Introduction
In this and the next chapter, we study value added tax (VAT). VAT is a tax on
turnover rather than on profits.
As the name of the tax suggests, it is charged on the value added. If someone
in a chain of manufacture or distribution buys goods for £1,000 and sells them
for £1,200 he has increased their value by £200. (He may have painted them,
packed them or distributed them to shops to justify his mark-up, or he may
simply be good at making deals to buy cheaply and sell dearly.) Because he has
added value of £200, he collects VAT of £200 20% = £40 (assuming a
standard rate of 20%) and pays this over to the government. The VAT is
collected bit by bit along the chain and finally hits the consumer who does not
add value, but uses up the goods.
VAT is a tax with simple computations but many detailed rules to ensure its
enforcement. You may find it easier to absorb the detail if you ask yourself, in
relation to each rule, exactly how it helps to enforce the tax.
In the next chapter, we will look at the rules for zero-rated and exempt supplies,
the rules for imports and exports and some of the special schemes.
Study guide
| Intellectual level | ||
| 6 | Value added tax, tax administration and the UK tax system: | |
| (a) | The contents of the Paper F6 study guide for value added tax (VAT) under headings: | 2 |
| | F1 The VAT registration requirements | |
| | F2 The computation of VAT liabilities | |
| The following additional material is also examinable: | ||
| (i) | Advise on the impact of the disaggregation of business activities for VAT purposes | 3 |
| (ii) | Advise on the impact of divisional registration | 3 |
Exam guide
VAT is a very important tax for businesses as there are few small enough not to be registerable. You may be required to advise on almost any aspect, such as registration, including group and divisional registration.
This chapter revises your knowledge of the scope of VAT, the requirement to register and the computation of the VAT liability in straightforward cases. The examination team has identified essential underpinning knowledge from the F6 syllabus which is particularly important that you revise as part of your P6 studies. In this chapter, the relevant topics are:
| Intellectual level | ||
| F1 | The VAT registration requirements | |
| (a) | Recognise the circumstances in which a person must register or deregister for VAT (compulsory) and when a person may register or deregister for VAT (voluntary) |
2 |
| (c) | Explain the conditions that must be met for two or more companies to be treated as a group for VAT purposes, and the consequences of being so treated | 1 |
The main changes in 2015/16 from 2014/15 in the material you have previously studied at F6 level is to the limits for registering and deregistering for VAT. The rules for discounts have also changed so that VAT is now payable on the actual amount received.
Disaggregation and divisional registration are new topics.
1 Basic principles
FAST FORWARD
VAT is charged on turnover at each stage in a production process, but in such a way that the burden is borne by the final consumer.
One of the competencies you require to fulfil Performance Objective 15 Tax computations and assessments of the PER is to prepare or contribute to computations or assessments of indirect tax liabilities. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.
1.1 Introduction
The legal basis of value added tax (VAT) is to be found in the Value Added Tax Act 1994 (VATA 1994), supplemented by regulations made by statutory instrument and amended by subsequent Finance Acts. VAT is administered by HM Revenue and Customs (HMRC).
VAT is a tax on turnover, not on profits. The basic principle is that the VAT should be borne by the final consumer. Registered traders may deduct the tax which they suffer on supplies to them (input tax) from the tax which they charge to their customers (output tax) at the time this is paid to HMRC. So, at each stage of the manufacturing or service process, the net VAT paid is on the value added at that stage.
1.2 Example: the VAT charge
During 2015 a forester sells wood to a furniture maker for £100 plus VAT. The furniture maker uses this wood to make a table and sells the table to a shop for £150 plus VAT of 20%. The shop then sells the table to the final consumer for £300 plus VAT. VAT will be accounted for to HMRC as follows.
Input tax Output tax Payable
Cost 20% Net sale price 20% to HMRC
£ £ £ £ £
Forester 0 0 100 20.00 20.00
Furniture maker 100 20.00 150 30.00 10.00
Shop 150 30.00 300 60.00 30.00
60.00
Because the traders involved account to HMRC for VAT charged less VAT suffered, their profits for income tax or corporation tax purposes are based on sales and purchases net of VAT.
2 The scope of VAT
FAST FORWARD
VAT is charged on taxable supplies of goods and services made by a taxable person in his business.
2.1 General principles
VAT is charged on taxable supplies of goods and services made in the UK by a taxable person in the course or furtherance of any business carried on by him. It is also chargeable on the import of goods into the UK (whether they are imported for business purposes or not, and whether the importer is a taxable person or not), and on certain services received from abroad if a taxable person receives them for business purposes.
Special rules for trade with the European Union (the EU) are covered later.
| A taxable supply is a supply of goods or services made in the UK, other than an exempt supply. |
Key term
A taxable supply is either standard-rated or zero-rated. The standard rate is usually 20%.
Certain supplies, which fall within the classification of taxable supplies, are charged at a reduced rate of 5%. An example is the supply of domestic fuel.
2.2 Supplies of goods
Goods are supplied if exclusive ownership of the goods passes to another person.
