Late Payment Legislation
Late and non-payment of commercial invoices is one of the most common causes of business failure. In 2023, the number of private sector businesses increased for the first time in two years; up 0.8% to 5.6 million. The latest FSB Small Business Index (SBI) indicates that 188,500 firms could close over the next 12 months, with late payment of invoices being a deciding factor. According to the more conservative estimates, SMEs are carrying more than £67 billion of late payment debt. Overdue invoices are saddling businesses with debt they would ordinarily have been able to clear down.
Late payment of invoices places a strain on cash flow, tying up working capital and restricting growth. There is also a high risk that late payment will become a bad debt and affect profitability. Despite the impact late payment can have, dealing with the situation remains a taboo subject for many. Inflation does not just affect consumer goods. It has been battering SMEs alongside increased debt levels. According to the SBI, the cost of doing business is still rising for 82.5% of SMEs. The highest levels of inflation are being seen in overheads, fuel, and utilities. Due to a shortage of candidates to fill vacancies, wages must increase to remain competitive. This means the cost of chasing invoices is also increasing.
The UK was one of the first countries in Europe to recognise that late payment of commercial debt has a negative impact on the whole economy. When businesses close, redundancies follow, the welfare bill increases, and the economy gets smaller. The Government first introduced legislation to help combat the problem in 1998 when The Late Payment of Commercial Debts Act came into force. For the first time legislation gave businesses a statutory right to charge interest on the late payment of commercial debt. It was originally designed to be used by small businesses against larger firms. The statutory interest rate of 8% above the Bank of England base rate enables businesses to offset the cost of bank borrowings. It has since been expanded to include all businesses, including public sector organisations. Since 1998, all presiding governments have continued to promote a culture of prompt payment and even made amendments to the legislation; for example, there is now a provision to claim fixed amounts of compensation from the debtor. The most significant amendment came in 2013, allowing the cost of instructing a third party (such as Advocate) to be reclaimed from the debtor.
The Late Payment of Commercial Debts Act
Criteria
Late payment legislation applies only to commercial debt recovery. Businesses do not have to be limited companies, with the definition including sole traders, the self-employed, partnerships, charities and public sector organisations. The legislation does not cover debts owed to or by consumers.
Defining Late Payment
If you have agreed to a credit period with a customer, the payment is late if it is not made by the last day of the agreed credit period.
If you have not agreed to a specific credit period, then the legislation sets a 30-day default period. The 30-day default period starts on the day the goods or services are delivered by the supplier. Whether an invoice is a day or a month overdue, it is still overdue. The Late Payment of Commercial Debts Act can still be applied, and Advocate can still be instructed to recover payment.
Late payment interest is accrued from the expiry date of the credit period or the 30-day default period.
Calculating Late Payment Interest
Statutory late payment interest is chargeable at 8% above the Bank of England base rate. Although the bank sets the base rate eight times a year, statutory interest rates are only set twice a year, covering the periods 1 January – 30 June and 1 July – 31 December based on the prevailing base rate at the start of each period. For example, with a base rate of 5.25% on 1 July, statutory late payment interest is 13.25% and accrued on a daily basis.
Calculating Late Payment Compensation
Compensation can be charged in addition to interest. The amounts are fixed and apply to each invoice that makes up the unpaid debt:
Unpaid Invoice Compensation
Up to £999.99 £40.00
£1,000 to £9,999.99 £70.00
£10,000 or more £100.00
Calculating Late Payment Recovery Costs
Late payment legislation allows creditors to reclaim the reasonable costs of recovering a debt, including the use of a third party. Reasonable costs are easier to quantify with the use of a third party such as Advocate Commercial Debt Recovery, as the reasonable costs are simply the recovery fee we charge to the debtor.
VAT on Late Payment Charges
With regards to VAT and late payment charges, in most cases, as no supply has been made, late payment compensation and late payment interest are considered to be outside the scope of VAT. However, where a third party (such as Advocate) is instructed to collect late payment charges at the same time as collecting payment of the principal account, HMRC considers the collection as a single supply subject to VAT. Therefore, Advocate has to apply VAT to late payment charges. The VAT applied is recoverable under normal VAT regulations.
Late Payment in Contracts
It is not uncommon for businesses to have late payment charges included within their terms and conditions or contracts. Most creditors choose to apply the maximum level of interest and compensation. Some apply lower charges, which Advocate reflect in the late payment calculations. If late payment charges are not part of an agreement, the default interest, compensation and recovery costs take precedence. Advocates fees are legally enforceable under The Late Payment of Commercial Debts Regulations 2013 which negates the need for the debtor’s consent to both apply and enforce the charges.
Read and download the Late Payment Regulations: