| An Introduction
to VAT
What is VAT?
VAT is a tax chargeable on taxable supplies made in the UK by taxable
persons. Credit is given for tax paid to other businesses and the
net balance is payable or reclaimable - normally on a quarterly
basis.
Taxable persons
A taxable person is defined as one of the following carrying on
a business:
- An individual
- A partnership
- An unincorporated association, e.g. trust or charity
- A limited company
Supplies
VAT law covers all types of supply of goods or services (outputs),
whether of a revenue or capital nature. Supplies include sale, hire,
or loan of goods. Output normally falls into four categories:
- Positive rated - taxable at 17.5% or 5%
- Zero rated - including socially or economically important items,
e.g. exports, most food, books, newspapers, public transport,
drugs on prescription, children's clothing
- Exempt supplies - including necessities such as insurance,
postage, finance, education, and health
- Some receipts are outside the scope of VAT, e.g. dividends,
shares of profit compensation for losses, non UK supplies
Should I be registered for VAT?
You should notify HM Revenue & Customs when:
- Vatable turnover for the past twelve months exceeds £61,000
- There are reasonable grounds for believing that your turnover
for the next 30 days will exceed £61,000
In the first case, notification must be within thirty days of the
end of the relevant months. In the latter case, notification must
be within thirty days of the date on which grounds first existed.
It is important to monitor turnover because there is a penalty
for late registration. This is in addition to the tax payable.
Can I register for VAT if my vatable turnover does not exceed the
prescribed limits?
It is possible to register voluntarily provided you have a bona
fide business.
Cash accounting scheme
There is a special scheme applicable to businesses where taxable
turnover is expected to be not more than £660,000 in the next
12 months.
This allows the trader to account for VAT on the basis of payments
received and made rather than on tax invoices issued and received.
It may be advantageous to use cash accounting from the date of
registration, although some businesses will not benefit from this
scheme.
Retail schemes
Special schemes of accounting for VAT are available to retailers.
We can advise on the best choice.
Credit for input tax
Input tax paid on purchases can be recovered by registered taxable
persons, who are able to offset input tax against their output tax
liabilities. Traders with fully exempt outputs cannot register or
reclaim any input tax. Credit is available for all VAT paid on inputs
where a VAT invoice is available, except for tax on private expenditure,
business entertainment, motor cars, certain building materials,
and goods bought under a second-hand goods scheme. Recovery of input
tax may be restricted if the business makes both taxable and exempt
supplies.
How often will I have to complete a VAT return?
Every quarter, a return is issued and must be submitted to HM Revenue
& Customs no later than thirty days from the end of the quarter.
Make returns and payments on time because extensive legislation
exists to levy penalties on defaulters. Businesses with regular
repayments may make monthly returns. Those using the Annual Accounting
Scheme need make only one return per year, which has to be submitted
two months after the end of the scheme year.
We would be pleased to advise you what records you need to keep
to complete the VAT return.
Can I file my VAT return online?
A service for online filing VAT returns is now operational. For
access to this visit www.hmrc.gov.uk
When can, or must, I deregister?
- You must deregister when taxable supplies are no longer made,
e.g. when trading ceases
- You can deregister when anticipated turnover for the next year
(measured from any time) is less than £59,000, but this
may not be in your interests - seek our advice first
Tax invoices
Specific rules are laid down as to the form and content of tax invoices.
These are to ensure that all the necessary information is recorded
for the determination of the rate of tax to be applied, the liability
of the supplier to account for the output tax due on the supply,
and the entitlement of the recipient to reclaim all or any of it
as input tax.
There is no requirement to issue a tax invoice for a zero-rated
or exempt supply. However, it would seem appropriate to issue some
form of invoice for either type of supply to establish that VAT
is not chargeable on it.
Copies of all tax invoices issued and received must be retained
for at least six years unless a shorter period (normally at least
three years) is agreed with HM Revenue & Customs.
