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As most people will know, UK domestic VAT law is derived from EU legislation, but what is the actual relationship?
It is important to understand how both elements of legislation work in cases of dispute with HMRC as it often provides additional ammunition.
History
Most Member States already had a system of VAT before joining the EU but for some countries VAT had to be introduced together with membership of the EU. When the UK joined the EU in 1972 it replaced two taxes; purchase tax and selective employment tax with VAT.
In 1977, the Council of the European Communities sought to harmonise the national VAT systems of its Member States by issuing the Sixth Directive to provide a uniform basis of assessment and replacing the Second Directive promulgated in 1967.
Council Directive 2006/112/EC (the VAT Directive) sets out the infrastructure for a common VAT system which each Member State is required to implement by means of its own domestic legislation. This important Directive codifies into one piece of legislation all the amendments to the original Sixth Directive, thus clarifying EU VAT legislation currently in force.
Intention
The aim of the VAT Directive is to harmonise the indirect tax within the EU, and it specifies that VAT rates must be within a certain range. The basic aims are:
EU Statements
There are four types of EU statements:
EU Legislation as part of UK Legislation
EU law is made effective for UK legislation via European Communities Act 1972 section 2. The effects of EU law as regards UK VAT legislation is summarised as follows.
Direct effect
The Court of Justice has held “wherever the provisions of a directive appear … to be unconditional and sufficiently precise, those provisions may … be relied upon as against any national provision which is incompatible with the directive insofar as the provisions define rights which individuals are able to assert against the state” (Case: Becker). Also in UFD Ltd it was stated that “in all appeals involving issues of liability, the Tribunal should consider the relevant provisions of the Council directives to ensure that the provisions of the UK legislation are consistent therewith”.
Primacy of EU Directives over UK legislation
A UK court which is to apply provisions of EU law is under a duty to give full effect to those provisions, if necessary refusing of its own motion to apply any conflicting provision of national legislation.
Interpretation of UK law
If UK VAT legislation is unclear or ambiguous, Tribunals are “entitled to have regard to the provisions of the relevant EU Directive in order to assist in resolving any ambiguity in the construction of the provisions under consideration’ (Case: English-Speaking Union of the Commonwealth).
Legal principles
In implementing the common VAT structure, domestic legislation is required to recognise certain legal principles.
Examples of some of these are the principle of:
Practical application for most taxpayers
Practically, a result of the above is that taxpayers are regularly able to recover VAT (plus interest) paid to HMRC in error in cases where the UK domestic legislation has not implemented EU law correctly. However, HMRC has no right to recovery where VAT has been under-collected as a result of inappropriate implementation of the EU legislation.
Penalties for VAT infringements are draconian and there is still an alarming array of enforcement powers to trap the unwary. By being conscious of the problem areas and planning carefully, it should be possible to avoid becoming an unwitting victim of the system. This article focuses mainly on VAT compliance.
Late Registration
You must notify HMRC if your turnover exceeds £82,000 in twelve months, or if you believe it will exceed £82,000 in the next thirty days. The penalty for failing to notify liability falls within the single penalty system and it could be up to 100% of the VAT due. There is no penalty if the taxpayer has a reasonable excuse for not registering at the correct time.
After Registration
Every VAT registered business needs to ensure that it is organised to deal with VAT correctly and on time:
Default surcharge
A default occurs if HMRC has not received your return and all the VAT due by the due date. The relevant date is the date that cleared funds reach HMRC’s bank account. If the due date is not a working day, payment must be received on the last preceding working day. .
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%. 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.
Errors on returns and claims
Incorrect returns incur a penalty under the following penalties apply:
If a taxpayer takes ‘reasonable care,’ then no penalty is due.
More on errors here
Retention of records
The period for retaining records is six years. There is a fixed penalty of £500 for breaching this requirement.
Default interest
The rate of interest is set by the Treasury and is broadly in line with commercial rates of interest.
Appeals
Appeals against penalties may be made to the independent tribunal. The tribunal 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.
Access to information
HMRC 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
If you receive a VAT assessment (because you have not submitted a return), you must check it and notify HMRC 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.
Some of these penalties may not apply if there is a reasonable excuse, but the scope is limited and should not be relied upon
If in doubt, contact us. It is important that you seek professional advice as early as possible.
