Tag Archives: input-tax

Small businesses/start ups: Should I register for VAT voluntarily?

By   1 February 2024
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VAT Basics – voluntary registration

Why?

OK, so why would a business choose to VAT register when it need not? Let’s say its turnover is under the VAT registration limit of £90,000, isn’t it just best to avoid the VATman if at all possible?

Planning

This is not an article which considers whether a business MUST register, but rather it looks at whether it is a good idea to register on a voluntary basis if it is not compulsory. The first time a business would probably consider VAT planning.

Decision

As a general rule of thumb; if you sell to the public (B2C) then probably not. If you sell to other VAT registered businesses (B2B) then it is more likely to be beneficial.

If you sell B2B to customers overseas it is almost certain that VAT registration would be a good thing, as it would if you supply zero rated goods or services in the UK. This is because there is no output tax on sales, but full input tax recovery on costs; VAT nirvana! A distinction must be made between zero rated supplies and exempt supplies. If only exempt supplies are made, a business cannot register for VAT regardless of level of income.

Compliance

Apart from the economic considerations, we have found that small businesses are sometimes put off VAT registration by the added compliance costs (especially since MTD) and the potential penalties being in the VAT club can bring. Weighed against this, there is a certain kudos or prestige for a business and it does convey a degree of seriousness of a business undertaking. We also come across situations where a customer will only deal with suppliers who are VAT registered.

The main issue

The key to registration is that, once registered, a business may recover the VAT it incurs on its expenditure (called input tax). So let us look at some simple examples of existing businesses for comparison:

Examples

  • Example 1

A business sells office furniture to other VAT registered business (B2B)

It buys stock for 10,000 plus VAT of 2,000

It incurs VAT on overheads (rent, IT, telephones, light and heat etc) of 2,000 plus 400 VAT

It makes sales of 20,000

If not registered, its profit is 20,000 less 12,000 less 2400 = 5600

If VAT registered, the customer can recover any VAT charged, so VAT is not a disincentive to him

Sales 20,000 plus 4000 VAT (paid to HMRC)

Input tax claimed = 2400 (offset against payment to HMRC)

Result: the VAT is neutral and not a cost, so profit is 20,000 less 12,000 = 8000, a saving of 2400 as compared to the business not being registered.  The 2400 clearly equals the input tax recovered on expenditure.

  • Example 2

A “one-man band” consultant provides advice B2B and uses his home as his office. All of his clients are able to recover any VAT charged.

He has very few overheads that bear VAT as most of his expenditure is VAT free (staff, train fares, use of home) so his input tax amounts to 100.

He must weigh up the cost (time/admin etc) of VAT registration against reclaiming the 100 of input tax. In this case it would probably not be worthwhile VAT registering – although the Flat Rate Scheme may be attractive.

  • Example 3

A retailer sells adult clothes to the public from a shop. She pays VAT on the rent and on the purchase of stock as well as the usual overheads. The total amount she pays is 20,000 with VAT of 4000.

Her sales total 50,000

If not VAT registered her profit is 50,000 less 24,000 = 26,000

If VAT registered she will treat the value of sales as VAT inclusive, so of the 50,000 income 8333 represents VAT she must pay to HMRC. She is able to offset her input tax of 4000.

This means that her profit if VAT registered is 50,000 less the VAT of 8333 = 41,667 less the net costs of 20,000 = 21,667

Result: a loss of 4333 in profit.

As may be seen, if a business sells to the public it is nearly always disadvantageous to be voluntarily VAT registered. It may be possible to increase her prices by circa 20%, but for a lot of retailers, this is unrealistic.

Intending traders

If a business has not started trading, but is incurring input tax on costs, it is possible to VAT register even though it has not made any taxable supplies. This is known by HMRC as an intending trader registration. A business will need to provide evidence of the intention to trade and this is sometimes a stumbling block, especially in the area of land and property. Choosing to register before trading may avoid losing input tax due to the time limits (very generally a business can go back six months for services and four years for goods on hand to recover the VAT). Also cashflow will be improved if input tax is recovered as soon as possible.

Action

Careful consideration should be given to the VAT status of a small or start-up business. This may be particularly relevant to start-ups as they typically incur more costs as the business begins and the recovery of the VAT on these costs may be important. In most cases it is also possible to recover VAT incurred before the date of VAT registration.

This is a basic guide and there are many various situations that require further consideration of the benefits of voluntary VAT registration. We would, of course, be pleased to help.

VAT: Fuel and power HMRC update

By   10 January 2024
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HMRC has updated its VAT Notice 701/19 from 5 January 2024.