The following are treated as supplies of goods.
- The supply of any form of power, heat, refrigeration or ventilation, or of water
- The grant, assignment or surrender of a major interest (the freehold or a lease for over 21 years) in land
- Taking goods permanently out of the business for the non-business use of a taxable person or for other private purposes including the supply of goods by an employer to an employee for his private use
- Transfers under an agreement contemplating a transfer of ownership, such as a hire purchase agreement
Gifts of goods are normally treated as sales at cost (so VAT is due). However, business gifts are not supplies of goods if:
- The total cost of gifts made to the same person does not exceed £50 in any 12 month period. If the £50 limit is exceeded, output tax will be due in full on the total of gifts made. Once the limit has been exceeded a new £50 limit and new 12 month period begins
- The gift is a sample (unlimited number of samples allowed)
2.3 Supplies of services
Apart from a few specific exceptions, any supply which is not a supply of goods and which is done for a consideration is a supply of services. Consideration is any form of payment in money or in kind, including anything which is itself a supply.
A supply of services also takes place if:
- Goods are lent to someone for use outside the business
- Goods are hired to someone
- Services bought for business purposes are used for private purposes
The European Court of Justice has ruled that restaurants supply services rather than goods.
2.4 Taxable persons
The term ‘person’ includes individuals, partnerships (which are treated as single entities, ignoring the individual partners), companies, clubs, associations and charities. If a person is in business making taxable supplies, then the value of these supplies is called the taxable turnover. If a person’s taxable turnover exceeds certain limits then he is a taxable person and should be registered for VAT.
3 Registration 12/12, 12/14, 9/15
FAST FORWARD
A trader becomes liable to register for VAT if the value of taxable supplies in any period up to 12 months exceeds £82,000 or if there are reasonable grounds for believing that the value of the taxable supplies will exceed £82,000 in the next 30 days. A trader may also register voluntarily.
3.1 Compulsory registration
At the end of every month a trader must calculate his cumulative turnover of taxable supplies to date. However this cumulative period does not extend beyond the previous 12 months. The trader becomes liable to register for VAT if the value of his cumulative taxable supplies (excluding VAT) exceeds £82,000. The person is required to notify HMRC within 30 days of the end of the month in which the £82,000 limit is exceeded. HMRC will then register the person with effect from the end of the month following the month in which the £82,000 was exceeded, or from an earlier date if they and the trader agree.
Registration under this rule is not required if HMRC are satisfied that the value of the trader’s taxable supplies (excluding VAT) in the year then starting will not exceed £80,000.
A person is also liable to register at any time if there are reasonable grounds for believing that his taxable supplies (excluding VAT) in the following 30 days will exceed £82,000. Only taxable turnover of that 30 day period is considered not cumulative turnover. HMRC must be notified by the end of the 30 day period and registration will be with effect from the beginning of that period.
When determining the value of a person’s taxable supplies for the purposes of registration, supplies of goods and services that are capital assets of the business are to be disregarded, except for non zerorated taxable supplies of interests in land.
If a business makes taxable supplies in the UK but has no establishment here, it has to register for
VAT, whatever the value of its taxable supplies ie even if this is below the VAT registration threshold.
| Unless factors in the question indicate otherwise, assume the business does have an establishment in the UK when determining whether to register for VAT. |
Exam focus point
Fred started to trade in cutlery on 1 January 2015. Sales (excluding VAT) were £7,500 a month for the first nine months and £8,000 a month thereafter. From what date should Fred be registered for VAT?
| £ | ||
| Sales to 31 October 2015 | 75,500 | |
| Sales to 30 November 2015 | 83,500 | (exceeds £82,000) |
Fred must notify his liability to register by 30 December 2015 (not 31 December) and will be registered from 1 January 2016 or from an agreed earlier date.
When a person is liable to register in respect of a past period, it is his responsibility to pay VAT. If he is unable to collect it from those to whom he made taxable supplies, the VAT burden will fall on him. A person must start keeping VAT records and charging VAT to customers as soon as it is known that he is required to register. However, VAT should not be shown separately on any invoices until the registration number is known. The invoice should show the VAT inclusive price and customers should be informed that VAT invoices will be forwarded once the registration number is known. Formal VAT invoices should then be sent to such customers within 30 days of receiving the registration number.
Notification of liability to register must be made on form VAT 1. This can be downloaded from the HMRC website, can be requested by telephone, or an application to register can be made online through the website. Simply writing to, or telephoning, a local VAT office is not enough. On registration the VAT office will provide the trader with a certificate of registration. This shows the VAT registration number, the date of registration, the end of the first VAT period and the length of later VAT periods.
If a trader makes a supply before becoming liable to register, but gets paid after registration, VAT is not due on that supply.
3.2 Voluntary registration
A person may decide to become registered even though his taxable turnover falls below the registration limit. Unless a person is registered he cannot recover the input tax he pays on purchases.
