The VATman Cometh…
Taxes are a necessary evil. This seemingly obvious statement probably need not have been made until very recently, when an unholy alliance of journalists and politicians have somehow conspired to give the impression that paying tax is somehow meritorious: paying your “fair share” towards running the country, etc, etc.
The fact is, however, that this pseudo moralistic pressure is always exerted in trying to make other people pay tax: not oneself. I would be willing to have a bet that most of these who vociferously talk about paying a “fair share” are quite happy to find any way they can of saving tax themselves. And not many people make a voluntary contribution to the Exchequer (very public spirited though that would be).
Another undoubted fact is that it is business which bears the main brunt of taxation. If you think about the government’s main sources of income flow, these are PAYE, “National Insurance”, VAT, and Petroleum Revenue Tax. You might say that PAYE and NI are taxes on the individuals, but another equally valid way of looking at it is to see that these are burdens on the employer, who has to pay the employee enough to make him get out bed every morning, after all of the various government levies.
And not only are all these myriads of taxes a burden of business, but business is also put in the position of being an unpaid tax collector, liable to swingeing penalties if it gets any detail of the operation of these immensely complex systems wrong.
Anecdotally, the greatest burden on business in terms of administration and risk of expensive or even ruinous mistakes is value added tax. This is a very quirky system where liabilities of millions of pounds can turn on a word, or a few words, whose interpretation is not always at all clear. It’s meant to be a tax which just “passes through” the various levels of business to hit the end consumer: but a mistake in administering VAT can bring your business down.
It’s true that VAT planning is not as “sexy” as other types of tax planning, and it’s a common view that there’s nothing you can really do about VAT.
This common view couldn’t be more wrong! As an antidote to the above rather gloomy comments, what I am planning to do in this month’s article is list out my top ten VAT tips for business, and I hope that anyone reading this who runs a business will find things of interest in what follows. So here goes, in no particular order:-
Defer VAT Payments on Services
Unless you’re a small business on the cash accounting scheme, VAT will operate, once you’ve passed the £81,000 turnover threshold, on an invoice rather than a payment basis. So you can reclaim VAT on your expenses once your get an invoice from the supplier: but you also have to pay over VAT to the VATman when your sales invoices are raised, even if your customer hasn’t paid you.
The consequence of this, if you’re a net VAT payer (as most sorts of business are) rather than a net reclaimer of the tax, you’re constantly in the position of making an interest free loan to HMRC. This is because your whole sales ledger will include 20% VAT on it, which you’re obliged to pay over but which you haven’t yet received in cash.
Cash accounting is something of an antidote to this if you are a small enough business to qualify for it. However, even this comes with the counteracting disadvantage that you can’t reclaim the VAT on expenses until you in turn have paid the suppliers.
If you’re a supplier of goods rather than services, though, there is not a lot you can do about this. The rules are the rules.
With service providers, on the other hand, there is a very useful rule which those who provide “continuous supplies” of services can take advantage of. Continuous supplies are where you don’t just provide one service, bill it, and then go away, but where you raise a series of bills from time to time. Accountants, lawyers on a retainer, all kinds of professionals who have an ongoing relationship with a client: all of these provide “continuous supplies of services”.
The rule here, basically, is that if you stop short of issuing a VAT invoice, your VAT liability doesn’t arise until you get paid. So, if you issue a request for payment which explicitly states that it is not a VAT invoice, and preferably doesn’t even give your VAT number or the split between net, VAT, and gross, then it’s goodbye to the interest free loan to the government.
If you are a service provider of this type, look at the total amount owed to you by clients/customers. Then calculate the VAT element of this total figure, by taking 20/120. This is the amount that could be sitting in your bank account rather than taking a bite out of the government’s £1.4 trillion debt.
Prevention is an awful lot better than cure in the VAT sphere. Which is another way of saying that it is much better to find out any errors, or weaknesses in your system yourself than let the visiting VAT Inspector do it.
The problem with VAT is that, even these days, it’s looked on commonly as a straightforward tax that can be delegated to someone reasonably junior, such as a bookkeeper, to deal with from day to day. But actually, if that bookkeeper isn’t a VAT expert (and they can hardly be blamed for not being so) you are putting that person in the difficult position of having to make all kinds of decisions relating to how the system works with no expert assistance. For example, ask the average bookkeeper whether you can get the VAT back on the director’s restaurant bill, and you’re very unlikely to get the right answer (see further below!) In another example that we often see, let’s say you sublet a part of your business premises. Should VAT be applied to the rent? Very often the bookkeeper, in his or her unguided state, will make the decision that VAT should be so applied – causing immense problems and complexities for the business further on down the line.
If you think about it, what you are asking your bookkeeper to do is display a sound working knowledge of hundreds of pages of legislation in small print, which your accountant or tax adviser will have on his bookshelf in Tolleys “orange book” (one of the seven massive tomes of legislation that get published every year, and make interpreting our tax laws probably the major growth industry in the UK).
So is there a cure, doctor?
