September 2nd, 2011
Flat Rate Scheme
A business using the Flat Rate Scheme should not claim input tax on its VAT Returns.
Input tax may however be claimed on individual purchases of capital expenditure goods with a VAT inclusive cost of £2,000 or more. Note that Input tax cannot be claimed on expenditure which relates to work performed on a capital item, for example the refurbishment or extension of premises.
A business which has newly registered for VAT may also claim VAT on stock and assets on hand at the time of registration subject to the normal rules for such claims.
If a business using the FRS is required to account for acquisition tax on the purchase of goods from a supplier elsewhere in the European Union (EU) this cannot be claimed as input tax unless it relates to the purchase of capital expenditure goods costing £2000 or more including the related VAT.
September 2nd, 2011
Areas of risk within VAT input tax
The main areas of risk within VAT input tax broadly fall into the following categories:
Good record keeping is essential otherwise your VAT Return may be prepared on the basis of inaccurate or incomplete information.
Where a business operates from more than one location it is also important that procedures are in place to ensure that all relevant accounting information needed for completing the return is reported to the person that prepares it in time for inclusion on the return.
Even when records are well kept, mistakes, duplications and omissions may occur, resulting in input tax being claimed too early, too late or in the incorrect amount. If a computer package is used to calculate VAT Return values, care should be taken to ensure that correct date ranges are set and that all relevant transactions within the period date range are included.
The requirement to add back input tax if the related expenditure remains unpaid six months after the date of the supply or the due date for payment (whichever is the later) is also often overlooked.
Private and non-business use
In many businesses personal and business finances can be closely linked and input tax may be claimed incorrectly on expenditure which is partly or wholly for private or non-business purposes.
A ‘Business purpose’ can be a complex area in relation to input tax.
When expenditure has a mixed business and private/non-business purpose the related VAT should generally be apportioned and only the business element claimed.
When a business purchases an asset, or services resulting in the construction of a new asset, which has mixed business and private use (but not mixed business and non-business use other than private use), the VAT may currently be claimed in full at the time of purchase but output tax must subsequently be declared to reflect private use.
The application of this “Lennartz” approach to new purchases of land, property, boats and aircraft will be restricted from 1 January 2011
When goods on which a business has claimed input tax in full (such as an item of stock or an office computer) are subsequently put to private or non-business use, there is a deemed supply for VAT purposes and output tax is normally due on the cost of the supply. The deemed supply is one of goods if the change of use is permanent and of services if temporary.
When a business has expenditure which relates wholly or partly to existing or intended exempt supplies it becomes partly exempt and can only claim the related input tax if it is below the prescribed de minimis limit.
The partial exemption standard method determines how much input tax can be claimed unless an individual special method has been approved by HMRC. Many businesses do not recognise that they are partly exempt or carry out partial exemption calculations incorrectly, for example by using an unapproved special method or by omitting to carry out a longer period calculation.
If certain assets (computers or land/building works over specified values) have been purchased for use in the business, those assets are subject to adjustments under the Capital Goods Scheme (CGS) to reflect changes in the degree of taxable use. The need to consider CGS adjustments is often overlooked.
Input tax is often claimed in error on the provision of business entertainment.
Business entertainment includes the provision of hospitality or entrance to theatres, concerts and sporting events and similar expenditure. Entertainment costs analysed to expense headings such as advertising or marketing are often overlooked and the related VAT claimed in error.
Cars and motoring expenses
Input tax errors frequently occur in relation to the purchase or lease of cars and to motoring expenses in general. Input tax cannot be claimed on the purchase of most cars while the recovery of VAT incurred in leasing a car which is available for private use should generally be restricted to 50 per cent.
If a business supplies fuel for cars, an output tax scale charge is generally due for each car unless records are maintained to demonstrate that fuel has only been provided for business journeys.
Input tax claimed in respect of business mileage payments must be restricted to the fuel element of the mileage rate and be supported by original fuel purchase invoices.
There are distinct mechanisms for the payment and recovery of VAT on goods purchased from suppliers outside the EU (imports) and inside the EU (acquisitions).
If these are not applied correctly input tax error can result.
The purchase of many services from overseas suppliers requires the UK recipient to account for both output tax and input tax on the supply (the reverse charge), applying any appropriate restrictions to input tax recovery – this requirement is often overlooked or incorrectly performed.
September 2nd, 2011
Input VAT matters
Only registered traders can reclaim VAT on purchases providing:
- the expense is incurred for business purposes and
- there is a valid VAT invoice for the purchase.
Only VAT registered businesses can issue valid VAT invoices. VAT cannot be reclaimed on any goods or services purchased from a business that is not VAT registered. Proforma invoices should not be used as a basis for input tax recovery as this can accidentally lead to a duplicate VAT recovery claim.