Voluntary registration is advantageous where a person wishes to recover input tax on purchases. For example, consider a trader who has one input during the year which cost £1,000 plus £200 VAT; he works on the input which becomes his sole output for the year and he decides to make a profit of £1,000.
- If he is not registered he will charge £2,200 and his customer will obtain no relief for any VAT.
- If he is registered he will charge £2,000 plus VAT of £400. His customer will have input tax of £400 which he will be able to recover if he, too, is registered.
If the customer is a non-taxable person he will prefer (a) as the cost to him is £2,200. If he is taxable he will prefer (b) as the net cost is £2,000. Thus, a decision whether or not to register voluntarily may depend upon the status of customers. It may also depend on the status of the outputs and the image of his business the trader wishes to project (registration may give the impression of a substantial business). The administrative burden of registration should also be considered.
3.3 Intending trader registration
Providing that a trader satisfies HMRC that he is carrying on a business, and intends to make taxable supplies, he is entitled to be registered if he chooses. But, once registered, he is obliged to notify HMRC within 30 days if he no longer intends to make taxable supplies.
3.4 Exemption from registration
If a person makes only zero-rated supplies, he may request exemption from registration. The trader is obliged to notify HMRC of any material change in the nature of his supplies.
HMRC may also allow exemption from registration if only a small proportion of supplies are standardrated, provided that the trader would normally receive repayments of VAT if registered.
3.5 Group registration 12/11, 6/13, 9/15
Companies under common control may apply for group registration. The effects and advantages of group registration are as follows.
- Each VAT group must appoint a representative member which must account for the group’s output tax and input tax, thus simplifying VAT accounting and allowing payments and repayments of VAT to be netted off. However, all members of the group are jointly and severally liable for any VAT due from the representative member.
- Any supply of goods or services by a member of the group to another member of the group is, in general, disregarded for VAT purposes, reducing the VAT accounting required.
- Any other supply of goods or services by or to a group member is in general treated as a supply by or to the representative member.
- Any VAT payable on the import of goods by a group member is payable by the representative member.
Two or more companies are eligible to be treated as members of a group provided each of them is either established in the UK or has a fixed establishment in the UK, and:
- One of them controls each of the others, or
- One person (which could be an individual or a holding company) controls all of them, or Two or more persons carrying on a business in partnership control all of them.
Anti-avoidance rules prevent a company from belonging to a VAT group where it would otherwise be eligible but it is in fact run for the benefit of an external third party.
An application to create, terminate, add to or remove a company from a VAT group may be made at any time. Applications may be refused when it appears to HMRC to be necessary to do so for the protection of the revenue. However, if a company is no longer eligible to belong to a VAT group because the common control test is failed, the company must leave the VAT group even if revenue might not be lost.
A group registration, or any change to it, will take effect from the date the application is received by HMRC although applications may have an earlier or later effect. Therefore it is possible to apply in advance for group changes and it is also possible to apply for changes having a retrospective effect. However, HMRC have 90 days to refuse an application.
Individual companies which are within a group for company law purposes may still register separately and stay outside the VAT group. This may be done to ensure that a company making exempt supplies does not restrict the input tax recovery of the group as a whole (see the partial exemption rules in the next chapter).
It is not possible for a company to be in two VAT groups at the same time.
3.6 Divisional registration
A company which is divided into several units which each prepare accounts can apply for divisional registration. The only advantage of divisional registration is administrative convenience; the separate divisions do not become separate taxable persons and the company is itself still liable for the VAT. However, if divisions account for VAT separately it may make it more likely that VAT returns will be made on time, because data for the divisions do not have to be consolidated before returns are completed.
Broadly, the conditions for divisional registration are as follows.
- HMRC must be satisfied that there would be real difficulties in submitting a single VAT return by the due date.
- Each division must be registered even where that division’s turnover is beneath the registration limits.
- The divisions must be independent, self-accounting units, carrying on different activities or operating in separate locations.
- Input tax attributable or apportioned to exempt supplies (see the partial exemption rules in the next chapter) for the company as a whole must be so low that it can all be recovered (apart from VAT which can never be recovered because of the type of expenditure).
- Each division must make VAT returns for the same tax periods.
- Tax invoices must not be issued for supplies between the divisions of the same company as they are not supplies for VAT purposes.
3.7 Deregistration 6/15
3.7.1 Voluntary deregistration
A person is eligible for voluntary deregistration if HMRC are satisfied that the value of his taxable supplies (net of VAT and excluding supplies of capital assets) in the following one year period will not exceed £80,000. However, voluntary deregistration will not be allowed if the reason for the expected fall in value of taxable supplies is the cessation of taxable supplies or the suspension of taxable supplies for a period of 30 days or more in that following year.
HMRC will cancel a person’s registration from the date the request is made or from an agreed later date.
3.7.2 Compulsory deregistration 6/15
Traders may be compulsorily deregistered. Failure to notify a requirement to deregister within 30 days may lead to a penalty. Compulsory deregistration may also lead to HMRC reclaiming input tax which has been wrongly recovered by the trader since the date on which he should have deregistered.
