Penalties for Non-Compliance with the VAT Marginal Scheme
To use the VAT Margin Scheme legally, your business must follow specific rules set by HMRC. These include the types of goods you can sell, how you calculate VAT, and the way you keep your records.
Only certain goods qualify for the scheme, which typically includes second-hand items that you’ve bought for resale. If you’re a used car dealer, a jeweller, or a watch seller, this scheme is designed to make sure you only pay VAT on the profit margin, not the full sale price.
HMRC gives you the benefit of the scheme, but they expect precision in return. Failing to meet expectations can lead to costly consequences.
Let’s take a look at what some of these consequences are.
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What the VAT Margin Scheme really expects from your business
When using the VAT Margin Scheme, HMRC expects you to understand how the scheme works and that you’re using it properly, day-to-day.
First, only certain goods qualify for the scheme, which is usually second-hand, antique or refurbished items where VAT wasn’t charged on purchase. If you’re dealing in used cars, jewellery, or watches, you’re likely in the right space. But that doesn’t mean you can just apply the margin scheme to everything you sell. You need to check the eligibility of each item and make sure your purchases fall under the right category.
Then comes record keeping. HMRC expects clean, detailed records that show what you bought, how much you paid, and what you sold it for. You also have to calculate VAT based on the profit margin, not the full selling price. That’s the whole point of the scheme and where mistakes often begin.
Easy-to-miss VAT mistakes that could cost you greatly
Most businesses don’t set out to break VAT rules, it’s usually the small, overlooked things that cause the biggest trouble. And those small mistakes can add up fast.
One common issue is mixing up stock. Let’s say you sell both standard-rated goods and margin scheme items, for example, a watch dealer who sells new straps alongside second-hand timepieces. If your systems don’t clearly separate the two, you could easily charge or reclaim VAT incorrectly. HMRC sees this as a red flag.
And of course, poor record-keeping is always a risk. If HMRC reviews your books and finds missing information, mismatched figures, or vague descriptions, they might not give you the benefit of the doubt. Even honest mistakes can lead to backdated VAT bills, interest, or worse.
Most of these errors are preventable with the right setup. But when they’re missed, they slowly cause issues with your business and bottom line.
What happens when HMRC finds errors in your VAT records
Spotting a mistake in your VAT records might feel like a minor issue, but to HMRC, it could be the start of something much bigger. Once they identify an error, whether it’s through a routine check, a flagged return, or a whistleblower, they can dig deeper.
The first thing they usually do is issue a compliance check notice. This can come by post or email and usually asks for records covering a specific time period. If your paperwork is organised and your VAT treatment is correct, the review may end there. But if they find inconsistencies, the process can escalate.
If HMRC concludes that VAT was underpaid, even accidentally, you may face:
A backdated VAT bill, including the full standard VAT on affected sales (not just the margin)
Interest on the underpaid VAT, calculated from the date it was due
Financial penalties, which can range from 0% to 100% of the VAT due, depending on the nature of the error (careless, deliberate, or concealed)
For example, if you wrongly applied the scheme to a vehicle you bought with a VAT invoice, HMRC could require you to pay VAT on the full selling price, not just the margin. On a high-value car, that’s thousands of pounds at stake.
What’s more, HMRC doesn’t always stop with one period. If they believe the error was ongoing, they can go back up to four years or even twenty years if they believe it was deliberate.
In serious cases, especially if there’s a suspicion of fraud or repeated non-compliance, HMRC may remove your access to the scheme or refer the matter for criminal investigation. That’s rare but not off the table for them.
Even if it never gets that far, the stress, disruption, and financial strain of a VAT error can be huge. That’s why spotting and correcting issues early or avoiding them entirely is always the smarter move.
How VAT investigations start (and why they’re not always about fraud)
When HMRC gets involved, it’s easy to assume the worst. But not every VAT investigation starts with suspicion of fraud. In fact, many begin with something as simple as a small inconsistency in your VAT return or even just part of HMRC’s routine checks.
For example, if your profit margins look unusually low or your returns don’t match your typical trading pattern, the system might automatically flag your account for a closer look. They might also take an interest if you regularly amend past returns, delay filings, or have gaps in your records.
Another trigger is when businesses file VAT returns showing no VAT due over several periods while still showing healthy sales. That’s not necessarily wrong especially under the margin scheme but it will raise questions if it’s not properly backed by clear records.
Sometimes, it’s the suppliers or customers you deal with that can draw attention. If someone connected to your business is under investigation and your name comes up in their records, HMRC might look into your returns as well.
What’s important to remember is that HMRC often uses these checks to educate and correct, not just penalise. So yes, investigations can feel intimidating, but they’re not always about catching someone doing something wrong. They're often about making sure the system is being used properly and giving you a chance to fix things before they spiral.
Smart ways to protect your business from VAT penalties
Keep clean, consistent records.
This is your first line of defence. Make sure every margin scheme item has a clear audit trail from purchase to sale, including proof of eligibility (no VAT charged on purchase), purchase cost, sale price, and VAT margin calculation. The clearer your records, the fewer questions HMRC will ask.Don’t mix stock.
If you’re selling new and used goods (like new jewellery chains and second-hand rings), don’t let your systems treat them the same. Use separate sales codes or categories to avoid mistakes in VAT treatment.Watch your invoices.
Under the VAT Margin Scheme, you must not show VAT separately on sales invoices. Instead, a simple line like “VAT margin scheme – VAT not shown” is enough. Many businesses fall into the trap of using a standard invoice format that unintentionally breaks the rule.Do regular checks.
Even if you think everything’s in order, take time every few months to review your VAT returns, margin calculations, and eligible stock. A quick check could catch something small before it becomes a bigger issue.Work with someone who knows the scheme.
Not every accountant understands the details. Working with a specialist who deals with second-hand businesses (like used car dealers or jewellers) means you’re more likely to get things right from the start.
Conclusion
The VAT Margin Scheme can be a real asset for second-hand dealers, but only if you use it properly. From misapplied invoices to poor record keeping, even simple mistakes can lead to unexpected penalties, interest charges, or HMRC investigations.
At Rhombus Accounting Firm, we work with used car dealers, jewellers, and watch sellers across the UK to make sure they’re using the scheme correctly and staying on the right side of HMRC. If you’re not 100% sure about your current setup, we’re here to help you sort it before it becomes a problem.
Thanks for reading!
Meet Lewis
Lewis is a professional accountant and founder of Rhombus Accounting. He regularly shares his knowledge and best advice here on his blog and on other channels such as LinkedIn.
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