Most types of supply on which VAT recovery is sought must be supported by a valid VAT invoice. This generally needs to be addressed to the trader claiming the input tax. A very limited list of supplies do not require a VAT invoice to be held to support a claim, providing the total expenditure for each taxable supply is £25 or less (VAT inclusive). The most practical examples of these are car park charges and certain toll charges.
The following common items however never attract input VAT and so no VAT is reclaimable – stamps, train, air and bus tickets, on street car parking meters and office grocery purchases like tea, coffee and milk!
This is often an area of contention between taxpayers and HMRC as VAT is not automatically recoverable simply because it has been incurred by a VAT registered person.
In assessing whether the use to which goods or services are put amounts to business use (for the purpose of establishing the right to deduct input tax), consideration must be given as to whether the expenditure relates directly to the function and operation of the business or merely provides an incidental benefit to it.
Private and non-business use
In many businesses, personal and business finances can be closely linked and input tax may be claimed incorrectly on expenditure which is partly or wholly for private or non-business purposes.
Typical examples of where claims are likely to be made but which do not satisfy the ‘purpose of the business’ test include:
expenditure related to domestic accommodation
pursuit of personal interests such as sporting and leisure orientated activities
expenditure for the personal benefit of company directors/proprietors and
expenditure in connection with non-business activities.
Where expenditure has a mixed business and private purpose, the related VAT should generally be apportioned and only the business element claimed. Special rules apply to recover input tax claimed on assets and stock (commonly referred to in VAT as goods) when goods initially intended for business use are then put to an alternative use.
VAT is not reclaimable on many forms of business entertainment but VAT on employee entertainment is recoverable. The definition of business entertainment is broadly interpreted to mean hospitality of any kind which therefore includes the following example situations:
travel expenses incurred by non employees but reimbursed by the business, such as self employed workers and consultants
hospitality elements of trade shows and public relations events.
A VAT supply takes place whenever goods change hands, so in theory any goods given away result in an amount of VAT due. The rule on business gifts is that no output tax will be due, provided that the VAT exclusive cost of the gifts made does not exceed £50 within any 12 month period to the same person.
Where the limit is exceeded, output tax is due on the full amount. If a trader is giving away bought-in goods, HMRC will usually accept that he can disallow the tax when he buys the goods, which may be more convenient than having to pay output tax every time he gives one away.
Routine commercial transactions which might be affected include such things as:long service awards
prizes or incentives for sales staff.
Cars and motoring expenses
Input tax errors often occur in relation to the purchase or lease of cars and to motoring expenses in general. Some key issues are:
Input VAT is generally not recoverable on the purchase of a motor car because it is not usually exclusively for business use. This prohibition does not apply to commercial vehicles and vans, provided there is some business use.
Where a car is leased rather than purchased, 50% of the VAT on the leasing charge is not claimed for the same reason.
Where a business supplies fuel or mileage allowances for cars, adjustments need to be made to ensure that only the business element of VAT is recovered. There are a number of different methods which can be used, so do get in touch if this is relevant to you.
Output VAT issues
Selling on credit in the current economic climate may carry increased risk. Even where credit control procedures are strong there will inevitably be bad debts. As a supplier, output VAT must normally be accounted for when the sale is initially made, even if the debt is never paid, so there is a risk of being doubly out of pocket.
VAT regulations do not permit the issue of a credit note to cancel output tax simply because the customer will not pay! Instead, where a customer does not pay, a claim to recover the VAT on the sale as bad debt relief can be made six months after the due date for payment of the invoice.
A trader supplies and invoices goods on 19 October 2010 for payment by 18 November 2010 (ie a normal 30 day credit period). The earliest opportunity for relief if the debt is not settled would be 18 May 2011. The relief would be included in the return into which this date fell, depending on the return cycle of the business.
The amount of the claim
The taxpayer can only claim relief for the output tax originally charged and paid over to HMRC, no matter whether the rate of VAT has subsequently changed. In the above example the standard VAT rate charged would have been 17.5% (not the current 20%) so a claim can be made for only 17.5%. The claim is entered as additional input VAT – treating the uncollected VAT as an additional business expense – rather than by reducing output VAT on sales.
A customer is automatically required to repay any input VAT claimed on a debt remaining unpaid six months after the date of the supply (or the date on which payment is due if later). Mistakes in this area are so common that visiting HMRC officers have developed a programme enabling them to review Sage accounting packages and to list purchase ledger balances over 6 months old for disallowance.
Preventing the problem?
Small businesses may be able to register under the Cash Accounting Scheme, which means you will only have to account for VAT when payment is actually received.
September 2nd, 2011
A business may reclaim VAT incurred on goods it has purchased no more than four years before the date of registration. The goods must, however, be for its taxable business purposes and remain on hand at the date of registration.
A business may also reclaim VAT incurred on services it has purchased for its taxable business purposes during the six months before VAT registration.
VAT cannot be claimed on goods and services purchased before registration which relate to exempt supplies or non-business activities.