A tax invoice is required to show:
- An identifying number
- The date of the supply and the date of issue of invoice
- The name, address, and registration number of the supplier
- The name and address of the person to whom the goods and services
are supplied
- A description that is adequate for the purposes of identifying
the goods or services supplied
- For each description the quantity of the goods or the extent
or nature of the services,
- rice, the rate of tax, and the amount payable, excluding tax
- The total amount payable excluding tax
- The rate of any cash discount offered
- The total VAT payable
Anyone supplying goods or services direct to the public does not
have to supply a tax invoice unless the customer requires one. Where
the tax-inclusive value of supply is not more than £250, the
supplier may issue a simplified form of invoice giving only the
following details:
- Name, address and registration number of the retailer
- Date of supply
- A description, adequate to identify the goods or services supplied
- The total amount payable including tax
- The rate of tax at the time of the supply
Cash Accounting Scheme
What is cash accounting?
Cash accounting enables you to account for VAT on the basis of payments
received and made instead of on tax invoices issued and received.
The VAT payable or repayable for each accounting period will be
the difference between the total amount of VAT included in payments
received from your customers and the total amount of VAT included
in payments made to your suppliers.
Who can use the scheme?
Cash accounting is open to you if you are a registered trader with
an expected turnover not exceeding £660,000 in the next twelve
months. HM Revenue & Customs has applied for approval to increase
this turnover limit to £1,350,000. Approval is expected in
late 2006 with an anticipated implementation date of 1 April 2007.
The main conditions are that you should have made all necessary
VAT returns and have made arrangements with HM Revenue & Customs
to clear any arrears of VAT payments.
There is no need to apply to use the scheme, but you should start
to use it at the beginning of a tax period.
Will it be beneficial to me?
It all depends on the period of time between your issuing sales
invoices and receiving payment from your customers. The longer the
time lag, the more of benefit cash accounting is likely to be. If
you are usually paid as soon as you make a sale (e.g. if you use
a retail scheme) you will normally be worse off under cash accounting.
The same applies to the situation where you regularly receive repayments
of VAT (e.g. because you make zero-rated supplies).
The potential disadvantage arises because you will no longer be
able to take credit for VAT when you receive a tax invoice; you
will have to wait until you have actually made the appropriate payment.
One major advantage of the scheme is that it simplifies your bookkeeping
requirements, and many businesses can be controlled simply by using
an appropriately analysed cash book. Another important advantage
is that the problem of VAT on bad debts disappears - under conventional
VAT accounting you have to pay VAT whether you have been paid by
your customer or not, and VAT bad debt relief is not available until
the debt is at least six months old.
What conditions are there once I start using the scheme?
You must use it for the whole of your business and must normally
stay in it for at least two years (unless you exceed the turnover
limit). However, you are allowed to leave the scheme at any time
if you are not gaining any benefit or if your accounting system
cannot cope with the requirements.
You must be careful that you do not account again for any VAT on
receipts and payments already dealt with on invoices issued and
received before you started using the scheme.
Businesses are no longer able to use the scheme for sales of goods
and services invoiced in advance of the supply being made, or for
sales where the payment is not due for more than six months after
the invoice date.
What records must I keep?
The main accounting record will be a cash book summarising all payments
made and received, with a separate column for the relevant VAT.
You will also need to keep the corresponding tax invoices and ensure
that there is a satisfactory system of cross-referencing.
These VAT records must be kept for six years, unless you have agreed
a shorter period with your local VAT office.
Are there any special rules for cheques and credit cards?
A cheque receipt occurs on the date you receive the cheque or the
date on the cheque, whichever is the later. If the cheque is subsequently
dishonoured, you should adjust the VAT account accordingly.
Likewise, a cheque payment takes place on the date you send the
cheque to your supplier or the date on the cheque, whichever is
the later. However, if your cheque is dishonoured you cannot reclaim
the VAT.