Latest from the courts
In the recent case of KDT Management Ltd an appeal against a decision by HMRC not to allow the appellant to retrospectively apply the percentage of turnover it says was appropriate to its business under the FRS instead of the one it says it mistakenly chose was considered.
HMRC issued an assessment to recover VAT which was alleged to have been omitted from the appellant’s returns because it did not apply certain increases of rate to its turnover under the FRS of accounting for VAT.
It was also an appeal against a decision by HMRC not to allow the appellant to retrospectively apply the percentage of turnover it says was appropriate to its business under the FRS instead of the one it says it mistakenly chose.
The decision was that the appeal against the assessments to VAT and interest were upheld. The appeal against the decision not to backdate was also upheld and the decision was cancelled.
Please contact us if you have been in dispute over the rate applicable on a FRS, or if you think you may be using an inappropriate percentage. This is likely to mainly affect small businesses.
Details of the FRS here
OK, so why would a business choose to VAT register when it need not (let’s say it’s turnover is under the VAT registration limit of £82,000)? Isn’t it best just to avoid the VATman if at all possible?
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.
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.
Apart from the economic considerations, we have found that small businesses are sometimes put off VAT registration by the added compliance costs 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. It may also make life simpler (and reduce costs) if a business buys goods or services from other EC Member States. We also come across situations where a customer will only deal with suppliers who are VAT registered.
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:
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 little 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, please see article here
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.
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.
Building your own home is becoming increasingly popular. There are many things to think about, and budgeting is one of the most important.
The recovery of VAT on the project has a huge impact on the budget and care must be taken to ensure that a claim is made properly and within the time limits. You don’t have to be VAT registered to make a claim, this is done via a mechanism known as The DIY Housebuilders’ Scheme. It has specific rules which must be adhered to otherwise the claim will be rejected.
If you buy a new house from a property developer, you will not be charged VAT. This is because the sale of the house to you will be zero-rated. This allows the developer to reclaim the VAT paid on building materials from HMRC. However, if you build a house yourself, you will not be able to benefit from the zero-rating. The DIY Housebuilder’ Scheme puts you in a similar position to a person who buys a zero-rated house built by a property developer.
Who can make a claim?
You can apply for a VAT refund on building materials and services if you are:
Eligibility
New homes
The house must:
A claim may also be made for garages built at the same time as the house and to be used with the house.
Contractors working on new residential buildings should zero rate their supplies to you, so you won’t pay any VAT on these.
Conversions
The building being converted must usually be a non-residential building (eg; a barn conversion). Residential also buildings qualify if they haven’t been lived in for at least 10 years.
You may claim a refund for builders’ work on a conversion of non-residential building into home. These supplies will be charged at the reduced rate of 5% for conversion works. If the standard rate of 20% s charged incorrectly, you will not be able to claim the standard rated amount. Care should be taken that the contractor understands the VAT rules for conversions as these can be complex.
Communal and charity buildings
You may get a VAT refund if the building is for one of the following purposes:
What can you claim on?
Building materials
You may claim a VAT refund for building materials that are incorporated into the building and can’t be removed without tools or damaging the building.
What doesn’t qualify
You cannot claim for:
Examples of items you can, and cannot claim for are listed below.
How to claim
To claim a VAT refund, send form 431NB or 431C to HMRC
Local Compliance National DIY Team
SO987
Newcastle
NE98 1ZZ
What you need to know
You must claim within 3 months of the building work being completed.
You will usually get the refund in 30 working days of sending the claim.
You must include the following with your claim:
VAT invoices must be valid and show the correct rate of VAT or they will not be accepted in the claim.
HMRC usually examine every claim closely and often query them, so it pays to ensure that the claim is as accurate as possible first time. We find a review by us before submission ensures the maximum amount is claimed and delays are avoided.
Payments made after completion of the house cannot be claimed, and only one claim can be made for the whole project, so cashflow may be an issue.
Examples of items that you can claim for The items listed below are accepted as being ‘ordinarily’ incorporated in a building (or its site). This is not a complete list.Please contact us if you require assistance with a DIY Housebuild project.
A relevant business person `belongs’ in the relevant country. A `relevant country’ means:
A person who is not a relevant business person `belongs’ in the country of his usual place of residence. The `belonging’ definition applies equally to the recipient of a supply, where relevant.