Other points to note are:
- If HMRC are misled into granting registration then the registration is treated as void from the start.
- A person may be compulsorily deregistered if HMRC are satisfied that he is no longer making nor intending to make taxable supplies.
- Changes in legal status also require cancellation of registration. For example:
- A sole trader becoming a partnership
- A partnership reverting to a sole trader
- A business being incorporated
- A company being replaced by an unincorporated business
3.7.3 The consequences of deregistration
On deregistration, VAT is chargeable on all inventory and capital assets in a business on which input tax was claimed, since the registered trader is in effect making a taxable supply to himself as a newly unregistered trader. If the VAT chargeable does not exceed £1,000, it need not be paid.
This special VAT charge does not apply if the business (or a separately viable part of it) is sold as a going concern to another taxable person (or a person who immediately becomes a taxable person as a result of the transfer). Such transfers are outside the scope of VAT (except for certain buildings being transferred which are ‘new’ or opted buildings and the transferee does not make an election to waive exemption – refer to the section on land in the next chapter).
If the original owner ceases to be taxable, the new owner of the business may also take over the existing VAT number. If he does so, he takes over the rights and liabilities of the transferor as at the date of transfer.
3.8 Pre-registration input tax 12/14
VAT incurred before registration can be treated as input tax and recovered from HMRC subject to certain conditions.
If the claim is for input tax suffered on goods purchased prior to registration then the following conditions must be satisfied.
- The goods were acquired for the purpose of the business which either was carried on or was to be carried on by him at the time of supply.
- The goods have not been supplied onwards or consumed before the date of registration (although they may have been used to make other goods which are still held).
- The VAT must have been incurred in the four years prior to the effective date of registration.
If the claim is for input tax suffered on the supply of services prior to registration then the following conditions must be satisfied.
- The services were supplied for the purposes of a business which either was carried on or was to be carried on by him at the time of supply.
- The services were supplied within the six months prior to the date of registration.
Input tax attributable to supplies made before registration is not deductible even if the input tax concerned is treated as having been incurred after registration.
3.9 Disaggregation
A person’s registration covers all his business activities together. The turnover of all business activities carried on by a ‘person’ must be aggregated to find taxable turnover. However, if the same individual both carries on trade A alone and is a member of a partnership carrying on trade B, the turnover of the two trades will not normally be aggregated: the individual will have his taxable turnover in respect of trade A only, and the partnership will have its taxable turnover in respect of trade B only.
For example, a brother and sister might operate a pub with catering and bed and breakfast facilities. The catering could be operated by the brother, the pub could be operated by a partnership of the two people and the bed and breakfast business could be operated by the sister. This could avoid the need to register and account for output tax, if the turnover of each business was below the threshold for registration.
There are anti-avoidance provisions to prevent VAT benefits from the operation of one business through two or more entities. These provisions enable HMRC to direct that any connected businesses which have avoided VAT by artificially separating should be treated as one, whatever the reason for the separation. When deciding whether businesses are artificially separated, HMRC consider the extent to which those persons are bound by financial, economic or organisational links.
In the case of an individual carrying on trade A alone and trade B in partnership, to determine if the individual is essentially carrying on trade B alone, HMRC may consider whether there is:
- A proper written partnership agreement
- Evidence of the parties’ intentions
- Actual sharing of profits (not just income or expenses)
- Notification of customers, suppliers and other authorities (eg on stationery)
- Authority of partners to bind the firm Ownership of common assets
They may also consider how the business is treated for direct tax purposes.
If they consider the partnership to be artificial, the activities of the partnership will be treated as carried on in conjunction with the sole trade.
4 Accounting for VAT
4.1 VAT periods
FAST FORWARD
VAT is accounted for on regular returns. Extensive records must be kept.
The VAT period (also known as the tax period) is the period covered by a VAT return. It is usually three calendar months. The return shows the total input and output tax for the tax period.
HMRC allocate VAT periods according to the class of trade carried on (ending in June, September, December and March; July, October, January and April; or August, November, February and May), to spread the flow of VAT returns evenly over the year. When applying for registration a trader can ask for VAT periods which fit in with his own accounting year. It is also possible to have VAT periods to cover accounting systems not based on calendar months.
A registered person whose input tax will regularly exceed his output tax can elect for a one month VAT period, but will have to balance the inconvenience of making 12 returns a year against the advantage of obtaining more rapid repayments of VAT.
Certain small businesses may submit an annual VAT return (see later in this Text).
4.2 The VAT return
The regular VAT return to HMRC is made on form VAT 100. The boxes on a VAT return which a trader must fill in are as follows.
- Box 1: the VAT due on sales and other outputs
- Box 2: the VAT due on acquisitions from other EU member states
- Box 3: the total of boxes 1 and 2
- Box 4: the VAT reclaimed on purchases and other inputs
- Box 5: the net VAT to be paid or reclaimed: the difference between boxes 3 and 4
- Box 6: the total value (before cash discounts) of sales and all other outputs, excluding VAT but including the total in box 8
- Box 7: the total value (before cash discounts) of purchases and all other inputs, excluding VAT but including the total in box 9
- Box 8: the total value of all sales and related services to other EU member states
- Box 9: the total value of all purchases and related services from other EU member states
Input and output tax figures must be supported by the original or copy tax invoices, and records must be maintained for six years.