Sections 2, 3 and 5 have been amended to include information about the VAT treatment of charging of electric vehicles (EVs) when using charging points.

VAT: What is a proforma invoice and how can it be used?

By   11 December 2023
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VAT basics

Proforma invoices (proformas) are preliminary documents usually sent to buyers in advance of a delivery of goods/provision of services. Proformas will typically describe details of the purchase of goods/services and other important information, such as the terms of the transaction. Proformas are not “official” documents and represent an informal agreement. Usually, requesting a proforma represents a more serious interest on the part of a buyer than a quote – a buyer is generally committed to making a purchase but want to understand the details before proceeding with the approval process and making a binding agreement with the seller. They are therefore a useful business tool and use of them may result in a beneficial cashflow position for VAT (please see below).

Proforma translates from Latin as “for the sake of form”, and this provides an indication that the document is provisional or a step in a process.

It is also worth noting that the use of proformas is not mandatory.

The difference between an invoice and a proforma

Invoices (also called commercial invoices, VAT invoices or tax invoices) are distinct from proformas. They may contain similar information but serve different purposes. It is important to avoid confusing the two, since only invoices are legal documents; that is, they evidence a transaction and is the document on which VAT may be claimed. An invoice must contain certain information and there are specific legal obligations for providing them.

It is a matter of law whether an invoice is valid and when they must be issued. A proforma is not required to follow any set form, apart from the facts that they must not have an invoice number and must state that it is a proforma invoice. We also recommend that a proforma does not show the supplier’s VAT number for the avoidance of doubt.

Contents of a proforma

Proformas can be considered as “dummy invoices” and they are prepared by the seller usually to provide details of:

  • the issuing business’s name, address, and contact details
  • customer’s name and address
  • date of issue
  • length of time the pricing is valid
  • the goods/services requested, including quantities, type, and physical specifications
  • pricing, including individual costs as well as the total amount to be charged
  • terms of sale, including eg; shipping and delivery dates
  • payment terms
  • whether VAT is applicable

However, there are no set formats for proformas.

Use for buyer

The purpose of a proforma is to provide the buyer with an accurate and complete good faith estimate they can use to decide whether or not to go ahead with a transaction. It also avoids surprises when the actual tax invoice is issued.

VAT implications

The main distinctions are that, compared to a tax invoice, a proforma:

  • does not create a tax point
  • the recipient is unable to recover input tax on a proforma

Very broadly, the tax point (time of supply) this is the earliest of; invoice date, receipt of payment, goods transferred or services completed. The tax point fact is helpful in tax planning for suppliers. Broadly, using proformas, requests for payment, or similar documents rather than issuing an invoice, defers a tax point and consequently when VAT is payable to HMRC. This is especially relevant to businesses which provide ongoing services (known as continuous supplies of services).

Please contact us if you require more information on the commercial use of proformas.

 

VAT: The Partial Exemption Annual Adjustment

By   4 December 2023
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What is the annual adjustment? Why is it required?

An annual adjustment is a method used by a business to determine how much input tax it may reclaim.

Even though a partly exempt business must undertake a partial exemption calculation each quarter or month, once a year it will have to make an annual adjustment as well.

An annual adjustment is needed because each tax period can be affected by factors such as seasonal variations either in the value supplies made or in the amount of input tax incurred.

The adjustment has two purposes:

  • to reconsider the use of goods and services over the longer period; and
  • to re-evaluate exempt input tax under the de minimis rules.

An explanation of the Value Added Tax Partial Exemption rules is available here

Throughout the year

When a business makes exempt supplies it will be carrying out a partial exemption calculation at the end of each VAT period. Some periods it may be within the de minimis limits and, therefore, able to claim back all of its VAT and in others there may be some restriction in the amount of VAT that can be reclaimed. Once a year the business will also have to recalculate the figures to see if it has claimed back too much or too little VAT overall. This is known as the partial exemption annual adjustment. Legally, the quarterly/monthly partial exemption calculations are only provisional, and do not crystallise the final VAT liability. That is done via the annual adjustment.

The first stage in the process of recovering input tax is to directly attribute the costs associated with making taxable and exempt supplies as far as possible. The VAT associated with making taxable supplies can be recovered in the normal way while there is no automatic right of deduction for any VAT attributable to making exempt supplies.

The balance of the input tax cannot normally be directly attributed, and so will be the subject of the partial exemption calculation. This will include general overheads such as heating, lighting and telephone and also items such as building maintenance and refurbishments.