Once a VAT registration has been cancelled there are limited circumstances in which input tax can still be claimed.
Input tax can be claimed on goods and services supplied to the business while it was registered for VAT. It can also be claimed on services (such as legal or accountancy advice) which relate solely to the activities of the business while it was VAT registered.
VAT cannot be claimed on goods purchased after deregistration.
July 28th, 2011
Value Added Tax: An Introduction
VAT registered businesses act as unpaid tax collectors and are required to account both promptly and accurately for all the tax revenue collected by them.
The VAT system is policed by HMRC with heavy penalties for breaches of the legislation. Ignorance is not an acceptable excuse for not complying with the rules.
We highlight below some of the areas that you need to consider. It is however important for you to seek specific professional advice appropriate to your circumstances.
A transaction is within the scope of VAT if:
- there is a supply of goods or services
- made in the UK
- by a taxable person
- in the course or furtherance of business.
Inputs and outputs
Businesses charge VAT on their sales. This is known as output VAT and the sales are referred to as outputs. Similarly VAT is charged on most goods and services purchased by the business. This is known as input VAT.
The output VAT is being collected from the customer by the business on behalf of HMRC and must be regularly paid over to them.
However the input VAT suffered on the goods and services purchased can be deducted from the amount of output tax owed. Please note that certain categories of input tax can never be reclaimed, such as that in respect of third party UK business entertainment and for most business cars.
Taxable supplies are mainly either standard rated (20%) or zero rated (0%). The standard rate was 17.5% prior to 4 January 2011.
There is in addition a reduced rate of 5% which applies to a small number of certain specific taxable supplies.
There are certain supplies that are not taxable and these are known as exempt supplies.
There is an important distinction between exempt and zero rated supplies.
If your business is making only exempt supplies you cannot register for VAT and therefore cannot recover any input tax.
If your business is making zero rated supplies you should register for VAT as your supplies are taxable (but at 0%) and recovery of input tax is allowed.
Registration – is it necessary?
You are required to register for VAT if the value of your taxable supplies exceeds a set annual figure (£73,000 from 1 April 2011).
If you are making taxable supplies below the limit you can apply for voluntary registration. This would allow you to reclaim input VAT, which could result in a repayment of VAT if your business was principally making zero rated supplies.
If you have not yet started to make taxable supplies but intend to do so, you can apply for registration. In this way input tax on start up expenses can be recovered.
A taxable person is anyone who makes or intends to make taxable supplies and is required to be registered.
For the purpose of VAT registration a person includes:
If any individual carries on two or more businesses all the supplies made in those businesses will be added together in determining whether or not the individual is required to register for VAT.
Once registered you must make a quarterly return to HMRC showing amounts of output tax to be accounted for and of deductible input tax together with other statistical information. For businesses whose turnover is more than £100,000 (excluding VAT) returns must be filed online. In addition, smaller businesses which registered for VAT on or after 1 April 2010 have to file online, regardless of turnover. By April 2012 all other businesses will have to file online.
Returns must be completed within one month of the end of the period it covers, although generally an extra seven calendar days are allowed for online forms.
Electronic payment is also compulsory for those businesses filing online.
Businesses who make zero rated supplies and who receive repayments of VAT may find it beneficial to submit monthly returns.
Businesses with expected annual taxable supplies not exceeding £1,350,000 may apply to join the annual accounting scheme whereby they will make monthly or quarterly payments of VAT but will only have to complete one VAT return at the end of the year.
It is important that a VAT registered business maintains complete and up to date records. This includes details of all supplies, purchases and expenses.
In addition a VAT account should be maintained. This is a summary of output tax payable and input tax recoverable by the business. These records should be kept for six years.
Inspection of records
The maintenance of records and calculation of the liability is the responsibility of the registered person but HMRC will need to be able to check that the correct amount of VAT is being paid over. From time to time therefore a VAT officer may come and inspect the business records. This is known as a control visit.
The VAT officer will want to ensure that VAT is applied correctly and that the returns and other VAT records are properly written up.
However, you should not assume that in the absence of any errors being discovered, your business has been given a clean bill of health.
Offences and penalties
HMRC have wide powers to penalise businesses who ignore or incorrectly apply the VAT regulations. Penalties can be levied in respect of the following:
errors in returns.
Cash accounting scheme
If your annual turnover does not exceed £1,350,000 you can account for VAT on the basis of the cash you pay and receive rather than on the basis of invoice dates.
There are special schemes for retailers as it is impractical for most retailers to maintain all the records required of a registered trader.
Flat rate scheme
This is a scheme allowing smaller businesses to pay VAT as a percentage of their total business income. Therefore no specific claims to recover input tax need to be made. The aim of the scheme is to simplify the way small businesses account for VAT, but for some businesses it can also result in a reduction in the amount of VAT that is payable.