4.3 Electronic filing
Nearly all VAT registered businesses must file their VAT returns online and make payments electronically.
The time limit for submission and payment is one month plus seven days after the end of the VAT period. For example, a business which has a VAT quarter ending 31 March 2016 must file its VAT return and pay the VAT due by 7 May 2016.
4.4 Substantial traders
Once a trader’s total VAT liability for the 12 months or less to the end of a VAT period exceeds £2,300,000, the trader must start making payments on account of each quarter’s VAT liability during each quarter.
Two payments on account of each quarter’s VAT liability must usually be made. The first is due one month before the end of the quarter and the second is due at the end of the month which is the final month of the quarter. The amount of each payment on account made during the quarter is 1/24 of the trader’s annual VAT liability in the period in which the threshold is exceeded. For the purposes of calculating the payments on account (but not for the purposes of the £2,300,000 threshold for entry into the scheme), a trader’s VAT due on imports from outside the EU is ignored.
If the VAT liability for the quarter exceeds the total of the payments on account, a balancing payment is due one month after the end of the quarter to bring the total payments for that quarter to the amount of the VAT liability. If the VAT liability for the quarter is less than the total of the payments on account, HMRC will make a repayment to the trader.
Payments must be made and the quarterly VAT return submitted by the last day of the relevant month ie there is no additional seven days. Payments must be made electronically.
The default surcharge (see later in this chapter) applies to late payments.
Large Ltd is liable to make payments on account calculated at £250,000 each for the quarter ended 31 December 2015.
What payments/repayment are due if Large Ltd’s VAT liability for the quarter is calculated as:
(a) £680,000? (b) £480,000?
|
(a) |
||
| Date | Payment | |
| 30 November 2015 | Payment on account of £250,000 | |
| 31 December 2015 | Payment on account of £250,000 | |
| (b) | 31 January 2016 | Balancing payment of £(680,000 – 250,000 – 250,000) = £180,000 with submission of VAT return for quarter |
| Date | Payment/repayment | |
| 30 November 2015 | Payment on account of £250,000 | |
| 31 December 2015 | Payment on account of £250,000 | |
| 31 January 2016 | Repayment by HMRC of £(480,000 – 250,000 – 250,000) = £(20,000) on submission of VAT return for quarter |
Once a trader is in the scheme, the payments on account are reviewed annually at a set time. However, the trader can apply to reduce payments on account at any time if the total VAT liability for the latest four returns is less than 80% of the total on which the payments on account are currently based, ie the VAT liability decreases by 20% or more. Conversely, HMRC may increase the payments on account in between annual reviews if the trader’s total 12 month VAT liability increases by 20% or more, ie the VAT for the last four periods is at least 120% of the amount on which the payments on account are currently based. A trader can apply to leave the scheme if his 12 month VAT liability is below £1,800,000. A trader whose VAT liability at the annual review was below £2,300,000 will be automatically removed from the scheme six months later.
A trader may elect to pay his actual VAT liability monthly instead of making payments on account. For example, the actual liability for January would be due at the end of February. The trader can continue to submit quarterly returns as long as HMRC is satisfied the trader is paying sufficient monthly amounts.
4.5 Refunds of VAT
There is a four year time limit on the right to reclaim overpaid VAT. This time limit does not apply to input tax which a business could not have reclaimed earlier because the supplier only recently invoiced the VAT, even though it related to a purchase made some time ago. Nor does it apply to overpaid VAT penalties.
If a taxpayer has overpaid VAT and has overclaimed input tax by reason of the same mistake, HMRC can set off any tax, penalty, interest or surcharge due to them against any repayment due to the taxpayer and repay only the net amount. In such cases the normal four year time limit for recovering VAT, penalties, interest, etc by assessment does not apply.
HMRC can refuse to make any repayment which would unjustly enrich the claimant. They can also refuse a repayment of VAT where all or part of the tax has, for practical purposes, been borne by a person other than the taxpayer (eg by a customer of the taxpayer) except to the extent that the taxpayer can show loss or damage to any of his businesses as a result of mistaken assumptions about VAT.
4.6 Records
Every VAT registered trader must keep records for six years, although HMRC may sometimes grant permission for their earlier destruction. They may be kept on paper, on microfilm or microfiche or on computer. However, there must be adequate facilities for HMRC to inspect records.
All records must be kept up to date and in a way which allows:
- The calculation of VAT due
- Officers of HMRC to check the figures on VAT returns The following records are needed.
