VAT — seven key points for the smaller business

This fact­sheet focus­es on VAT mat­ters of rel­e­vance to the small­er busi­ness. A pri­ma­ry aim is to high­light com­mon risk areas as a bet­ter under­stand­ing can con­tribute to a reduc­tion of errors and help to min­imise penal­ties. Anoth­er key ingre­di­ent in achiev­ing that aim is good record keep­ing, oth­er­wise there is an increased risk that the VAT return could be pre­pared on the basis of incom­plete or incor­rect infor­ma­tion.

This aspect is not con­sid­ered fur­ther here but use­ful guid­ance can be found on the GOV.UK web­site.

See our fact­sheet ‘Mak­ing Tax Dig­i­tal for VAT’ on the manda­to­ry dig­i­tal record keep­ing and dig­i­tal VAT returns.

VAT return and payment deadlines

For the busi­ness­es that com­plete quar­ter­ly or month­ly returns, both the VAT return and any VAT payable are nor­mal­ly due to HMRC one month and sev­en days after the end of the VAT peri­od.

Where the due date falls on a week­end or bank hol­i­day the busi­ness should ensure that sub­mis­sion of the return and pay­ment of any VAT due has reached HMRC no lat­er than the last work­ing day pri­or to the dead­line.

Input tax

When VAT incurred on expen­di­ture is recov­er­able in a VAT return it is termed ‘input tax.’ Only VAT reg­is­tered busi­ness­es can reclaim VAT on pur­chas­es pro­vid­ing:

• the expense is incurred for busi­ness pur­pos­es
• the busi­ness is the recip­i­ent of the sup­ply of goods or ser­vices
• there is a valid VAT invoice for the pur­chase.

Only VAT reg­is­tered busi­ness­es can issue valid VAT invoic­es. Hence VAT can­not be reclaimed on any goods or ser­vices pur­chased from a busi­ness that is not VAT reg­is­tered. Pro­for­ma invoic­es should not be used as a basis for input tax recov­ery as this can acci­den­tal­ly lead to a dupli­cate VAT recov­ery claim.

Most types of sup­ply on which VAT recov­ery is sought must be sup­port­ed by a valid VAT invoice. This gen­er­al­ly needs to be addressed to the trad­er claim­ing the input tax. A very lim­it­ed list of sup­plies do not require a VAT invoice to be held to sup­port a claim, pro­vid­ing the total expen­di­ture for each tax­able sup­ply is £25 or less (VAT inclu­sive). The most prac­ti­cal exam­ples of these are car park charges and cer­tain toll charges.

The fol­low­ing com­mon items how­ev­er nev­er attract VAT and so there is no VAT to be reclaimed — stamps, train, air and bus tick­ets, on street car park­ing meters and office gro­cery pur­chas­es like tea, cof­fee and milk.

Business purpose

This is often an area of con­tention between tax­pay­ers and HMRC as VAT is not auto­mat­i­cal­ly recov­er­able sim­ply because it has been incurred by a VAT reg­is­tered per­son, or because the sup­pli­er has been paid by the busi­ness.

In assess­ing whether the use to which goods or ser­vices are put amounts to busi­ness use (for the pur­pose of estab­lish­ing the right to deduct the VAT as input tax), con­sid­er­a­tion must be giv­en as to whether the expen­di­ture relates direct­ly to the func­tion and oper­a­tion of the busi­ness or mere­ly pro­vides an inci­den­tal ben­e­fit to it.

Private and non-business use

In many busi­ness­es, per­son­al and busi­ness finances can be close­ly linked and input tax may be claimed incor­rect­ly on expen­di­ture which is part­ly or whol­ly for pri­vate or non-busi­ness pur­pos­es.

Typ­i­cal exam­ples of risk areas where claims are like­ly to be made but which do not sat­is­fy the ‘pur­pose of the busi­ness’ test include:

• expen­di­ture relat­ed to domes­tic accom­mo­da­tion where there is no busi­ness con­nec­tion
• pur­suit of per­son­al inter­ests such as sport­ing and leisure ori­ent­ed activ­i­ties
• expen­di­ture for the per­son­al ben­e­fit of com­pa­ny directors/proprietors and
• expen­di­ture in con­nec­tion with non-busi­ness activ­i­ties.

Where expen­di­ture has a mixed busi­ness and pri­vate pur­pose, the relat­ed VAT should gen­er­al­ly be appor­tioned and only the busi­ness ele­ment claimed. Spe­cial rules apply to adjust input tax claimed on assets and stock when goods ini­tial­ly intend­ed for busi­ness use are then put to an alter­na­tive use.