Credit card payments are to be accounted for by the date on the
sales voucher - not the date you receive payment from, or make payment
to, the card company.
What about part payments?
You must account for VAT each time you make or receive a payment,
even if it is a part payment, and even if it is a payment in kind.
Normally the VAT will be calculated using the VAT fraction (currently
7/47). However, a fair and reasonable apportionment must be applied
if there is a mixed standard and zero-rated supply.
What if my turnover exceeds £660,000?
There is a 25% tolerance built into the scheme. This means that
once you are using cash accounting, you can normally continue to
use it until the annual value of your taxable supplies reaches £825,000.
You must review your taxable turnover in the year ending at the
end of each tax period. If you exceed the tolerance of £825,000,
you must leave the scheme immediately, unless HM Revenue & Customs
allows or directs otherwise.
All outstanding tax must be accounted for within six months of
the period in which you leave the scheme.
Flat Rate Scheme
This scheme is designed to reduce the cost of complying with VAT
obligations by simplifying the way small businesses calculate their
VAT. It is available to businesses who expect their VAT exclusive
turnover in the next 12 months to be:
- No more than £150,000 taxable supplies, and
- No more than £187,500 total business income
Taxable supplies are calculated by looking at the total of supplies
at the positive and zero rates, excluding VAT and the value of any
capital assets expected to be sold. Total business income includes
taxable supplies and the value of exempt and other non-taxable income.
The flat rate scheme saves time by removing the need to calculate
and record output tax and input tax in calculating the net VAT due
to HM Revenue & Customs. The VAT in a period is calculated by
applying the flat rate percentage to the tax inclusive turnover
for the period.
HM Revenue & Customs has published a table showing rates applicable
to many business sectors. Some examples are:
Category of business carried on Appropriate percentage
Retail of food, newspapers, confectionery - 2%
Retail of vehicles or fuel - 7%
Photography - 9.5%
Estate agency - 11%
Hairdressing - 12%
Legal services - 13%
Computer and IT consultancy - 13%
The flat rate to be used depends on which trade sector most accurately
reflects any particular business. If a business includes supplies
in two or more sectors, the percentage to be used is that appropriate
to the main business activity as measured by expected turnover in
the year ahead.
If you are making supplies to other VAT registered businesses,
you give them a VAT invoice charging VAT at the normal rate for
the supply (not the flat rate percentage).
Most traders with qualifying turnover are eligible to join the
scheme, but there are a number of exclusions designed to prevent
abuse of the scheme as well as a few to avoid complex interaction
with other schemes. The scheme is optional, but traders wishing
to join should complete Form VAT 600 (FRS) (which can be printed
off the HM C&E website at www.hmrc.gov.uk).
Annual Accounting Scheme
What is annual accounting?
Under annual accounting, you make agreed payments on account and
need complete only one VAT return per year. The purpose of the scheme
is to aid cashflow and budgeting and reduce the paperwork involved.
Who can use the scheme?
Annual accounting is open to you if you have been registered for
at least a year, or immediately for businesses with a taxable turnover
of up to £150,000, and during the last twelve months your
credits for input tax have not exceeded your total output tax. Your
expected turnover in the coming year should not exceed £1,350,000
and you should be up-to-date with your VAT returns.
You have to apply to use the scheme, using form VAT600 at the back
of Notice 732. You can at the same time apply to join the Flat Rate
Scheme.
You may withdraw from the scheme voluntarily at any time by application
in writing to your local VAT office.
What are the advantages of annual accounting?
The advantages of annual accounting are:
- Only one VAT return per year, with an extra month for submission
- The return can be prepared at the same time as the annual accounts
- Cashflow is known in advance
- Monthly payments spread the load
- It simplifies the operation of retail or partial exemption
schemes
Are there any disadvantages?
Possible disadvantages are:
- Interim payments based on previous years may be higher than
necessary (but can be reduced if the difference is significant)
- Seasonal or other variations may create an adverse effect on
cashflow
How are the payments structured?