- Copies of VAT invoices, credit notes and debit notes issued
- A summary of supplies made
- VAT invoices, credit notes and debit notes received
- A summary of supplies received
- Records of goods received from and sent to other EU member states
- Documents relating to imports from and exports to countries outside the EU
- A VAT account
- Order and delivery notes, correspondence, appointment books, job books, purchases and sales books, cash books, account books, records of takings (such as till rolls), bank paying-in slips, bank statements and annual accounts
- Records of zero-rated and exempt supplies, gifts or loans of goods, taxable self-supplies and any goods taken for non-business use
5 The valuation of supplies
| VAT is charged on the VAT-exclusive price. Where a discount is offered for prompt payment, VAT is chargeable on the actual amount received for the supply. |
FAST FORWARD
|
5.1 General principles
The value of a supply is the VAT-exclusive price on which VAT is charged. The consideration for a supply is the amount paid in money or money’s worth. Thus with a standard rate of 20%:
Value + VAT = consideration £100 + £20 = £120 and the VAT fraction is
rate of tax 20 1
100+rate of tax 10020 6
Provided the consideration for a bargain made at arm’s length is paid in money, the value for VAT purposes is the VAT-exclusive price charged by the trader. If it is paid in something other than money, as in a barter of some goods or services for others, it must be valued and VAT will be due on the value.
If the price of goods is effectively reduced with money off coupons, the value of the supply is the amount actually received by the taxpayer.
5.2 Mixed supplies and composite supplies
Different goods and services are sometimes invoiced together at an inclusive price (a mixed supply). Some items may be chargeable at the standard rate and some at the zero-rate. The supplier must account for VAT separately on the standard rated and zero rated elements by splitting the total amount payable in a fair proportion between the different elements and charging VAT on each at the appropriate rate. There is no single way of doing this: one method is to split the amount according to the cost to the supplier of each element, and another is to use the open market value of each element. Mixed supplies are also known as ‘multiple supplies’.
If a supply cannot be split into components, there is a composite supply, to which one VAT rate must be applied. The rate depends on the nature of the supply as a whole. Composite supplies are also known as ‘compound supplies’.
A supply of air transport including an in-flight meal has been held to be a single, composite supply of transport (zero-rated) rather than a supply of transport (zero-rated) and a supply of a meal (standardrated). Contrast this with catering included in the price of leisure travel – there are two separate supplies: standard-rated catering and zero-rated passenger transport.
Broadly, a composite supply occurs when one element of the supply is merely incidental to the main element. A mixed supply occurs where different elements of the supply are the subject of separate negotiation and customer choice giving rise to identifiable obligations on the supplier.
5.3 Discounts
If the trader offers a discount for prompt payment, output VAT is charged on the actual amount received for the supply. The trader must either provide details of the discount on the sales invoice or must issue an invoice for the full amount and then issue a credit note if the discount is taken up.
5.4 Miscellaneous
For goods supplied under a hire purchase agreement VAT is chargeable on the cash selling price at the start of the contract.
If a trader charges different prices to customers paying with credit cards and those paying by other means, the VAT due in respect of each standard-rated sale is the full amount paid by the customer the VAT fraction.
When goods are permanently taken from a business for non-business purposes VAT must be accounted for on their market value. Where business goods are put to a private or non-business use, the value of the resulting supply of services is the cost to the taxable person of providing the services. If services bought for business purposes are used for non-business purposes (without charge), then VAT must be accounted for on their cost, but the VAT to be accounted for is not allowed to exceed the input tax deductible on the purchase of the services.
6 Administration
FAST FORWARD
VAT is administered by HMRC and the Tax Tribunal hears appeals.
6.1 Introduction
The administration of VAT is dealt with by HM Revenue and Customs (HMRC).
6.2 Local offices
Local offices are responsible for the local administration of VAT and for providing advice to registered persons whose principal place of business is in their area. They are controlled by regional collectors.
From time to time a registered person will be visited by HMRC staff from a local office to ensure that the law is understood and is being applied properly. If a trader disagrees with any decision as to the application of VAT given by HMRC he can ask his local office to reconsider the decision. It is not necessary to appeal formally while a case is being reviewed in this way. Where an appeal can be settled by agreement, a written settlement has the same force as a decision decided through the normal appeals process (see below). A trader can ask for a reconsideration even if he has already appealed to a VAT Tribunal.
HMRC may issue assessments of VAT due to the best of their judgement if they believe that a trader has failed to make returns or if they believe those returns to be incorrect or incomplete. The time limit for making assessments is normally four years after the end of a VAT period, but this is extended to 20 years in the case of fraud, dishonest conduct, certain registration irregularities and the unauthorised issue of VAT invoices.
HMRC sometimes write to traders, setting out their calculations, before issuing assessments. The traders can then query the calculations.
6.3 Appeals
A trader may appeal to the Tax Tribunal in the same way as an appeal may be made for income tax and corporation tax (see earlier in this Text). VAT returns and payments shown thereon must have been made before an appeal can be heard.
The Tribunal can waive the requirement to pay all VAT shown on returns before an appeal is heard in cases of hardship. It cannot allow an appeal against a purely administrative matter such as HMRC’s refusal to apply an extra statutory concession.
