Settle the contractual position, then automate. A charge you have no right to make doesn't improve by arriving on time, so four decisions come first: what you're entitled to charge, whether your authority is the contract or the Act, how the charge is treated for VAT, and what your rule is. The switch itself is the quick part.
In this article
The short version
- A late fee is triggered by breach, so it stands where it protects a legitimate interest in being paid on time and fails where it's out of all proportion (Makdessi).
- Between businesses you need no term: statutory interest plus a fixed sum of £40, £70 or £100 apply by default.
- You can't run both. Exercise a contractual right to interest and the debt is treated as never having carried statutory interest (section 3(3)).
- HMRC puts late payment interest outside the scope of VAT. The treatment of a flat fee isn't settled, so take that one to your accountant.
- Automate on a grace period and one rule for everybody, since the arguments come from applying it to some clients and not others.
Step one: the term you are relying on
A late fee is triggered by your client's breach of the payment obligation, and that puts it inside the penalty doctrine. The Supreme Court restated the doctrine in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Ltd v Beavis, where the test asks whether a secondary obligation "imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party" (paragraphs 31 to 32).
Two parts of that help when you draft. Your legitimate interest can extend "beyond the prospect of pecuniary compensation flowing directly from the breach", so being paid on time counts and not only being compensated for lateness. But it stops at performance, so a charge turns penal where your means of influencing behaviour are "unconscionable" or "extravagant by reference to some norm". A modest, cost-reflective administration charge is comfortable ground; £150 on a £400 invoice isn't.
One drafting point follows, and this is our reading of the primary and secondary distinction in Makdessi rather than anything the judgment says about invoices: a charge agreed up front as part of the price of a longer credit period isn't a consequence of breach, so the penalty rule has nothing to bite on.
For a consumer customer, the fairness rules apply on top: Schedule 2 of the Consumer Rights Act 2015 lists a term requiring a consumer in breach "to pay a disproportionately high sum in compensation" among those that may be unfair (Schedule 2, paragraph 6).
Step two: the statutory route, and why the two don't stack
Between businesses the statutory route needs nothing from you. Statutory interest runs at 8% over the Bank of England base rate, so for debts where interest starts to run between 1 July and 31 December 2026 that's 11.75%, plus a fixed sum of £40, £70 or £100 by size of debt (the arithmetic). Where your contract and the Act meet, the Act decides:
| Your position | What applies |
|---|---|
| No term, business customer | Statutory interest from the day after the relevant day, plus the fixed sum |
| A term that is a substantial remedy | Your contract governs and statutory interest doesn't apply (section 8(2)) |
| A term that isn't a substantial remedy | Void to that extent, so statutory interest applies instead |
| You exercise a contractual right to interest | The debt is treated as never having carried statutory interest (section 3(3)) |
| A charge out of all proportion to your interest in timely payment | Unenforceable as a penalty (Makdessi) |
Two rows catch people out. The enforceability risk on a contractual rate runs downwards, because section 9 treats a remedy as substantial unless it's both too weak to compensate or deter and unfair to rely on, so a 2% a year clause is the fragile one. And section 3(3) works retrospectively, so pick one authority and configure your system for that.
Step three: the VAT position
Interest is the clear half. HMRC's VAT Supply and Consideration manual says of a late-paid claim that "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" (VATSC06810).
A charge is less clear, and HMRC's direction of travel since 2022 runs the other way. Where a supplier charges to compensate for having made a supply available, the manual says this "will normally be further consideration for that supply". The carve-out is narrow: where a fee is "clearly punitive and is designed to prevent breach rather than to compensate for lost income", the link to the supply isn't sufficient and the fee is outside the scope of VAT (VATSC05930). HMRC applied the same reasoning to early termination fees from 1 April 2022 (Brief 2 (2022)).
So the tax answer and the contract answer pull against each other. A fee framed as compensation linked to your supply looks like further consideration, so VATable at the invoice rate. A fee that qualifies as "clearly punitive" falls outside VAT, and that's also the charge most exposed under Makdessi.
No HMRC source we could find addresses a flat administrative late fee on a trade invoice by name. So interest is settled, the fee is not, and your own wording is a question for your accountant before you switch anything on.