Yes, of course What you do is arrange an “MOT” or VAT “health check”, where somebody who does actually claim specialist knowledge comes and reviews your systems: in much the same way as the friendly visiting HMRC officer would do. If the health check comes out 100% favourable, all well and good. You can look on the cost of the health check as being akin to a kind of insurance premium. But if errors have been found, these are either likely to be one offs or recurrent system failures. Unless the one off error is a very large one, the systematic error is likely to be more of concern, and you and the adviser can sit down and discuss how to deal with the problem.
If the amount of money involved is large, I suspect that HMRC will be a lot more accommodating in the way of payment terms than if they had come themselves and found it. Also, and even more cogently, if you make an unprompted correction of the VAT position you’re not likely to be charged penalties: which can be as much as 100% of the tax, that is it can as much as double the tax due.
So, if you think the VAT affairs of your business are likely to be at all complicated, or if you’re not sure, do consider having a mock VAT inspection.
>Think Twice before “Group Registering”
VAT group registration is meant as an administrative convenience. If you have a group of companies, or companies and LLP’s, under common control, group registration means you don’t have to charge VAT on supplies between the group members, and you only have to do one VAT return for the whole group.
So far, so good. The drawback to VAT group registration, though, which you should always consider before applying, or consider if you are already group registered, indeed, is the fact that, in the event of one of the group members going insolvent owing VAT, all of the other members of the group are also on the hook for the arrears.
Of course, no one goes into a business intending to go bust (with a few rather less than honest exceptions), and nobody thinks that they are going to end up with a lot of creditors to pay with no money to pay them. But it is an unfortunate fact of economic life. That’s why you have limited liability entities, like companies and LLP’s, and it would be a shame, to put in mildly, if one failure in the group ended up dragging down the whole of it.
Small is Beautiful
I believe that our VAT registration threshold, at £81,000 turnover, is the highest in Europe, and this is obviously a good thing because it relieves an awful lot of very small businesses from the burden of administering the VAT system.
But you can volunteer to forego the benefit of this administrative relief if you want to: by including more than one business together in a single entity, like a company or partnership, so that all of the combined businesses exceed the threshold.
Remember, here, the principle that it is the person who is registered and not the business. So if, for example, you are running a “man and van” business, but also operate as a taxi driver on the side, you’ll end up in the financially unviable position of having to pay VAT on all your cab fares, if the combined turnover of the two businesses is more than £81,000.
If, instead of this, you form a partnership of one of the businesses with say your spouse or other half, you have two separate “persons” in VAT terms, and if one or both of the businesses is below the threshold, no VAT.
Needless to say, this is a principle that can be and has been exploited; and also needless to say, HMRC have weaponry which they can turn against the exploiters.
Where the VATman sees that “business splitting” is going on, he can issue a direction to the effect that, from now on, VAT has to be accounted for as if the various businesses were a single one, over the turnover threshold in consequence. The business splitter, in this situation, can at least console himself with the thought that he has saved a lot of VAT for periods up until the date of the direction. But it’s best not to be too cocky. If the VATman thinks that the business is really just one business which has been split by way of a “sham” into a lot of apparently smaller businesses, he can go back in time and ask for arrears.
To guard against this, you need to make sure that the various business activities are properly organised as separate businesses, and aren’t just a single business “dressed up” as number of different ones. For example, you should have different names, different bank accounts, different contact details and, preferably, different economic interests of ownership.
Save Stamp Duty Land Tax by Saving VAT
I’m talking, here, about the situation where you are buying a commercial property, and the vendor or his solicitors spring on you, usually at the last minute, the fact that VAT is going to be added to the agreed purchase price.
So, instead of financing a £400,000 purchase, say, you’ve suddenly got to find £480,000. It’s often no good telling the bank that you will be reclaiming the £80,000 VAT later, and can you have this amount extra on the previously negotiated loan?
Of course some banks are helpful to small businesses: I came across an instance in 1969, and again last year.
But seriously, this issue can cause immense headaches and even foul up an otherwise perfectly economically viable property purchase. So what can be done about it?
Let’s assume that you are buying the property to use in your own business. It’s a new office building, or warehouse or factory, say, that you will occupy as a sole trader, or your limited company will trade from. Because your trade is VATable, the VAT is reclaimable, but still presents this cash flow nightmare, besides the fact that the Stamp Duty Land Tax will now be based on £480,000 (in my example) rather than on £400,000: it is a “tax on a tax”.
If, to get round this, you acquire the property in a “landlord” entity, connected with your trading entity, your captive landlord entity will be able to put in an “option to tax” the property, before it buys it and lets it to your trading entity. The landlord entity could be another company in the same group, or it could be you yourself if your trade is through a company, etc. If the vendor is also a landlord (which is very often the case) this means it will be a landlord to landlord sale and will be treated as the transfer of a business as a going concern (providing the predecessor business was actually a going concern, ie there were tenants at some point in the not too distant past).
A transfer of a going concern doesn’t bear output tax, and in consequence you only have the £400,000 to find, and the stamp duty is based on that rather than the £480,000.