There may be a dispute over the deductibility of input tax which hinges on the purposes for which goods or services were used, or on whether they were used to make taxable supplies. The trader must show that HMRC acted unreasonably in refusing a deduction, if the goods or services are luxuries, amusements or entertainment.
6.4 Tax avoidance and evasion
Significant resources are deployed to tackle fraud, tax evasion and avoidance.
Avoidance is also countered by the requirement for traders to disclose to HMRC any use of a notifiable VAT avoidance scheme (see later in this Text).
7 Penalties
FAST FORWARD
A default occurs when a trader either submits his VAT return late, or submits the return on time but pays the VAT late. A default surcharge is applied if there is a default involving late payment during a default surcharge period.
7.1 The default surcharge 6/11
A default occurs when a trader either submits his VAT return late, or submits the return on time but pays the VAT late. It also occurs when a payment on account from a substantial trader is late. If a trader defaults, HMRC will serve a surcharge liability notice on the trader. The notice specifies a surcharge period running from the date of the notice to the anniversary of the end of the period for which the trader is in default.
If a further default occurs in respect of a return period ending during the specified surcharge period, the original surcharge period will be extended to the anniversary of the end of the period to which the new default relates. In addition, if the default involves the late payment of VAT (as opposed to simply a late return) a surcharge is levied.
The surcharge depends on the number of defaults involving late payment of VAT which have occurred in respect of periods ending in the surcharge period, as follows.
| Default involving late payment of VAT in the surcharge period | Surcharge as a percentage of the VAT outstanding at the due date |
| First | 2% |
| Second | 5% |
| Third | 10% |
| Fourth or more | 15% |
Surcharges at the 2% and 5% rates are not normally demanded unless the amount due would be at least £400 but for surcharges calculated using the 10% or 15% rates there is a minimum amount of £30 payable.
If a substantial trader is late with more than one payment (on account or final) for a return period, this only counts as one default. The total VAT paid late is the total of late payments on account plus the late final payment.
Peter Popper has an annual turnover of around £300,000. His VAT return for the quarter to 31.12.15 is late. He then submits returns for the quarters to 30.9.16 and 31.3.17 late as well as making late payment of the tax due of £12,000 and £500 respectively.
Peter’s VAT return to 31.3.18 is also late and the VAT due of £1,100 is also paid late. All other VAT returns and VAT payments are made on time. Outline Peter Popper’s exposure to default surcharge.
A surcharge liability notice will be issued after the late filing on the 31.12.15 return outlining a surcharge period extending to 31.12.16.
The late 30.9.16 return is in the surcharge period so the period is extended to 30.9.17. The late VAT payment triggers a 2% penalty. 2% £12,000 = £240. Since £240 is less than the £400 de minimis limit it is not collected by HMRC.
The late 31.3.17 return is in the surcharge period so the period is now extended to 31.3.18. The late payment triggers a 5% penalty. 5% £500 = £25. Since £25 is less than the £400 de minimis limit it is not collected by HMRC.
The late 31.03.18 return is in the surcharge period. The period is extended to 31.03.19. The late payment triggers a 10% penalty. 10% £1,100 = £110. This is collected by HMRC since the £400 de minimis does not apply to penalties calculated at the 10% (and 15%) rate.
Peter will have to submit all four quarterly VAT returns to 31.3.19 on time and pay the VAT on time to ‘escape’ the default surcharge regime.
A trader must submit one year’s returns on time and pay the VAT shown on them on time in order to break out of the surcharge liability period and the escalation of surcharge percentages.
A default will be ignored for all default surcharge purposes if the trader can show that the return or payment was sent at such a time, and in such a manner, that it was reasonable to expect that HMRC would receive it by the due date. Posting the return and payment first class the day before the due date is generally accepted as meeting this requirement. A default will also be ignored if the trader can demonstrate a reasonable excuse for the late submission or payment.
The application of the default surcharge regime to small businesses is modified. A small business is one with a turnover below £150,000. When a small business is late submitting a VAT return or paying VAT it will first receive a letter from HMRC offering help. No penalty will be charged. If a further default occurs within 12 months of the letter then a surcharge liability notice is issued, and the surcharge system formally begins as described above. Subsequent defaults then lead to surcharges of 2%, 5%, 10% and 15% if the VAT payment is late as described above, with the surcharge period extended each time. Effectively a small business is allowed an extra chance to default (and receive a help letter first) before the usual default surcharge system begins.
7.2 Penalties for errors
FAST FORWARD
There is a common penalty regime for errors in tax returns, including VAT. Errors in a VAT return up to certain amounts may be corrected in the next return.
7.2.1 Common penalty regime
The common penalty regime for making errors in tax returns discussed earlier in this Text applies for value added tax.
7.2.2 Errors corrected in next return
Errors on previous VAT returns not exceeding the greater of:
£10,000 (net under-declaration minus over-declaration); or 1% × net VAT turnover for return period (maximum £50,000); may be corrected in the next return.
Other errors should be notified to HMRC on form VAT652 or by letter.