Step four: setting it up so it runs
Record each of these where your team can see it, since the value in automating a fee is that every client gets the same treatment on the same day. And check the charge reconciles back to the invoice, because a fee that never reaches the ledger leaves a balance nobody can account for.
| Setting | What to decide |
|---|---|
| Due date | Your agreed payment date, or 30 days from invoice where you agreed none (section 4) |
| Grace period | How many days after the due date the charge starts |
| What is charged | Statutory interest plus the fixed sum, or your contractual rate. One or the other |
| Recalculation | Interest accrues daily, so whatever your client pays from shows the current figure |
| Frequency | GOV.UK's limit on the fixed sum: "you can only charge the business once for each payment" |
| Presentation | Government guidance is to raise a new invoice for the interest |
| Exceptions | Who is out of scope, and why. Write the reason down |
| Review | Who sees a charge before it goes out, and above what value |
Your due date matters more than your fee: an automation running off the wrong relevant day charges the right amount from the wrong morning.
When applying it shouldn't be your job
Some of this belongs to a person. Whether to waive the charge for a client who has been reliable for six years, how to handle someone who rings to say they're in trouble, when the fee is worth less than the conversation: those are judgement calls, covered in when a client refuses to pay the interest.
Deciding your rule is the easy half. Applying it to every client on the day it falls due, in the same words, without any single instance turning into a fight, is the hard half. That's a scheduling problem competing with everything else in your week, and businesses affected by late payment spend an average of 86 hours a year chasing.
Which is where handing the routine part to an agent comes in. You set the rules of engagement: the grace period, which clients are in scope, what it can apply without asking you, and the value at which you want to see it first. Adfin applies statutory interest and the fixed compensation from the due date, updates the payment link as interest accrues, honours your grace period and reconciles the charge back to the invoice.
The per-client argument is the narrow one. There's no reliable evidence of a best day or hour to send a reminder across all businesses, and anyone naming one is guessing. Your client's own record does support how that client behaves: which channel they answer, whether the last three invoices needed a nudge. What none of it replaces is your judgement about a client who has stopped paying.
Common questions
How do I apply late payment fees automatically? Settle the authority first: a proportionate contractual term, or the statutory entitlement, needing no term between businesses. Then configure the due date, a grace period, the amount, who's in scope and who reviews it.
Do I need a clause in my terms to charge a late fee? Not for statutory interest and the fixed sum on a business debt, since both apply as implied terms. A charge of your own design needs a term, proportionate to your interest in being paid on time.
Is a late payment fee subject to VAT? Interest for late payment is outside the scope of VAT as compensation for delay, per HMRC's manual. The position on a flat fee isn't settled and depends on how the charge is characterised, so check your wording with your accountant.
Can I charge my contractual rate and statutory interest together? No. Section 3(3) treats the debt as never having carried statutory interest to the extent a contractual right is exercised, so configure your automation for one route.
Should I use a grace period? It usually helps. Payment runs land a day or two either side of a due date, so a short grace period keeps the charge for genuine lateness.
Can I apply late fees to consumer customers? The statutory right covers business to business debts, so with a consumer you're relying on your own terms being fair. Schedule 2 of the Consumer Rights Act 2015 flags a disproportionately high sum in compensation as a term that may be unfair.
Sources
- legislation.gov.uk — Consumer Rights Act 2015, Schedule 2 (accurate as of August 2026)
- legislation.gov.uk — Late Payment of Commercial Debts (Interest) Act 1998, section 3 (accurate as of August 2026)
- legislation.gov.uk — Late Payment of Commercial Debts (Interest) Act 1998, section 4 (accurate as of August 2026)
- legislation.gov.uk — Late Payment of Commercial Debts (Interest) Act 1998, section 8 (accurate as of August 2026)
- legislation.gov.uk — Late Payment of Commercial Debts (Interest) Act 1998, section 9 (accurate as of August 2026)
- Supreme Court — Cavendish Square Holding v Makdessi (accurate as of August 2026)
- HMRC — Revenue and Customs Brief 2 (2022) (accurate as of August 2026)
- HMRC — VAT Supply and Consideration manual, VATSC05930 (accurate as of August 2026)
- HMRC — VAT Supply and Consideration manual, VATSC06810 (accurate as of August 2026)
- Small Business Commissioner — late payment research (accurate as of August 2026)
This article explains how late payment charges work and is legal information, not legal advice. It isn't tax advice either: the VAT treatment of a flat late fee isn't settled by any HMRC source we could find, so take your own wording to your accountant before you automate a charge. Last updated August 2026.