Business establishment is not defined in the legislation but is taken by HMRC to mean the principal place of business. It is usually the head office, headquarters or ‘seat’ from which the business is run. There can only be one such place and it may take the form of an office, showroom or factory.
Fixed establishment is not defined in the legislation but is taken by HMRC to mean an establishment (other than the business establishment) which has both the technical and human resources necessary for providing and receiving services on a permanent basis. A business may therefore have several fixed establishments, including a branch of the business or an agency. A temporary presence of human and technical resources does not create a fixed establishment in the UK.
Usual place of residence. A body corporate has its usual place of residence where it is legally constituted. The usual place of residence of an individual is not defined in the legislation. HMRC interpret the phrase according to the ordinary usage of the words, ie; normally the country where the individual has set up home with his/her family and is in full-time employment. An individual is not resident in a country if only visiting as a tourist.
More than one establishment. Where the supplier/recipient has establishments in more than one country, the supplies made from/received at each establishment must be considered separately. For each supply of services, the establishment which is actually providing/receiving the services is normally the one most directly connected with the supply but all facts should be considered including
However, where an establishment is actually providing/receiving the supply of services, it is normally that establishment which is most directly connected with the supply, even if the contractual position is different.
VAT groups
A VAT group is treated as a single entity. This also applies when applying the ‘place of belonging’. As a result, a group has establishments wherever any member of the group has establishments.
This is an area which often leads to uncertainty, and therefore VAT issues. It is also an area where VAT planning may; save time, resources and avoid unexpected VAT costs, either in the UK or another country.
For more on our International Services
VAT Penalties
I have made a lot of references to penalties in other articles over the years. So I thought it would be a good idea to have a closer look; what are they, when are they levied, rights of appeal, and importantly how much could they cost if a business gets it wrong?
Overview
Broadly, a penalty is levied if the incorrect amount of VAT is made, either by understating output tax due, or overclaiming input tax, or accepting an assessment which is known to be too low.
Amount of penalty
HMRC detail three categories of inaccuracy. These are significant, as each has its own range of penalty percentages. If an error is found to fall within a lower band, then a lower penalty rate will apply. Where the taxpayer has taken ‘reasonable care,’ even though an error has been made, then no penalty will apply.
Reasonable care
There is no definition of ‘reasonable care’. However, HMRC have said that they would not expect the same level of knowledge or expertise from a self-employed person, as from a large multi-national.
HMRC expect that, where an issue is unclear, advice is sought, and a record maintained of that advice. They also expect that, where an error is made, it is adjusted, and HMRC notified promptly. They have specifically stated that merely to adjust a return will not constitute a full disclosure of an error. Therefore a penalty may still be applicable.
What the penalty is based on
The amount of the penalty is calculated by applying the appropriate penalty rate (above) to the ‘Potential Lost Revenue’ or PLR. This is essentially the additional amount of VAT due or payable, as a result of the inaccuracy, or the failure to notify an under-assessment. Special rules apply where there are a number of errors, and they fall into different penalty bands.
Defending a penalty
The percentage penalty may be reduced by a range of ‘defences:’
– Telling; this includes admitting the document was inaccurate, or that there was an under-assessment, disclosing the inaccuracy in full, and explaining how and why the inaccuracies arose;
– Helping; this includes giving reasonable help in quantifying the inaccuracy, giving positive assistance rather than passive acceptance, actively engaging in work required to quantify the inaccuracy, and volunteering any relevant information;
– Giving Access; this includes providing documents, granting requests for information, allowing access to records and other documents.
Further, where there is an ‘unprompted disclosure’ of the error, HMRC have power to reduce the penalty further. This measure is designed to encourage businesses to review their own VAT returns.
A disclosure is unprompted if it is made at a time when a person had no reason to believe that HMRC have discovered or are about to discover the inaccuracy. The disclosure will be treated as unprompted even if at the time it is made, the full extent of the error is not known, as long as fuller details are provided within a reasonable time.
HMRC have included a provision whereby a penalty can be suspended for up to two years. This will occur for a careless inaccuracy, not a deliberate inaccuracy. HMRC will consider suspension of a penalty where, given the imposition of certain conditions, the business will improve its accuracy. The aim is to improve future compliance, and encourage businesses which genuinely seek to fulfil their obligations.