Business entertainment

VAT is not reclaimable on most forms of busi­ness enter­tain­ment although VAT incurred on employ­ee enter­tain­ment is recov­er­able. The def­i­n­i­tion of busi­ness enter­tain­ment is broad­ly inter­pret­ed to mean hos­pi­tal­i­ty of any kind pro­vid­ed to some­one who is not an employ­ee, which can include the fol­low­ing exam­ple sit­u­a­tions:

• trav­el expens­es incurred by non employ­ees but reim­bursed by the busi­ness, such as self employed work­ers and con­sul­tants
• hos­pi­tal­i­ty ele­ments of trade shows and pub­lic rela­tions events.

Business gifts

A VAT sup­ply takes place when­ev­er busi­ness goods change hands, so in the­o­ry any goods giv­en away by a busi­ness will result in an amount of VAT due. The rule on busi­ness gifts is that no out­put tax will be due on gifts to the same per­son, pro­vid­ed that the VAT exclu­sive cost of the gifts to that per­son does not exceed £50 with­in any 12-month peri­od.

Where the £50 lim­it is exceed­ed, VAT is due (out­put tax) on the full amount. There is a deemed sup­ply of the goods for VAT pur­pos­es. Where this occurs HMRC will usu­al­ly accept the busi­ness can dis­al­low the VAT when buy­ing the goods, which may be more con­ve­nient than hav­ing to cal­cu­late out­put tax every time a gift is giv­en.

Rou­tine com­mer­cial trans­ac­tions which might be affect­ed include such things as:

• long ser­vice awards
• Christ­mas gifts
• prizes or incen­tives for sales staff.

Cars and motoring expenses

Input tax errors often occur in rela­tion to the pur­chase or lease of cars and with motor­ing expens­es in gen­er­al. Some key issues are:

• VAT on the pur­chase of a motor car is gen­er­al­ly blocked from recov­ery because it is assumed there will be avail­abil­i­ty for pri­vate motor­ing and hence the vehi­cle is not exclu­sive­ly for busi­ness use. This pro­hi­bi­tion does not nor­mal­ly apply to com­mer­cial vehi­cles and vans, pro­vid­ed there is an ele­ment of busi­ness use.
• Where a car is leased rather than pur­chased, 50% of the VAT on the leas­ing charge is blocked from recov­ery for the same rea­son.
• Where a busi­ness sup­plies fuel or mileage allowances for cars, adjust­ments need to be made to ensure that only VAT on the busi­ness ele­ment of the expense is recov­ered. There are a num­ber of dif­fer­ent meth­ods which can be used, so do get in touch if this is rel­e­vant to you.

Output tax issues

Bad debts

Sell­ing goods or ser­vices on cred­it in the cur­rent eco­nom­ic cli­mate may car­ry increased risk. Even where cred­it con­trol pro­ce­dures are strong there will inevitably be a risk of suf­fer­ing bad debts. A sup­pli­er must nor­mal­ly account for out­put tax when the sale is made, even if the debt is nev­er paid by the cus­tomer, so there is a risk of being dou­bly out of pock­et.

VAT reg­u­la­tions do not per­mit the issue of a cred­it note to can­cel out­put tax sim­ply because the cus­tomer will not pay! Instead, where a cus­tomer does not pay, then pro­vid­ed the out­put tax has been account­ed for by the sup­pli­er, a claim to recov­er the VAT as bad debt relief can be made six months after the due date for pay­ment of the invoice.

The amount of the claim

The tax­pay­er can only claim relief for the out­put tax orig­i­nal­ly charged and paid over to HMRC, no mat­ter whether the rate of VAT has sub­se­quent­ly changed. The claim is entered into box 4 of the VAT return — treat­ing the uncol­lect­ed VAT as an addi­tion­al busi­ness expense — rather than by reduc­ing out­put tax.

The customer

A cus­tomer is auto­mat­i­cal­ly required to repay to HMRC any input VAT claimed on a pur­chase where the sup­pli­er remains unpaid six months after the date of the sup­ply (or the date on which pay­ment is due if lat­er). Mis­takes in this area are so com­mon that vis­it­ing HMRC offi­cers have devel­oped a pro­gramme enabling them to review Sage account­ing pack­ages and to list pur­chase ledger bal­ances over six months old, mak­ing it easy to issue an assess­ment to dis­al­low the VAT claimed.

Preventing the problem?

Small­er busi­ness­es (with annu­al turnover less than £1.35m) may be enti­tled to join the Cash Account­ing Scheme, which means they will only have to account for VAT on sales when pay­ment is actu­al­ly received from the cus­tomer.

There is a clear cash­flow ben­e­fit as well as built-in relief VAT from bad debts. The trade-off is that cash account­ing only per­mits a busi­ness to recov­er VAT on expen­di­ture at the time it makes pay­ment to sup­pli­ers.