You can avoid most problems with VAT by making sure you deal with all the paperwork correctly. That means issuing VAT invoices with the correct date or 'tax point', retaining them from suppliers, keeping proper VAT records, dealing with your VAT returns on time and so on.
Problems with VAT are more likely if your VAT accounting is complicated. Retailers in particular should make sure that they are using the right VAT accounting scheme.
Below are some of the most common problematic areas:
Irreclaimable input VAT
- Supplies for personal (non-business) use
• If goods or services are bought for both business and non-business use, the input VAT may be apportioned with only the business element recovered.
• Alternatively, VAT can be recovered in full on the entire purchase of goods, provided that output VAT is declared on a self-supply of the non-business element.
- Free accommodation to employees
• Generally, input VAT cannot be reclaimed unless employees have to be given domestic accommodation wholly for a business purpose and HMRC agreement is obtained.
- Meals at work for sole traders, partners and directors
• These groups cannot reclaim VAT on meals at work, but can claim for subsistence expenses while on business trips.
- Entertainment for third parties
• VAT on business entertainment for third parties (eg customers and suppliers) can never be reclaimed.
• Reclaims may be allowed for VAT related to staff entertainment. The entertainment must have a discernible business purpose.
• Where the entertainment is for both employees and outsiders, it may be possible to reclaim some VAT.
- Supplies purchased to make exempt sales (partial exemption)
• Generally before you can reclaim input VAT, expenditure must be directly attributable to VATable supplies.
• Small amounts may be reclaimed if within certain set limits. The calculation of recoverable VAT in this instance is complex and there are anomalies such as VAT recovery rights. Get expert advice.
Output VAT treatment in special cases
It is not always obvious when to charge output VAT or which part of the 'sale' to calculate it on. Output VAT must sometimes be charged as if the transaction was a 'notional' sale or on services that are usually thought of as zero rated or exempt.
Output VAT is usually due on the full value. There are some exceptions, such as free samples to customers, gifts costing less than £50, gifts of services and goods to charity.
- Taking goods for personal use
• If you pay nothing, VAT is charged on the cost (normally the market cost) as if it is a sale.
• Special rules apply to cars and fuel.
- Post, packaging and delivery charges to customers
Although you do not pay VAT on public postal services, you must charge VAT at the same rate as the goods being delivered or posted. This applies provided that the contract is for 'delivered goods', even if you show a separate charge on your price list or invoice.
• If UK delivery is offered as an optional extra, VAT will be due on the charge.
• If the goods are for export, or leave from outside the UK, you should take advice.
• Beware of overpaying VAT which you will never get back by calculating VAT on the full price rather than on the discounted price.
• The VAT payable on a supply depends on how the discount is offered.
• If an unconditional discount (such as a trade discount) is given, the VAT is based on the discounted value of the full sale.
• The same applies for prompt payment discounts - even if the customer does not pay promptly.
• Mixed supplies may contain components liable to different VAT rates. You work out the total VAT liability in proportion to the value of each component.
• Composite supplies have one VAT liability based on the main component.
- Part-exchange or barter transactions
• VAT must be calculated as if the transaction had been entirely for cash (ie purchases and sales at the full price). VAT invoices must be issued accordingly.
Problems with VAT mistakes
If you discover you have made a mistake, you must correct it. There is an error reporting threshold of £10,000 or 1% of your total sales (whichever is higher) up to a maximum of £50,000, and also a time limit for how far back you can go to correct any VAT mistakes.
Provided you are within the limits, you can adjust past errors on your current VAT return. You will also need to correct any errors in your VAT accounts.
Customer bad debt relief
Late payments from customers can cause problems with VAT. The VAT you have to pay to HMRC is normally based on when the transaction took place, not when payment was received. So late payments - or, worse, bad debts - can cause serious VAT problems.
If a customer defaults and you have already paid the output VAT to HMRC, you can claim bad debt relief if the invoice is more than six months overdue. It must be written off in a specific VAT bad debt account. Similarly, if you default, you normally have to repay any VAT you've claimed but not paid.
Avoid this situation if your turnover is less than £1.35m by using the cash accounting scheme, where your VAT returns will be based on the dates when payments are made and received.
VAT payment problems
Problems with VAT payments can also arise if you have used the output tax (ie VAT you have charged on sales) as a source of finance and are unable to pay the VAT over when it is due. The risk of this kind of VAT problem can be reduced with good cash low forecasting and control. The annual accounting scheme (where you make pay regular instalments based on your estimated VAT liability) may also help you better manage your cashflow.
VAT inspections and investigations
Whether or not you have any problems with VAT, you will probably face tax enquiries from time to time. These can vary from routine inspections to more serious investigations if HMRC suspects that all is not as it should be.
You can reduce the likelihood and frequency of tax enquiries by dealing with VAT efficiently. Well-organised VAT records will also make the actual inspection process run more smoothly.
If you do face any sort of enquiry - whether you have problems with VAT or not - you may want to take advice. Depending on the circumstances, it may be worthwhile having your accountant present while an inspection takes place.
VAT penalties and surcharges
Failing to submit or pay a VAT return carries a fixed surcharge of up to 15% based on how many times you default in a 12-month period. Other penalty amounts are linked to the reason for errors and the tax potentially lost, but these can be reduced if you voluntarily disclose the error to HMRC:
• no penalty if you take reasonable care - which includes telling HMRC if you discover a mistake
• up to 30% if you have been careless or failed to send in a return
• up to 70% if the error was deliberate
• up to 100% if the error was deliberate and you tried to conceal it
Help and advice
If you do think you are going to have a problem with paying your VAT, contact the HMRC Payment Support Service on 0300 200 3835 as soon as possible. Like any tax payment problems, you need to take action immediately, rather than hoping it will go away.
Safeguard your position by getting a decision in writing from HMRC
• If in doubt, contact HMRC and ask for a written ruling.
• HMRC will only be bound by any ruling if all the facts have been disclosed.