Businesses with a net turnover between £100,000 and £1,350,000
will make nine monthly interim payments of 10% of the previous year's
VAT payments, commencing on the last day of the fourth month of
the VAT year.
Those with an annual taxable turnover of £100,000 or less
make quarterly interim payments of 20% of the previous year's net
liability (no interim payments are required if the annual VAT payable
is less than £2,000).
In both cases, the interim payments may be adjusted to take into
account any expected changes in turnover and trading. The balance
of VAT due for the year is payable two months after the year end,
together with submission of the VAT return.
Payments must be made by direct debit, or by a choice of electronic
payment methods.
What if my turnover goes over £1,350,000?
There is a 25% tolerance built into the scheme. This means that
once you are using annual accounting, you can normally continue
to use it until the end of the year in which the value of your taxable
supplies exceeds £1,687,500.
Are there other conditions?
HM Revenue & Customs may expel you from the scheme in certain
circumstances, including:
Failure to submit the return by the due date
Failure to make any payment on time, unless in circumstances beyond
your control
Recovering VAT on Staff Expenses
Although the VAT rules normally prevent you reclaiming VAT on
supplies that are not made direct to you, there are certain circumstances
when the rules are relaxed.
Subsistence expenses
For instance, the VAT element of subsistence expenses paid to your
employees may be treated as input tax. In order to qualify for this
concession, employees must be reimbursed for their actual expenditure
and not merely receive round sum allowances.
VAT invoices (which may be made out to the employee) must also
be obtained.
Reimbursement for road fuel
The VAT legislation permits you to treat as your own supply road
fuel which is purchased by a non-taxable person whom you then pay
for the actual cost of the fuel. This would therefore allow you
to recover input tax when you reimburse your employees for the cost
of road fuel used in carrying out their employment duties.
Again, VAT invoices must be obtained.
Mileage allowances
The legislation also enables you to reclaim the VAT element (or
a reasonable approximation) on the amount attributable to fuel of
mileage allowances paid to employees (or subcontractors). The fuel
element must be close to the fuel-only mileage rates.
HM Revenue & Customs requires the following records to be kept:
- The mileage travelled and whether business or private
- The vehicle’s c.c.
- Rate of mileage allowance
- The amount of input tax claimed
VAT Do’s and Don’ts
- DO keep a monthly record of your turnover - late registration
can result in severe penalties
- DO notify your local VAT office when major changes take place
- changes must be notified within thirty days
- DO retain records for the last six years - these could be demanded
by law
- DO obtain and keep VAT invoices - these are your authority
to claim back VAT on supplies made to you
- DO charge VAT on supplies to your staff
- DO charge VAT on any equipment or vehicles (except motor cars)
that you sell or part-exchange
- DO account for VAT on fuel used for private motoring using
the appropriate scale charge
- DON’T claim the VAT paid on the purchase of a motor car - it
is not recoverable except in some very special cases
- DON’T claim the VAT paid on goods or services used for private
purposes. Where there is an element of private use (e.g. telephone)
an appropriate percentage should be claimed. Special arrangements
apply to private use of petrol (see above)
- DON’T claim the VAT paid on entertaining
- DON’T forget to account for VAT on inter-company charges
- DON’T charge VAT on the transfer of a business as a going concern
(make sure contracts incorporate appropriate VAT provisions)
How to Survive the Enforcement
Powers
Contents
- Late registration
- Default surcharge
- Serious misdeclaration
- Retention of records
- Default interest
- Appeals
- Action points
Although some of the penalties for VAT infringements have been
less severe in recent years, there is still an alarming array of
enforcement powers to trap the unwary. By being aware of the problem
areas and planning carefully, it should be possible to avoid becoming
an unwitting victim of the system.
