Tag Archives: penalties

VAT: The Partial Exemption Annual Adjustment

By Marcus Ward 4 December 2023

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: Changes to the DIY Housebuilders’ Scheme

By Marcus Ward 20 November 2023

The DIY Housebuilders’ Scheme is a tax refund mechanism for people who build, or arrange to have built, a house they intend to live in. It also applies to converting commercial property into a house(s). This puts a person who constructs their own home on equal footing with commercial housebuilders. There is no need to be VAT registered in order to make the claim.

The Scheme can be complex, but here is our Top Ten Tips for claimants.

The Changes

From 5 December 2023, the follow changes apply:

claimants will be allowed to submit claims electronically
the deadline for making claims will be extended to six months (from three)
the list of documents required to support a claim has been amended
a new requirement for additional evidence when a derelict building has been converted into dwelling(s) – to be made on a specific form

These changes are set out in The Value Added Tax (Refunds to “Do-It-Yourself” Builders) (Amendment of Method and Time for Making Claims) Regulations 2023 and guidance is provided by HMRC here.

The new deadline applies to claims made on, or after 5 December 2023. The deadline, broadly, begins when a dwelling is complete. There is sometimes a dispute on the completion date, so this case and commentary may be of assistance.

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

By Marcus Ward 13 November 2023

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:

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
there must be material available
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 reliefs for charities – A brief guide

By Marcus Ward 24 October 2023

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 Marcus Ward 17 October 2023

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.

Goodbye paper VAT registration applications

By Marcus Ward 9 October 2023

From November 2023 HMRC is removing the paper version of the VAT 1 Form – applying for VAT registration.

Around 95% of applicants (or their agents) currently use the online registration service: How to register for VAT and in order to improve processing time HMRC is removing the paper VAT 1 Form.

From November only a very limited number of businesses will be able to use the Form VAT 1 and these will only be available by specific request from the VAT Helpline. Those businesses are:

those exempt from Making Tax Digital
businesses applying for a registration exception
businesses joining the agricultural flat rate scheme
overseas partnerships
certain entities without a Unique Taxpayer Reference

VAT: Updated guidance for medical professionals

By Marcus Ward 2 October 2023

HMRC has updated VAT Notice 701/57 – Health professionals and pharmaceutical products.

The changes, in summary, are:

Para 2.1 – Pharmacy technicians (only in England, Scotland and Wales) has been added to the meaning of a health professional list.

Para 2.5 – Services directly supervised by a pharmacist has been removed: Services that are not exempt from VAT.

Para 4.7 has been updated to make it clear when forensic physicians services are exempt healthcare.

Para 5.2 – Services supervised by pharmacists are now included when referring to a health professional: Exemption of care services performed by a person not enrolled on a statutory medical register.

The exemptions covered in the health and welfare area are complex and even slight differences in circumstances can change the VAT liability of a supply. Additionally, there are further exemptions for charities and NFP bodies and the age-old issue of business/non-business.

We advise that specialist advice is sought when considering the VAT position of supplies in this area.

Evidence of UK establishment required for certain VAT registered businesses

By Marcus Ward 2 October 2023

Businesses registered for VAT at a high-volume address will be asked by HMRC to prove they are established in the UK.

High-Volume Addresses

A high-volume address is where a single UK address is listed as the principal place of business (PPOB) for many VAT-registered businesses. We understand that many thousands of businesses are registered at single addresses in the UK.

HMRC will require proof of a place of belonging in the UK to avoid online marketplaces failing to account for output tax.

Online marketplaces

Online marketplaces are liable for the output VAT from sales on their platforms by overseas traders. HMRC understand that Non Established Taxable Persons (NETPs) have incorporated in the UK and provided UK address details to marketplaces. Since they are then no longer “overseas traders” these rules do not apply. In these situations, the NETP does not declare VAT and the marketplace does not become liable for it.

HMRC is writing to all VAT registered businesses with a PPOB at a high-volume address to ask for evidence to demonstrate that the business is actually established in the UK. If the business does not respond, by default, HMRC will consider the business to be a NETP and seek to recover VAT from the online marketplace business.

Evidence of UK establishment

HMRC will outline what specific evidence it will accept in their letter.

VAT: HMRC partial exemption guidance updated

By Marcus Ward 18 September 2023

VAT Notice 706 has been updated on 14 September 2023 and the option to send an email to get an approval for a partial exemption special method has been removed from sections 6.2, Appendix 2 and how to apply.

Para 6.2 – “Get approval for a special method

You cannot change your method without our prior approval. You must continue to use your current method, whether that is the standard method or a special method, until we approve or direct the use of another method or direct termination of its use.

You can get approval for a special method by using the online service.

If you are unable to use the online service, contact VAT Written Enquiries team by post.

You must explain clearly how your proposed method will work, you should see Appendix 2 in this guide.

When you propose a special method you must include a declaration that the method is fair from its effective date of application, and for the foreseeable future so that from its effective date a fair amount of input tax is recovered”.