Of course, when considering how to bring about this “landlord and tenant” relationship within your own business empire, you really need to think about the effects of how you structure the purchase on all the other taxes, like inheritance tax, capital gains tax, and even corporation tax. But there’s bound to be a best way of doing it.
Clawing Back “Old” VAT
Very often, if you are starting a new business, you will be bringing into use assets that you bought before, like computer and other equipment. If your new business registers for VAT, and you still have the invoice for whatever it was, you can put this in as pre-registration input VAT, and claim it back in your first VAT return. A new company can even reclaim VAT incurred before it was incorporated, in these circumstances.
Flat Rate VAT
Like the comparatively high VAT turnover threshold, flat rate VAT is intended to help small businesses with their administration. So, if you are in a comparatively small way of business, look at the tables on the HMRC website, or get a booklet from a local VAT Enquiry Centre (if you can find one – those who aren’t on the internet are the “forgotten people” as far as our technology crazed government is concerned).
The flat rate scheme basically works, for those within certain thresholds, by reducing the rate at which you have to pay over VAT in your VAT return to a percentage below the full 20% rate. This is a “rough and ready” way of allowing for VAT due on inputs incurred, and very often, if you do the sums, you will see that you are saving a significant amount of tax by signing up to the VAT flat rate scheme.
For example, if you are in a type of business whose flat rate is 13%, you are effectively being given 7% of your turnover as an estimate of the input tax you are incurring. Your input tax, depending on the circumstances, may be nothing like as much as this, and so you are quids in by using the VAT flat rate scheme.
Avoiding Getting “Stuck” with VAT on Building New Dwellings
This whole topic could, and no doubt should, form the basis for an article in itself. As a policy objective, those imposing VAT in this country decided that building new houses was a Good Thing, and therefore shouldn’t bear the burden of VAT at the then full rate of 8% (which has since gradually and inexorably climbed to the present 20%).
The trouble is, the makers of tax law are just as prone, or even more prone, to introduce what you might call “negative loopholes” as they are to introduce loopholes. Let me explain.
Despite the overall intention that building new homes should be zero rated, that is shouldn’t bear any VAT, you can end up with non reclaimable VAT on your purchases and subcontractors if, having built the property, you then let it rather than selling it. This is because rents of residential property are exempt from VAT, which means that VAT incurred in making that exempt supply isn’t reclaimable.
There are two ways of getting round this. One is to put all of the building through a separate building contracting company, perhaps one that you control and own 100% yourself. Because the service of building the new homes is also zero rated, you, as the owner, won’t have any tax to reclaim, or have the reclaim blocked, if you then proceed to let the newly built home(s) to tenants.
The other way of avoiding the problem, which is what you would need to look at if you have already built the property and incurred VAT in the owning entity, is to trigger some kind of supply of the newly completed dwellings to another, connected, entity like a company or individual/partnership, who then proceeds to let to the tenants. The supply that you have triggered, which is likely to be a sale of the freehold or long leasehold, will be itself zero rated and therefore the new, connected, owner of the property again will have no input VAT to be blocked.
As a general rule of thumb, anyone, in any circumstances, who is doing new build should include VAT as one of his planning considerations before the first brick is laid.
Reclaim VAT on “Staff” Entertaining
And now for something completely different. Entertaining is certainly one of the “fiscal lepers” in normal circumstances, in that you can’t claim the cost of entertaining people against your profits for direct tax purposes, and you also can’t get the VAT back.
But both in direct tax and in VAT, there is an exception, which is the entertainment of the business’s own employees.
So if the two directors of a small company feel like going out for a posh meal, even if there is no pretence that his is anything to do with the business, the company, as their employer, can reclaim the VAT as staff entertaining, on the grounds that remunerating its directors is a valid expense for the purpose of the company’s business.
There have been some murmurings about this from HMRC and Customs & Excise from time to time, however the principle is pretty clear, which is that a company cannot have any “private” expenditure, and where they are particularly keen on blocking input tax reclaims, such as in the area of the provision of accommodation for directors, they need to introduce special rules to do so.
All the same, this is one of those sensitive areas where you shouldn’t go out of your way to provoke the taxman. Drink (and eat) responsibly!
The VATman Cometh
Finally, a very important VAT tip. If you are subject to a VAT visit from HMRC, they will very often, even now, insist on seeing the main director of the business and grilling him or her about the way the business is run. VAT officers will issue this “requirement” with great confidence, or even, in some cases, arrogance.
But there isn’t a word of truth in it. The VATman has no right, as such, to see you. It may be that you have a specific issue you actually want to see them about: and that’s different. However, you aren’t obliged to assist them with a fishing expedition, and the general rule of thumb has got to be to leave the bookkeeper to deal with the visiting officer, and courteously, but firmly, resist requests for an interview.
Quite apart from not wanting to fuel possible further lengthy in depth enquiries, there’s your own time to consider. Running the business is generally speaking going to be a much better use of your time, both for the sake of your own financial wellbeing and, dare I suggest it, that of the government and society.