HMRC have issued new guidance on the Annual Accounting Scheme.
A business can use form VAT600AA if it is already registered for VAT and wants to join the Annual Accounting Scheme.
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VAT Schemes Guide – Alternative ways of accounting for tax
It is important to compare the use of each scheme to standard VAT accounting to establish whether a business will benefit. Some schemes are compulsory and there are particular pitfalls for businesses using certain schemes.
I thought that it would be useful to consider the schemes all in one place and look at their features and pros and cons.
These schemes reviewed here are:
- Cash Accounting Scheme
- Annual Accounting Scheme
- Flat Rate Scheme
- Margin schemes for second-hand goods
- Global Accounting
- VAT schemes for retailers
Cash Accounting Scheme
Normally, VAT returns are based on the tax point (usually the VAT invoice date) for sales and purchases. This may mean a business having to pay HMRC the VAT on sales which customers have not yet paid for.
The VAT cash accounting scheme (CAS) instead bases reporting on payment dates, both for purchases and sales. A business will need to ensure its records include payment dates.
A business is only eligible for CAS if its estimated taxable turnover is no more than £1.35m, and can then remain in the scheme as long as it remains below £1.6m.
Advantages
- usually beneficial for cash flow especially if its customers are slow to pay
- output tax is not payable at all if a business has a bad debt (other bad debt relief here)
Disadvantages
- it is generally not beneficial for a repayment business (one which reclaims more VAT than it pays, eg; an exporter or supplier of zero rated goods or services)
- it is not usually beneficial if a business purchases significant amounts of goods or services on credit
Annual Accounting Scheme
The Annual Accounting Scheme allows a business to pay VAT on account, in either nine monthly or three quarterly payments. These instalments are based on VAT paid in the previous year. It is then required to complete a single, annual VAT return which is used to calculate any balance owed by the business or due from HMRC.
A business is eligible for the scheme if its estimated taxable turnover is no more than £1.35m and is permitted to remain in the scheme as long as it remains below £1.6m.
Advantages
- reduces paperwork as only the need to complete one return instead of four (although it does not remove the requirement to keep all the normal VAT records and accounts)
- improves management of cash flow
Disadvantages
- not suitable for repayment businesses as they would only receive one repayment at the end of the year
- if turnover decreases, the interim payments may be higher than under standard accounting
Flat Rate Scheme
The Flat Rate Scheme (FRS) is designed to assist smaller businesses reduce the amount of time and complexity required for VAT accounting. The FRS removes the need to calculate the VAT on every transaction. Instead, a business pays a flat rate percentage of its VAT inclusive turnover. The percentage paid is less than the standard VAT rate because it recognises the fact that no input tax can be claimed on purchases. The flat rate percentage used is dependent on a business’ trade sector.
A business is eligible for this scheme if its estimated taxable turnover in the next year will not exceed £150,000. Once using the scheme, a business is permitted to continue using it until its income exceeds £230,000.
If eligible, a business may combine the FRS with the Annual Accounting Scheme, additionally, there is an option to effectively use a cash basis so there is no need to use CAS. Unfortunately, changes to the scheme rules regarding ” limited cost traders” mean that the scheme has become less attractive.
Advantages
- depending on trade sector and circumstances, may result in a real VAT saving
- simplified record keeping; no requirement to separate gross, VAT and net in accounts
- fewer rules; no issues with input tax a business can and cannot recover on purchases
- certainty of knowing how much of income is payable to HMRC
Disadvantages
- no reclaim of input tax incurred on purchases
- limited cost traders impact
- if a business buys a significant amount from VAT registered businesses, it is likely to result in more VAT due
- likely to be unattractive for businesses making zero-rated or exempt sales because output tax would also apply to this hitherto VAT free income
- low turnover limit
Margin Scheme for Second Hand Goods
A business normally accounts for output tax on the full value of its taxable supplies and reclaims input tax on its purchases. However, if a business deals in second-hand goods, works of art, antiques or collectibles it may use a Margin Scheme. This scheme enables a business to account for VAT only on the difference between the purchase and selling price of an item; the margin. It is not possible to reclaim input tax on the purchase of an item and there will be no output tax if no profit is achieved (however, if an item is sold for less than the purchase price, a business cannot offset losses against the profits of other items to reduce the overall VAT liability).