The calculation

Using the partial exemption standard method the calculation is based on the formula:

Total taxable supplies (excluding VAT) / Total taxable (excluding VAT) and exempt supplies x 100 = %

This gives the percentage of non-attributable input VAT that can be recovered. The figure calculated is always rounded up to the nearest whole percentage, so, for example, 49.1 becomes 50%. This percentage is then applied to the non-attributable input VAT to give the actual amount that can be recovered.

Once a year

Depending on a businesses’ VAT return quarters, its partial exemption year ends in either March, April, or May. The business has to recalculate the figures during the VAT period following the end of its partial exemption year and any adjustment goes on the return for that period. So, the adjustment will appear on the returns ending in either June, July, or August. If a business is newly registered for VAT its partial exemption “year” runs from when it is first registered to either March, April or May depending on its quarter ends.

Special methods

The majority of businesses use what is known as “the standard method”. However, use of the standard method is not mandatory and a business can use a “special method” that suits a business’ activities better. Any special method has to be “fair and reasonable” and it has to be agreed with HMRC in advance. When using a special method no rounding of the percentage is permitted and it has to be applied to two decimal places.

Commonly used special methods include those based on staff numbers, floor space, purchases or transaction counts, or a combination of these or other methods.

However, even if a business uses a special method it will still have to undertake an annual adjustment calculation once a year using its agreed special method.

De minimis limits

If a business incurs exempt input tax within certain limits it can be treated as fully taxable and all of its VAT can be recovered. If it exceeds these limits none of its exempt input tax can be recovered. The limits are:

  • £625 per month on average (£1,875 per quarter or £7,500 per annum) and;
  • 50% of the total input VAT (the VAT on purchases relating to taxable supplies should always be  greater than the VAT on exempt supplies to pass this test)

The partial exemption annual adjustments are not errors and so do not have to be disclosed under the voluntary disclosure procedure. They are just another entry for the VAT return to be made in the appropriate VAT period.

Conclusion

If a business fails to carry out its partial exemption annual adjustment it may be losing out on some input VAT that it could have claimed. Conversely, it may also show that it has over-claimed input tax. When an HMRC inspector comes to visit he will check that a business has completed the annual adjustment. If it hasn’t, and this has resulted in an over-claim of input VAT, (s)he will assess for the error, charge interest, and if appropriate, raise a penalty. It is fair to say that partly exempt businesses tend to receive more inspections than fully taxable businesses.

VAT: Best judgement; what is it, and why is it important?

By   13 November 2023
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If HMRC carry out an inspection and decide that VAT has been underdeclared (eg: either by understating sales, applying the incorrect VAT rate, or overclaiming input tax) an inspector has the power to issue an assessment to recover VAT that it is considered underdeclared. This is set out in The VAT Act 73(1)

“Where a person has failed to make any returns … or where it appears to the Commissioners that such returns are incomplete or incorrect, they may assess the amount of VAT from him to the best of their judgment and notify it to him”.

So, the law requires that when an inspector makes an assessment (s)he must ensure that the assessment is made to the best of their judgement, otherwise it is invalid and will not stand.

Guidance to surviving a VAT inspection here.

HMRC’s methods of assessing cash businesses here.

Definition of best judgment

Per Van Boeckel vs HMCE (1981) the judge set out three tests:

  1. HMRC must make a value judgment on the material set before it honestly and bona fide and not knowingly set an inflated figure and then expect the taxpayer to disprove it on appeal
  2. there must be material available
  3. HMRC is not expected to do the work of the taxpayer but instead fairly interpret the material before it and come to a reasonable conclusion rather than an arbitrary one

If any of these three tests are failed, then best judgement has not been employed. However, the onus is on the appellant to disprove the assessment.

There were further comments on the matter:

“There are…obligations placed on the Commissioners to properly come to a view on the amount of tax that was due to the best of their judgement. In particular:

  • a value judgement must be made on the material put before them
  • they must perform their function honestly
  • there must be material on which to base their judgement
  • but they should not be required to do the job of the taxpayer, or carry out extensive investigations

This means that the assessing inspector must fairly consider all material placed before them and, on that material, come to a decision that is reasonable and not arbitrary, taking into account the circumstances of the business. In some cases, some “guesswork” may be required, but it should be honestly made based on the information available and should not be spurious, but HMRC must be permitted a margin of discretion.

Experience insists that it is usually more successful if the quantum of a best judgement assessment is challenged.

Where a business successfully disputes the amount of an assessment and the assessment is reduced, it will rarely fail the best judgement test.

In the case of MH Rahman (Khayam Restaurant) CO 2329/97 the High Court recognised the practice whereby the tribunal adopts a two-step approach, looking initially at the question of best judgement and then at the amount of the assessment. The message of the High Court appeared to be that the Tribunal should concern itself more with the amount of an assessment rather than best judgement.

