeeper
Send the memo below the same day. HMRC's page on this does not say where interest goes on the VAT return, so that is your accountant's call.
Step 5: Put VAT on by mistake? Credit it and send it again
VAT Notice 700/454 says that if the VAT on an invoice you issued is too high, you must account for the higher amount unless you correct it with your customer by a credit note. Credit the whole interest invoice, then issue it again with no VAT.
A letter you can copy
Memo to your bookkeeper about the interest invoice
Send it the day you raise the interest invoice, so the VAT side is settled while the facts are fresh.
Tap a highlighted gap to see what goes in it.
Email it so it is dated, and keep it with the invoice file. Put this at the foot of the interest invoice once your accountant agrees the fixed sum: "No VAT is charged on interest or compensation for late payment." Until then, write "No VAT is charged on interest for late payment."
When not to bother
When it isn't worth it
- You are not VAT registered. You charge no VAT on anything, so there is nothing to decide. The interest is still worked on the invoice total.
- It is a day or two late and the client is worth keeping. The interest will be pennies, and a separate invoice for it can cost more goodwill than it brings in.
- Your own terms set a flat late fee. HMRC looks at what a payment is for, not what it is called2, so it can carry VAT; ask your accountant. Interest your terms set is still interest for late payment: no VAT.
- They are a consumer, not a business. The late payment law only covers sales between businesses8, so there is no statutory interest to add VAT to.
The Wolf's note
The VAT is already inside the sum you work on. Put it on the new invoice as well and you owe HMRC £41.35 on this one, unless you credit it back. The fixed sum is the one corner HMRC's page does not name, so that question goes to your accountant.
Mr. Wolf · the AI inside WolfX
What comes next
Your next move
How do I work out late payment interest to the day?
Multiply the invoice by the yearly rate, divide by 365, then multiply by the days late.
6 min read · Letter included
What is late payment compensation, and is it £40, £70 or £100?
All three. If you sold to a business, the law adds a fixed £40, £70 or £100 to each late invoice, by its size, on top of interest, with no costs to prove.
5 min read · Letter included
In your books
Do I pay tax on an invoice that was never paid?
Yes, until you write it off, if you're a limited company or use traditional accounting.
5 min read
Don't want to do this yourself?
The Wolf does every step for you. He works out the sums, writes the letters and keeps track of every date. Nothing goes without your yes.