In both cases, a penalty for error may be imposed. Correction of an error on a later return is not, of itself, an unprompted disclosure of the error and fuller disclosure is required for the penalty to be reduced. Default interest (see below) on the unpaid VAT as a result of the error is only charged where the limit is exceeded for the error to be corrected on the next VAT return.
7.3 Interest on unpaid VAT
FAST FORWARD
Default interest is charged on unpaid VAT if HMRC raise an assessment of VAT or the trader makes a voluntary payment before the assessment is raised. It runs from the date the VAT should have been paid to the actual date of payment but cannot run for more than three years before the assessment or voluntary payment.
Interest (not deductible in computing taxable profits) is charged on VAT which is the subject of an assessment (where returns were not made or were incorrect), or which could have been the subject of an assessment but was paid before the assessment was raised. It runs from the reckonable date until the date of payment. This interest is sometimes called ‘default interest’.
The reckonable date is when the VAT should have been paid (one month and seven days from the end of the return period), or in the case of VAT repayments, seven days from the issue of the repayment order. However, where VAT is charged by an assessment, interest does not run from more than three years before the date of the assessment. Where the VAT was paid before an assessment was raised, interest does not run for more than three years before the date of payment.
In practice, interest is only charged when there would otherwise be a loss to the Exchequer. It is not, for example, charged when a company failed to charge VAT but if it had done so another company would have been able to recover the VAT.
7.4 Reasonable excuse
A penalty may not be due if the trader can show that there is reasonable excuse for the failure, or the penalty may be mitigated by HMRC or by the Tribunal. There is no definition of ‘reasonable excuse’. However the legislation states that the following are not reasonable excuses:
- An insufficiency of funds to pay any VAT due
- Reliance upon a third party (such as an accountant) to perform the task in question
Many cases have considered what constitutes a reasonable excuse but decisions often conflict with one another. Each case depends on its own facts. Here are some examples:
- Whilst ‘ignorance of basic VAT law’ is not an excuse, ignorance of more complex matters can constitute a reasonable excuse.
- There have been a number of cases where it has been accepted that misunderstandings as to the facts give rise to a reasonable excuse.
- Although the law expressly excludes an insufficiency of funds from providing a reasonable excuse, the Tribunal will, in exceptional circumstances, look behind the shortage of funds itself and examine the case of it – this is generally restricted to cases where an unexpected event (eg bank error) has led to the shortage of funds.
Exam focus You are not required to know any of the other VAT penalties for your exam. point
Chapter roundup
| | VAT is charged on turnover at each stage in a production process, but in such a way that the burden is borne by the final consumer. |
| | VAT is charged on taxable supplies of goods and services made by a taxable person in his business. |
| | A trader becomes liable to register for VAT if the value of taxable supplies in any period up to 12 months exceeds £82,000 or if there are reasonable grounds for believing that the value of the taxable supplies will exceed £82,000 in the next 30 days. A trader may also register voluntarily. |
| | VAT is accounted for on regular returns. Extensive records must be kept. |
| | VAT is charged on the VAT-exclusive price. Where a discount is offered for prompt payment, VAT is chargeable on actual amount received for the supply. |
| | VAT is administered by HMRC and the Tax Tribunal hears appeals. |
| | A default occurs when a trader either submits his VAT return late, or submits the return on time but pays the VAT late. A default surcharge is applied if there is a default involving late payment during a default surcharge period. |
| | There is a common penalty regime for errors in tax returns, including VAT. Errors in a VAT return up to certain amounts may be corrected in the next return. |
| | Default interest is charged on unpaid VAT if HMRC raise an assessment of VAT or the trader makes a voluntary payment before the assessment is raised. It runs from the date the VAT should have been paid to the actual date of payment but cannot run for more than three years before the assessment or voluntary payment. |
Quick quiz
- On what transactions will VAT be charged?
- What is a taxable person?
- When may a taxable person be exempt from registration?
- How are transfers between group companies treated under a VAT registration?
- When may a person choose to be deregistered?
- What is the time limit in respect of claiming pre-registration input tax on goods?
- What is a default?
Answers to quick quiz
- VAT is charged on taxable supplies of goods and services made in the UK by a taxable person in the course or furtherance of any business carried on by him.
- Any ‘person’ whose taxable turnover exceeds the registration limit, or a person with no UK establishment, making taxable supplies in the UK. The term ‘person’ includes individuals, partnerships, companies, clubs, associations and charities.
- If a taxable person makes only zero-rated supplies he may request exemption from registration.
- Any supplies between VAT group members are ignored for VAT purposes.
- A person is eligible for voluntary deregistration if HMRC are satisfied that the value of his taxable supplies in the following year will not exceed £80,000.
- The VAT must have been incurred in the four years prior to the effective date of registration.
- A default occurs when a trader either submits his VAT return late or submits the return on time but pays the VAT late.
| Number | Level | Marks | Time |
| Q31 | Introductory | 10 | 19 mins |
| Q32 | Introductory | 10 | 19 mins |
