When VAT was introduced in the UK in 1973 it was a ‘simple tax’ according to the then Chancellor of the Exchequer, Anthony Barber. However, it has evolved significantly over the last 44 years and is now more complex than envisaged by Mr Barber all those years ago.
Stripping VAT back to its basics and identifying the different ways in which VAT interacts with your business, may be useful reading for UK businesses.
As VAT is a transactional tax, a good place to start is the supply chain i.e. what do you do? Who do you transact with? Where are they located? Transactions between UK parties should be straightforward (assuming you can correctly identify whether VAT is due and at what rate) but when you add in an international aspect (whether that’s a foreign customer or you perform your work overseas), the VAT rules become more complicated.
The VAT rules differ based on whether you supply goods or services and whether your customer is a business or a consumer. Certain services overseas could lead to a VAT registration requirement overseas; for example running events or supplying digital services. Whilst purchases from suppliers outside the UK typically won’t have VAT on them they will likely have a requirement to account for VAT on these purchases under the reverse charge procedure (charge yourself VAT and, to the extent you are able, reclaim it).
For entities that are not VAT registered it is important to note that the value of purchases from outside the UK count towards the VAT registration threshold. Therefore, if you have a taxable turnover of £80,000 and spend £6,000 buying something from outside the UK you have breached the current UK VAT registration threshold and not registering for VAT on time could result in penalties.
Exempt and zero rated are often used interchangeably which is understandable because no VAT is charged on either. However they have very different implications. When an entity makes exempt supplies it has an impact on VAT recovery on costs. If only exempt supplies are made then VAT registration is not possible as taxable supplies are required to register for VAT. If a business makes both exempt and taxable supplies it will be required to undertake partial exemption calculations which can be complicated. Zero rated transactions are taxable, just at 0% and therefore do not impact your VAT recovery. They need to be recorded separately to ensure that VAT returns can be calculated appropriately.
You may wonder why contracts are important from a VAT perspective other than to state the price and whether the price is inclusive or exclusive of VAT but actually the scope of work and terms of the agreement will determine what is actually being provided and to who. Indeed, HMRC may well request copies of contracts if there is any doubt over the VAT treatment of your supplies or the eligibility of VAT recovery on costs incurred. The wording and parties of contracts are vitally important when it comes to determining who is eligible to reclaim VAT when there are multiple parties involved (e.g. corporate restructuring). Similarly, where there are multiple parties it may be necessary to identify whether someone is providing something or simply acting as an agent bringing other parties together and the VAT treatment may well differ.
Marketing and entertaining
What does your business do to increase sales or promote your business or cause? Do you entertain clients or provide them with free gifts? Do you run promotions? VAT recovery is blocked on costs relating to client entertainment (VAT on staff entertainment is recoverable typically) but VAT on gifts given to customers can be reclaimed as long as the cost of the gift is under £50 (either as a one off or the total of several gifts in a 12 month period). Please note that vouchers are treated differently. Promotions can be complicated if it involves multi-buy deals with products at different VAT rates or, as mentioned above, vouchers are involved.
An area that seems to cause confusion is whether to add VAT when you are recharging expenses to clients. As with seemingly many answers in the VAT arena, it depends on the situation. A disbursement is a payment made on behalf of your customers for goods or services received and used by them. If that cost was subject to VAT, no VAT should be claimed by you as it is not your VAT to recover. It is your customer’s VAT to recover and therefore, it should be recharged gross to them with no VAT added. This is different to a recharge of expenses which are costs incurred by you to deliver your supply to your customers (e.g. travel costs). These should be recharged plus VAT as they form part of the fee for providing the service to customers. This is the case even if the original expense did not have VAT on it (e.g. rail travel).
HMRC’s approach has evolved over the years and focuses now on taxpayer behaviour. HMRC accept that people can make errors and therefore, they focus on how errors occur when determining whether the taxpayer i.e. your business, should be subject to a penalty. If a taxpayer has taken reasonable care then no penalty will be applied. HMRC’s interpretation of reasonable care depends on the type/size of business. As a minimum though, HMRC will expect a clear process and audit trail showing how the VAT return has been completed. If you have additional calculations to determine your VAT liability (e.g. partial exemption, retail schemes, margin schemes) then the associated workings for this should be clear also.
The areas of VAT that I think are the most complicated for businesses are property and partial exemption. Property transactions can be daunting because of the values involved but whether it’s a new build, a renovation or a commercial property, there are various VAT issues that need to be considered which will determine whether you need to charge VAT, whether you can reclaim VAT and whether you are partly exempt going forward.
Where a VAT registered trader has both taxable and exempt transactions it is considered partly exempt – this is often overlooked, for example, if an otherwise fully taxable trader decides to let out some spare office space or meeting room or gains commissions in relation to certain insurance or finance transactions and does not realise that these could generate exempt income. The standard method for partial exemption purposes is taxable turnover divided by total turnover however in some instances this does not give fair result and therefore, is it possible to calculate the recovery percentage in a different way but this needs to be agreed with HMRC (referred to as a special method). It is important to note that the input tax reclaimed in each tax period is provisional and must be reviewed at the end of your VAT year (March, April or May depending on your VAT periods) to ensure that the VAT claimed is correct based on the actual use of the purchases over a longer period. This is called the annual adjustment.
We are always happy to help with any VAT queries or concerns so please do get in touch.