Arguments which may be employed to reduce a best judgement assessment are, inter alia:

  • period of calculation is unrepresentative
  • wastage
  • discounts
  • staff use
  • theft
  • seasonal trends
  • competition
  • sales
  • opening hours
  • client base, etc

HMRC’s guidance to its own officers states that: Any assessments made must satisfy the best judgement criteria. This means that given a set of conditions or circumstances, “you must take any necessary action and produce a result that is deemed to be reasonable and not arbitrary”.

In other words, best judgement is not the equivalent of the best result or the most favourable conclusion. It is a reasonable process by which an assessment is successfully reached.

In the case of CA McCourtie LON/92/191 the Tribunal considered the principles set out in Van Boeckel and put forward three further propositions:

  • the facts should be objectively gathered and intelligently interpreted
  • the calculations should be arithmetically sound, and
  • any sampling technique should be representative

Tribunals will not treat an assessment as invalid merely because they disagree as to how the judgement should have been exercised. It is possible that a Tribunal may substitute its own judgement for HMRC’s in respect of the amount of the assessment. However, this does not necessarily mean that because a different quantum for the assessment was arrived at that the assessment failed the best judgement test.

Further, it is not the function of the Tribunal to engage in a process that looks afresh at the totality of the evidential material before it (M & A Georgiou t/a Mario’s Chippery, QB October 1995 [1995] STC 1101).

It should be also noted that even if one aspect of an assessment is found not to be made to best judgement this should not automatically invalidate the whole assessment – Pegasus Birds [2004] EWCA Civ1015.

Summary

There are significant difficulties in arguing that an inspector did not use best judgement and it is a high bar to get over.

In order to succeed on appeal, it would be required to be demonstrated, to the judge’s satisfaction, that the assessment was raised:

  • dishonestly
  • vindictively
  • capriciously
  • arbitrarily
  • spuriously
  • via an estimate or a guess in which all elements or best judgement are absent
  • wholly unreasonably

and that this action applies to the assessment in its entirety.

VAT: What is culture? The Derby Quad case

By   6 November 2023
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Latest from the courts

In the Derby Quad Ltd First-Tier tribunal (FTT) case the issue was whether the appellant’s supplies of admission to a screening were of a theatrical performance which would be cultural and exempt, or akin to a cinema presentation which is standard rated.

Background

A RSC live performance of The Tempest performed at Stratford-upon-Avon was live screened at The Quad venue in Derby by way of a broadcast – A so-called live event performed by a company other than DQ. The Quad is a comprehensive creative centre with indie cinema, art gallery, café-bar and event spaces for hire. DQ pays theatre companies a percentage of the proceeds from ticket sales to the screenings, and a small flat fee per simultaneous screening to help offset the satellite transmission costs.

The core of the dispute was whether the live events were a ‘live performance’ as required by The VAT Act 1994, Schedule 9, Group 13 item 2(b) for exemption.

The Arguments

The appellant contended that a live event was different from a cinematic film where the admission price is subject to VAT – it is an “experience”. The event is thought of as an experience on its own and is of artistic merit. It allows for audience participation and interaction even remotely.

To support this, it was stated that 84% percent of audiences “felt real excitement” because they knew the performance was being broadcast live that evening. Watching the show with others was also an important factor. Audiences tended to applaud at the end of the screening and they appear to feel connected to the performance and the audience. Further, the majority of audiences attending live events enjoyed the collective experience of watching as a group. This differs from audiences at cinemacasts of films and or recordings who typically watch as an individual or as a couple.

HMRC’s position was that admission charges to cinematic performances, and to live performances broadcast from other locations, were taxable.

Decision

The differences in the experiences of members of the audience and the actors/performers between a live theatre performance and at a live event are ones of kind, and not just degree, as they go to the essence of what makes and constitutes a theatrical performance and require interaction. A live event is, consequently, not capable of being a ‘theatrical performance’.

The actors in Stratford would receive no feedback from the audience in The Quad in a way they would from the audience at the live ‘physical’ event.

The FTT found that this is not a modern variant of a theatre performance and the appeal was dismissed.

Commentary

An interesting case which highlights the fact that subtle variations of supplies, and their interpretations can significantly affect the VAT outcome. In light of technical advances in this area we will need to watch how the definition of ‘theatrical performances’ develops.