Appealing a penalty
HMRC have an internal reconsideration procedure, where a business should apply to in the first instance. If the outcome is not satisfactory, the business can pursue an appeal to the First Tier Tribunal. A business can appeal on the grounds of; whether a penalty is applicable, the amount of the penalty, a decision not to suspend a penalty, and the conditions for suspension.
The normal time limit for penalties to four years. Additionally, where there is deliberate action to evade VAT, a 20 year limit applies. In particular, this applies to a loss of VAT which arises as a result of a deliberate inaccuracy in a document submitted by that person.
These are just the penalties for making “errors” on VAT returns. HMRC have plenty more for anything from late registration to issuing the wrong paperwork.
Assistance
My advice is always to check on all aspects of a penalty and seek assistance for grounds to challenge a decision to levy a penalty. We have a very high success rate in defending businesses against inappropriate penalties. It is always worth running a penalty past us.
A benefit to charities?
In the case of Sveda (C-126/14) which was recently heard by the European Court of Justice (ECJ) the issue was whether input tax was recoverable on the construction of a recreational woodland path which ended at a shop that Sveda owned and made taxable supplies from. Full case here
90% of the construction costs were met by Grant received from the Lithuanian Ministry of Agriculture on the condition that the path was made available free of charge to the public for a period of five years. There was no dispute that the grant was outside the scope income for Sveda.
The authorities disallowed the VAT claimed on 100% of the costs on the grounds there was no link to taxable supplies since free access is a non-economic activity because there was no consideration paid to use the path. Alternatively, there was a contention that only 10% of the VAT should be reclaimed, since the company only met 10% of the cost.
Sveda argued that, although the path could be used free of charge, the purpose was increase taxable sales from its shop (food, drink and souvenirs). This meant there was a link between the VAT incurred and its economic activity as a whole.
The ECJ rejected the view that the input tax should be blocked in its entirety or in part. Its view was that the expenditure was incurred with the intention of carrying out an economic taxable activity, even if there was no direct link to any one specific supply and use of the path was free. The VAT was overhead VAT. No exempt supplies (that would break the chain of deduction) took place.
So, although the path was used for a non-business activity (free access) the ECJ deemed that the input tax incurred on the costs of building the path was deductible. As there was a link to economic activities the VAT is treated as overhead and, in this case, fully recoverable.
Although Sveda is a commercial company and the decision will no doubt be of assistance to commercial entities, there may be a significant impact on charities and NFP organisations. This judgment highlights the basic right to deduct VAT where a link to taxable supplies made by a taxable person can be demonstrated. It does not matter whether the link is to one taxable supply or to all the taxable economic activities. The non-business use of the asset did not prevent recovery. The outcome would no doubt have been different if Sveda was only involved in building the path and just providing free access to it without also selling items form the shop.
On a personal note, this case has echoes of one I took to Tribunal for The Imperial War Museum – with a similar successful outcome. HMRC views here
Let’s hope it will be just as useful for the taxpayer as the landmark IWM decision.
If you think you, or a charity you are aware of, or a client of yours may be affected by this decision, please contact me. This may be the case if the charity undertakes both business and non-activities. I would always counsel that a charity should have its activities reviewed from a VAT perspective. There are usually savings that could be made.
More on our charity services here
Can you rely on a VAT ruling received from HMRC when they have been provided with full information in writing? You would like to think so wouldn’t you? And in the past, you have been able to. 
However, the long standing protection from assessments for deemed underdeclared VAT as a result of incorrect advice or actions by HMRC has been withdrawn. This was commonly known as “Sheldon Statement” protection.
HMRC now state that there are some circumstances in which their primary duty is to collect tax according to the statute and it may mean that they can no longer be bound by advice they have given.
Despite all their publicity of their National Help Line and Advice Centre, plus the clearance procedures introduced to assist taxpayers with their obligations, HMRC can still renege on their advice!
Even if you are fortunate enough to actually get a decision from HMRC (which is increasingly difficult and frustrating) you can’t rely on it.
This makes it even more important to avoid errors and the increased risk of VAT penalties and interest.
This leaves the question as to whom businesses can rely on for accurate, cost effective VAT saving advice and guidance on getting VAT right? The answer, clearly, is to contact their friendly local VAT consultant…