Late registration
You must notify HM Revenue & Customs if your turnover exceeds
£61,000 in twelve months, or if you believe it will exceed
£61,000 in the next thirty days.
The penalty for failing to notify liability is a specified percentage
of the net tax (output tax less input tax) for the penalty period
(subject to a minimum penalty of £50):
Delay in registering Penalty
9 months or less 5%
9 - 18 months 10%
Over 18 months 15%
After registration
Every VAT registered business needs to ensure that it is organised
to deal with VAT correctly and on time:
- Is there someone in your business who controls VAT accounting
and ensures that new products etc. are properly dealt with for
VAT purposes?
- Do your business systems ensure that all output tax and input
tax are properly recorded?
- Are systems in force to ensure that proper evidence is obtained
to support VAT input tax claims?
- Where VAT is not charged on supplies made, is this correct
in law and is proper evidence retained?
- Are there systems in force to ensure that non-deductible input
tax is not reclaimed, e.g. most VAT on motor cars, or business
entertaining?
- Is VAT always considered before contracts are made?
Default surcharge
A default occurs if HM Revenue & Customs has not received your
return and all the VAT due by the due date. The relevant date is
the date that a cheque is received. If the due date is not a working
day, payment must be received on the last preceding working day.
As a general guide, the payment (normally accompanying a return)
should be posted first class at least two working days before the
due date. It will help if you obtain a form P326 (certificate of
posting) from the Post Office.
A cheque must be correct in all respects and not post-dated, otherwise
payment will not have been made.
Consequence of default
You receive a warning after the first default - the Surcharge Liability
Notice (SLN). Do not ignore this notice. If you fail to pay the
VAT due on the due date within the next five quarters, the surcharge
will be 2% of the outstanding tax. The surcharge increases to 5%
for the next default, and then by 5% increments to a maximum of
15%. Lower rate (2% and 5%) surcharge assessments will not be issued
for less than £400. At rates of 10% and 15% the surcharge
liability becomes subject to a minimum charge of £30.
Each default, whether it is late submission of the return or late
payment, extends the surcharge liability period, but only late payment
incurs a surcharge.
Special arrangenments for small businesses
Businesses with qualifying turnover up to £150,000 will be
sent a letter offering help and support following the first default
rather than a SLN. This arrangement is intended to allow extra time
to sort out any short-term difficulties before formally entering
the default surcharge system. Any further default within twelve
months will result in the issue of a SLN.
Disclosures of errors in previous returns
Net VAT errors of £2,000 or less discovered during a VAT period
may be included in the VAT return for that period, and will form
part of the Gross Amount of Tax (GAT). The GAT is the total VAT
on purchases plus the total VAT on sales in the period. This counts
as a voluntary disclosure and will avoid both a misdeclaration penalty
and interest.
Net VAT errors over £2,000 must be notified either by letter
or on a special form (VAT 652 - The Voluntary Disclosure of Errors).
This avoids a misdeclaration penalty, but interest will still be
charged. Entering such errors on the normal VAT return could lead
to prosecution.
The opportunity to disclose voluntarily ceases once a trader has
reason to believe that HM Revenue & Customs is making enquiries
into his or her affairs.
Misdeclaration
If previous errors are not voluntarily disclosed, a Misdeclaration
Penalty may apply. The penalty is 15% of the misdeclaration, and
is triggered if the underdeclaration equals or exceeds either £1
million or 30% of the GAT.
The underdeclaration used in applying these tests is the net underdeclaration
for the period concerned, taking account of errors in favour of
HM Revenue & Customs. Therefore, if a trader omits a month's
figures, with output tax of £2,400 and input tax of £1,500,
the underdeclaration is the £900 difference between the two
and not the £2,400 of output tax omitted.
This penalty may equally apply if a trader received a VAT assessment
that understates the liability to tax and does not bring this understatement
to the attention of HM Revenue & Customs within 30 days. However,
in this case the test relates to the True Amount of Tax (TAT), which
is the difference between input and output tax that should have
been shown on the return.