VAT: Revoke an option to tax after 20 years have passed – update

By   6 November 2023
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HMRC’s Form VAT1614J has been updated. This form is used to revoke an option to tax (OTT) land or buildings for VAT purposes after 20 years have passed. There is a new address to which the form and supporting documents are sent:

BT VAT

HM Revenue and Customs

BX9 1WR

Scanned copies of the form can be emailed to: optiontotaxnationalunit@hmrc.gov.uk

 

Background: Revoking an option where more than 20 years have elapsed since it first had effect.

A business may revoke an OTT without prior permission from HMRC where more than 20 years have elapsed since the option first had effect. This is done by submitting the Form VAT1614J.

When the OTT first has effect: An OTT first had effect on the day it was exercised, or any later day that was specified when opting to tax.

Who can revoke: The relevant guidance VAT Notice 742A – which has the force of law here states that the ‘Taxpayer’ can revoke the OTT. The taxpayer is defined as the person who exercised the option to tax or is treated as making that option by virtue of a real estate election.

When the revocation will take effect: The revocation will take effect from the day that the taxpayer specifies when HMRC is notified, but this cannot be any earlier than the day on which the taxpayer notifies HMRC.

Outcomes of revoking an Option To Tax

  • any income (rent or sale) relating to the property becomes exempt
  • any input tax relating to the property is not recoverable (subject to the de minimis rules)
  • if no other taxable supplies are made a business must deregister

Revocation of option: The VAT Act 1994, Schedule 10, 25(1)(a).

VAT reliefs for charities – A brief guide

By   24 October 2023
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Charities and Not For Profit (NFP) entities – A list of VAT reliefs in one place

Unfortunately, there is no “general” rule that charities are relieved of the burden of VAT.

In fact, charities have to contend with VAT in much the same way as any business. However, because of the nature of a charity’s activities, VAT is not usually neutral and often becomes an additional cost. VAT for charities often creates complex and time consuming technical issues which a “normal” business does not have to consider.

There are only a relatively limited number of zero rated reliefs specifically for charities and not for profit bodies, so it is important that these are taken advantage of. These are broadly:

  • advertising services* received by charities
  • purchase of qualifying goods for medical research, treatment or diagnosis
  • new buildings constructed for residential or non-business charitable activities
  • self-contained annexes constructed for non-business charitable activities
  • building work to provide disabled access in certain circumstances
  • building work to provide washrooms and lavatories for disabled persons
  • supplies of certain equipment designed to provide relief for disabled or chronically sick persons

* HMRC have set out its views on digital/online advertising in Revenue and Customs Brief 13 (2020): VAT charity digital advertising relief. 

There are also special exemptions applicable to supplies made by charities:

  • income from fundraising events
  • admissions to certain cultural events and premises
  • relief from “Options to Tax” on the lease and acquisition of buildings put to non-business use
  • membership subscriptions to certain public interest bodies and philanthropic associations
  • sports facilities provided by non-profit making bodies

Although treating certain income as exempt from VAT may seem attractive to a charity, it nearly always creates an additional cost as a result of the amount of input tax which may be claimed being restricted. Partial exemption is a complex area of the tax, as are calculations on business/non-business activities which fundamentally affect a charity’s VAT position.

The reduced VAT rate (5%) is also available for charities in certain circumstances:

  • gas and electricity in premises used for residential or non-business use by a charity
  • renovation work on dwellings that have been unoccupied for over two years
  • conversion work on dwellings to create new dwellings or change the number of dwellings in a building
  • installation of mobility aids for persons aged over 60

Additionally, there are certain Extra Statutory Concessions (*ESCs) which benefit charities. These zero rate supplies made to charities, these are:

  • certain printed stationery used for appeals
  • collection boxes and receptacles
  • lapel stickers and similar tokens, eg; remembrance day poppies

* ESCs are formal, published concessions but have no legal force.

We strongly advise that any charity seeks assistance on dealing with VAT to ensure that no more tax than necessary is paid and that penalties are avoided. Charities have an important role in the world, and it is unfair that VAT should represent such a burden and cost to them.

VAT: Partial exemption – updated HMRC guidance

By   17 October 2023
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HMRC has published updated partial exemption guidance in Manual PE21500.

The main changes are in respect of updated case law, including the Royal Opera House Court of Appeal case dealing with the attribution of input tax.

In that case the CoA considered: the test of direct and immediate link, economic necessity, business/non-business, and chains of transactions.

A VAT Did you know?

By   12 October 2023
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We know that burying a deceased person is exempt, but exhumation is standard rated and we now know, thanks to the UK Funerals On-line Ltd FTT case, that the service of the repatriation of the body of a deceased person can be viewed as either an exempt supply of funeral services or a zero-rated supply of transport services.

This being the case, zero rating trumps exemption via of The VAT Act 1994, section 30(1).