Examples of special methods (PESM) are:

sectors and sub-sectors
multi pot
time spent
headcount
values
number of transactions
floor space
cost accounting system
pro-rata
combinations of the above methods

Partial Exemption guidance here

VAT: Alternative Dispute Resolution (ADR) What is it? How does it work?

By Marcus Ward 15 September 2023

What is ADR?

ADR is the involvement of a third party (a facilitator) to help resolve disputes between HMRC and taxpayers. It is mainly used by SMEs and individuals for VAT purposes, although it is not limited to these entities. Its aim is to reduce costs for both parties (the taxpayer and HMRC) when disputes occur and to reduce the number of cases that reach statutory review and/or Tribunal.

The process

Practically, a typical process is; HMRC officials and the facilitator meet with the taxpayer and adviser in a room, and agree on what the disputes are. They then retire to two separate, private rooms, and the facilitator goes between the two parties and mediates on a resolution.

ADR is a free service and the only costs the taxpayer will incur are fees from their advisers on preparation and any representation they require on the day.

Features of ADR

Without prejudice discussions – Anything said or documents produced during the ADR process cannot be used in future proceedings without the express consent of both parties subject to the obligations placed on the parties by the operation of English law
Evidence is that ADR can work for both VAT and Direct Taxes disputes both before and after an appealable decision or assessment has been made. However, ADR for VAT disputes is more suited to post appealable decision and assessments
Memorandum of Understanding (MOU) and a Code of Conduct – a MOU is created to commit taxpayers/agents to the requirements of the ADR process
The average time for all completed ADR cases is 61 days. This figure is from application to resolution. The average elapsed time for VAT it is 53 days
The average age of VAT disputes is eight months
An ADR Panel has been created to accept or reject applications for ADR. It screens all applications and not just those where ADR was thought to be inappropriate.
Customer / Agent Questionnaire Summary – Findings from customers and agents included:
- An appreciation of the personal interaction that the ADR process allowed
- Facilitators were even handed and impartial in all cases and kept the taxpayer well informed
- ADR was particularly well suited to resolution of long standing disputes.

Is Tribunal preferable?

Taking a case to Tribunal is often an expensive, complicated and time consuming option, but used to be the only option open to a taxpayer to challenge a decision made to HMRC. From personal experience, the number of cases from which HMRC withdraw “on the steps of the court” illustrate a weakness in their legal procedures and possibly a lack of confidence in presenting their cases. This is very frustrating for our clients as they have already incurred costs and invested time when HMRC could have pulled out a lot earlier. Of course, our clients cannot apply for costs. The sheer number of cases going through the Tribunal process means that there are often very long and frustrating delays getting an appeal heard.

A true alternative?

Therefore, should we welcome ADR as a watered down version of a Tribunal hearing? Or is it actually something else entirely?

HMRC say that “ADR provides an excellent opportunity for Local Compliance to handle disputes in a modern and collaborative way. It is not intended to replace statutory internal review which is an already established process aimed at resolving disputes without a tribunal hearing. Review looks at legal challenges to decisions whereas ADR is more suitable for disputes where there might be more than one tenable legal outcome”.

Results so far

After an initial two-year pilot which shaped the final programme, and was guided by a Working Together group that included CIOT, AAT, ICAEW and legal representatives HMRC concluded that “ADR has shown that many disputes, where an impasse has been reached, can be resolved quickly without having to go to tribunal.” And “ADR is a fair and even-handed way of resolving tax disputes between HMRC and its customers and helps save time and costs for everyone.” Ignoring the dreadful use of the word “customers”… what has the profession made of the scheme?

Hui Ling McCarthy – Barrister has reported “HMRC’s ADR studies have produced extremely encouraging and positive results – owing in large part to HMRC’s willingness to engage with taxpayers, advisers and the professional bodies and vice versa. Taxpayers involved in a dispute with HMRC would be well-advised to take advantage of ADR wherever appropriate”.

Outcome

So what was the outcome of the two year scheme? The headline is that 58% of cases were successfully resolved, 8% were partially resolved and 34% were unresolved.

Of the fully resolved facilitations

33% were resolved by educating the taxpayer/agent about the correct tax position.
24% were resolved due to the facilitator obtaining further evidence.
23% were resolved by educating the HMRC decision maker about the correct tax position.
20% were resolved through facilitators restoring communication between both parties.

Conclusion

These figures are encouraging and the conclusion that; well planned, constructive meetings, with the intervention of an HMRC facilitator, do increase the chances of dispute resolution, appear to be well founded.

Further, the fact that the project team saw no evidence of any demand from HMRC, taxpayers or their agents for access to external mediators and that there is also conclusive evidence from taxpayers that HMRC facilitators have acted in a fair and even-handed manner add to the feeling that ADR is a useful new tool.

Commentary

The comments from HMRC on ADR is (probably understandable) positive. However, reactions from the profession and taxpayers who have gone through the process are equally generous on ADR as a mechanism for settling disputes.

My view is that any alternative to a Tribunal hearing is welcome and even if ADR works half as well as reports conclude then it should certainly be explored. It should definitely be considered as an alternative to simply accepting a decision from HMRC with which a taxpayer disagrees.