Businesses trading beneath the VAT registration threshold need to constantly monitor their taxable turnover. If that turnover exceeds £85,000 (based on income received) at the end of any rolling twelve-month period the business must notify HMRC of its liability to register for VAT within 30 days of the end of that period and register for VAT from the first day of the following month. Businesses must calculate their total turnover for the previous twelve months at the end of every month. A liability to register also arises where, at any time, it is expected that turnover will exceed the threshold in the following 30 days.
Frequently, a business only becomes aware that it has exceeded the VAT registration threshold when it prepares its annual statutory accounts. Calculating when the registration threshold has been reached can be a time-consuming and costly exercise. If not done correctly and at the right time it can lead to late registration penalties and owing VAT to HMRC that often cannot be recovered from customers.
It may be possible to agree with HMRC that a business can be exceptionally exempt from VAT registration, if a one-off transaction increased turnover above the threshold temporarily. However, once the threshold has been breached it is often difficult to persuade HMRC that this was a one-off. If you are undertaking an unusual transaction that could take your business over the VAT threshold you should take advice in advance.
Flat Rate Scheme and Cash Accounting
Many smaller businesses with a turnover of less than £150,000 have taken advantage of the flat rate scheme for VAT (FRS), which is a simplification allowing them to pay VAT at a fixed percentage of turnover for their trade, whilst still collecting VAT from customers.
That percentage has a built in allowance for VAT on costs based on the type of business carried out. With the exception of capital expenditure on goods where the VAT inclusive cost exceeds £2,000, VAT incurred by a business using the FRS cannot be claimed on its VAT return. Use of the FRS can reduce administrative costs for businesses and in some cases reduces the overall amount of VAT payable to HMRC. As part of the scheme, businesses receive a 1% discount in their first year of VAT registration. Businesses sometimes misinterpret this to mean that they receive the discount in their first year of using the flat rate scheme. It is important to interpret and apply the rules correctly, particularly when beginning to use the scheme. Businesses should ensure they choose the correct business sector and that the applicable percentage rate is applied to the VAT inclusive turnover figure.
All businesses should consider regularly whether the scheme still benefits them, whether they are operating in a different sector and need to change their Flat Rate percentage and whether they have exceeded the annual turnover under which the FRS can continue to be used, currently £230,000.
A business with an annual turnover of less than £1,350,000 is eligible to use the Cash Accounting scheme, meaning that VAT is not accounted for on income until payment is received. This can have significant cashflow advantages for some businesses but the disadvantage is that VAT incurred on expenditure can also only be claimed when the supplier has been paid. Particular care is needed when joining or leaving the scheme as these events can lead to a duplication or omission of VAT.
Many businesses are partly exempt for VAT purposes, meaning that they must apportion their non-attributable input VAT between what can and cannot be recovered. For example, a business that makes both taxable and exempt supplies must normally restrict the amount of input VAT it recovers on overhead costs which support the whole business. However, there are de minimis tests which determine if input VAT attributable to exempt activity is “insignificant” enough to be recovered as if it were attributable to taxable activity. A business can be treated as fully taxable in any tax period if the total value of exempt input tax is not more than £625 per month on average and less than half of the total input tax in that period. However, smaller businesses may also be eligible to use simplified tests which can save them having to perform detailed and time-consuming partial exemption calculations each quarter.
Option to Tax
The option to tax (OTT) has been an area of significant confusion for businesses which often believe that once an OTT has been exercised over a property, the option is transferred to any new owners of the property. This is not the case and any new owners will need to notify their own option to tax the property in order to continue treating income arising from the property as taxable. For example, A opts to tax its commercial property and lets it to tenants who pay VAT on their rent. A then sells the property to B. B will not be able to charge the tenants VAT, nor will it be able to recover any associated input VAT unless it also exercises an option to tax. If B does not opt this also normally means that A has to charge VAT on the sale of the property as it cannot be treated as the transfer of a going concern. This is a very simplistic explanation and advice should be sought on such transfers to ensure the best VAT outcome is achieved.
Businesses should also ensure that any property being opted is clearly specified when the option is notified to HMRC and should be aware that the option will sometimes not have any effect e.g. with dwellings and buildings used for charitable purposes. If in doubt, specialist advice should always be taken.
Fuel Scale Charge
Businesses are entitled to recover VAT on fuel which is purchased for business purposes. However, it can be challenging to establish and evidence whether fuel is put to business or personal use. One way that HMRC allows businesses to address this more easily is via the fuel scale charge. Under this system, businesses may recover all of the input VAT incurred on fuel without performing any apportionment of mileage, provided they pay a fuel scale charge to HMRC. The charge payable for each car is calculated according to its CO2 emissions so more environmentally friendly cars pay a lower scale charge. VAT on the charge is accounted for in Box 1 of the VAT return as output VAT payable to HMRC.
This system is easy to operate and can provide a reasonable result in terms of the net VAT position although it can be more beneficial not to reclaim VAT incurred on fuel where the VAT payable on the scale charge exceeds the amount of VAT incurred. However, we have encountered situations where all of the input VAT incurred on fuel has been claimed without payment of the required fuel scale charges to HMRC. If a failure to declare fuel scale charges is discovered by HMRC, penalties may be payable in addition to payment of the scale charges themselves.
Reclaiming Input VAT on Expenditure
Errors are often made in relation to the reclaim of input VAT on the return as there are a number of circumstances (in addition to partial exemption outlined above) where HMRC can disallow the reclaim. These include the following:
- The business does not hold a proper VAT invoice from the supplier.
- The invoice is addressed to a different person, for example to an individual instead of the VAT registered company.
- The invoice relates to goods or services not used for business activities
- The invoice has a tax point after the end of the VAT period
- VAT was not properly due on the goods or services being invoiced or has been charged at the incorrect rate.
- The invoice was for the purchase of a car (although some businesses can reclaim this)
This newsletter is intended as a general guide to current VAT issues and is not intended to be a comprehensive statement of the law. No liability is accepted for the opinions it contains or for any errors or omissions. Constable VAT cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this newsletter. Specialist VAT advice should always be sought in relation to your particular circumstance.