Persistent misdeclaration
Following a serious misdeclaration, HM Revenue & Customs has
the power to issue a penalty liability notice (PLN) stating that
a penalty of 15% of the tax lost will be levied if there is more
than one material inaccuracy in any of the next eight accounting
periods. A material inaccuracy is a net underdeclaration, which
equals or exceeds the lesser of £500,000 and 10% of the GAT.
Conduct involving dishonesty
If HM Revenue & Customs suspects conduct involving dishonesty,
it can invoke a civil penalty of up to 100% of the tax at risk.
It may also pursue criminal penalties where the circumstances warrant
it. These can lead to unlimited fines or prison sentences of between
six months and seven years.
Retention of records
The period for retaining records is six years. There is a fixed
penalty of £500 for breaching this requirement.
Breaches of regulations
The amount of the penalty varies with the type and frequency of
the breach involved. The basic penalty is £5 per day while
the breach continues. This is increased to £10 per day if
there has been an earlier breach of the same regulation within the
previous two years, and £15 per day if there has been more
than one earlier breach.
In some cases, this basic daily penalty is increased to a daily
percentage of the tax involved, if this is greater. The percentage
rises in line with the number of previous breaches, in exactly the
same way as the basic daily penalty. The possible percentages are
1/6%, 1/3% and 1/2%.
Daily penalties are subject to a maximum of a hundred times the
daily amount.
Default interest
Interest on tax will arise in certain circumstances, including cases
where:
- An assessment is made to recover extra tax for a period for
which a return has already been made (this includes errors voluntarily
disclosed)
- A person has failed to notify his or her liability to register
(or made late notification), and an assessment covering a period
longer than three months is made to recover the tax due
- An invoice purporting to include VAT has been issued by a person
not authorised to issue tax invoices
Where an assessment covers a period exceeding three months, HM
Revenue & Customs is required to break it down into return periods.
This is necessary to establish the period for which interest is
to be charged. Normally, interest accrues from the due date for
submission of the return for the period concerned. However, the
maximum period is three years, although interest will continue to
run on assessments remaining unpaid after thirty days from the date
of issue.
The rate of interest is set by the Treasury and is broadly in line
with commercial rates of interest.
Appeals
Appeals may be made to the VAT tribunal against penalties. The tribunal
now has powers of mitigation in appropriate circumstances. Where
the appeal is against the imposition of interest, penalties, or
surcharge, the tax must be paid before an appeal can be heard.
The tribunal is given the authority to increase assessments that
are established as being for amounts less than they should have
been.
A formal procedure is now established for appeals to be settled
by agreement. This agreement must be in writing, and there is a
thirty-day cooling off period during which the taxpayer may cancel
the agreement.
Access to information
HM Revenue & Customs has extensive powers to obtain information.
It can enter premises and gain access to computerised systems and
remove documents.
A walking possession agreement can arise where distress is levied
against a person's goods.
The sting in the tail
None of the above penalties or interest is allowable as a deduction
when computing income for corporation or income tax purposes.
Action points
- Remember that discovered errors in excess of £2,000 must
be separately disclosed on form VAT 652, and not incorporated
in the VAT return
- Default interest applies to such errors and the Misdeclaration
Penalty may apply if you do not declare errors voluntarily before
you have reason to believe that HM Revenue & Customs is making
enquiries into your affairs
- If you receive a VAT assessment (because you have not submitted
a return), you must check it and notify HM Revenue & Customs
within thirty days if it understates your liability
- Make sure your systems and records are adequate to enable you
to establish the gross amount of tax relating to a VAT period.
The preparation of annual accounts cannot be regarded as a safeguard
against penalties
- Make sure you get your VAT return and payment in on time. A
certificate of posting could be useful evidence
- Some of these penalties may not apply if there is a reasonable
excuse, but the scope is limited and should not be relied upon
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