There is a special margin schemes for auctioneers and a variation of the Margin Scheme (Global Accounting) is considered below.
Advantages
- usually beneficial if buying from (non-VAT registered) members of the public
- purchaser will not see a VAT charge
- although no input tax claimable on purchases of scheme items, VAT may be claimed in the usual way on overheads and other fees etc
Disadvantages
- record keeping requirements are demanding and closely checked, eg; stock records and invoices which are required for both purchases and sales
- cannot be used for items purchased on a VAT invoice
- can be complex and create a cost if goods exported
- although no VAT due on sales if a loss is made, there is no set-off of the loss
Global Accounting
The problem with the Second Hand Goods Scheme is that full details of each individual item purchased and sold has to be recorded. Global Accounting is an optional, simplified variation of the Second Hand Margin Scheme. It differs from the standard Margin Scheme in that rather than accounting for the margin achieved on the sale of each individual item, output tax is calculated on the margin achieved between the total purchases and total sales in a particular accounting period.
Advantages
- simplified version of the Margin Scheme
- record keeping requirements reduced
- losses made on sales reduce VAT payable
- beneficial for businesses which buy and sell bulk volume, low value eligible goods
Disadvantages
- cannot be used for; aircraft, boats, caravans, horses or motor vehicles
- similar to Margin Scheme disadvantages apart from loss set off
VAT Schemes for Retailers
It is usually difficult for retailers to issue an invoice for each sale made, so various retail schemes have been designed to simplify VAT. The appropriate scheme for a business depends on whether its retail turnover (excluding VAT) is; below £1m, between £1m and £130m and higher.
Smaller businesses may be able to use a retail scheme with CAS and Annual Accounting but it cannot combine a Retail Scheme with the FRS. However, retailers may choose to use the FRS instead of a Retail Scheme.
Using standard VAT accounting, a VAT registered business must record the VAT on each sale. However, via a Retail Scheme, it calculates the value of its total VAT taxable sales for a period, eg; a day, and the proportions of that total that are taxable at different rates of VAT; standard, reduced and zero.
According to the scheme a business uses it then applies the appropriate VAT fraction to that sales figure to calculate the output tax due. A business may only use the Retail Scheme for retail sales and must use the standard accounting procedures for other supplies. A business must still issue a VAT invoice to any customer who requests one. It is a requirement of any scheme choice that HMRC must consider it fair and reasonable.
A business can join a retail scheme at the beginning of any VAT period and HMRC does not need to be notified.
Examples of Retail Schemes
- Apportionment
- Direct calculation
- The point of sale scheme
The required calculations vary for each scheme.
NB: There are special arrangements for caterers, retail pharmacists and florists.
Advantages
- no requirement to issue an invoice for each sale
- most schemes are relatively simple to administer once set up. Technology assists in a helpful way with EPOS systems
- simplifies record keeping
Disadvantages
- it is usual for each line sold to need to be coded correctly for VAT liability
- smaller businesses without state of the art technology may be at a disadvantage
- time and resources required to set up and maintain systems
- in some cases the calculation depends on staff “pressing the right button”
- often complex calculations and record keeping
- very precise and complicated rules
- lack of understanding by a number of inspectors
- complexity increases the risk of misdeclaration
Overall
As may be seen, there are a lot of choices for a business to consider, especially a start-up. Choosing a scheme which is inappropriate may result in VAT overpayment and a lot of unneeded record keeping and administration. There are real savings to be made by using a beneficial scheme, both in terms of VAT payable and staff time. There are also some schemes which are compulsory, like the Tour Operators’ Margin Scheme (TOMS).
We are happy to review a business’ circumstances and calculate what schemes would produce the best outcome.
Please contact us if you require further information.
VAT: The Partial Exemption Annual Adjustment
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.