VAT inspections used to be a fairly regular occurrence for VAT registered business owners and were often viewed as a terrifying and potentially costly experience. Whilst the regularity of VAT inspections has decreased significantly over the past 5 to 10 years, due to more targeted and risk based approach by HMRC, the experience remains one that most businesses dread. However, this shouldn’t be the case provided the business has made every effort to be VAT compliant and has maintained its financial records in line with legislative requirements.
Having said this, even the most diligent business operator can make a mistake in their accounting records which might result in a VAT officer issuing an assessment for under paid or over claimed VAT following a routine VAT inspection. The most common errors which might result in an assessment are outlined here, though this list is not exhaustive!
1. VAT on fuel
Many businesses reclaim VAT on fuel purchased by directors or partners and employees of the business, but make the mistake of not restricting the VAT claimed to fuel used exclusively for business purposes. HMRC allow VAT to be claimed on fuel used by the business, but will expect to see detailed mileage records to support these claims or, where this is too onerous to maintain, expect the business to pay a corresponding scale charge as output tax, to account for the private use element of the fuel purchased.
2. VAT on Motor Cars
Similar to the treatment of fuel, HMRC will disallow VAT recovery on the purchase of a car for use in the business, unless it can be demonstrated that the car is used exclusively for business purposes e.g. a driving school car or a taxi. In some cases, a business may purchase a car as a pool car, for use by all employees. VAT can only be reclaimed where it can be demonstrated that the strict conditions around pool cars is met, primarily that the car remains at the business premises overnight and is not allocated to one individual.
Another common error is where 100% of the VAT charged on cars leased for business use is recovered as input tax. Only 50% of the VAT charged on cars leased for business use is recoverable; this is often stated on the supplier’s invoice but may still be overlooked by business users.
3. Not charging VAT on non-standard supplies
Businesses are usually good at charging VAT correctly on their core business supplies. However, as soon as something slightly out of the ordinary, or less regular, occurs then these supplies can often be overlooked. In many cases businesses might believe VAT does not apply. Examples included inter-company management charges, supplies made to staff, barter transactions (where no money changes hands) and recharges of costs to third parties.
4. Receipt of reverse charge services
Today’s business place is often worldwide, with UK businesses receiving supplies of services from suppliers based overseas. More often than not, invoices received from overseas businesses will not include a charge to UK VAT. Subject to limited exceptions, this is correct and UK VAT should instead be accounted for on the value of those supplies by the UK business recipient of the services under the reverse charge procedure.
Many businesses make the mistake of thinking that because no VAT was charged on the supply, this should be treated as a zero rated purchase. However, the output tax that would be due, had the supply be received from a UK supplier, should be declared by the recipient on the same VAT return as the corresponding input tax would be claimed. For many businesses this accounting procedure will have no net impact on their VAT return, but for businesses that are partially exempt, correctly recording receipt of reverse charge services can result in an input tax restriction.
5. Recovering VAT on entertainment
HMRC have always looked closely at business entertainment to ensure that input tax is not claimed in relation to this expense. Many businesses do not appreciate that taking a client, or potential client, to lunch is considered business entertaining, with many arguing that it is simply a marketing opportunity. However, any form of entertainment remains blocked from input tax recovery and some business owners continue to be caught out.
6. Aged Creditors
Many businesses are familiar with the bad debt rules as it applies to output tax paid to HMRC i.e. where output tax has been accounted for on a supply made and no payment received from the customer after 6 months, the business can claim back this output tax from HMRC on the basis that the supply has become a bad debt. However, the majority fail to consider the flip side of this rule which requires the business to repay input tax to HMRC that has been recovered on invoices received from suppliers, but where payment to the supplier remains outstanding after 6 months.
7. Import VAT
Import VAT can be recovered by businesses subject to receipt of official documentation from HMRC to evidence the import, known as the C79 certificate, which is normally received approximately 3 weeks after the month end in which the goods were received in the UK. Many businesses make the mistake of reclaiming import VAT on receipt of invoices from shipping agents, which is only a VAT invoice for the purpose of the agents’ own charges and not the import VAT.
8. Failing to account for VAT on deposits
Often businesses will take deposits from customers when accepting an order for goods or services, but fail to account for VAT on these payments until the balancing payment has been received. This is incorrect, as receipt of payment, in full or in part, creates a tax point for VAT purposes and VAT is due at the date payment is received, unless this is preceded by the issue of a tax invoice.
9. Reclaiming input tax without supporting invoices
In order to recover VAT incurred on expenses, a VAT registered business is required to retain evidence to support the expenditure in the form of a valid VAT invoice. Where no such evidence is retained, HMRC can refuse to refund the VAT claimed, or clawback VAT where it has already been claimed on a past VAT return. Where a business has mislaid a VAT invoice prior to a VAT inspection and cannot obtain a copy, in some instances HMRC may accept alternative evidence to support an input tax claim, such as bank statements showing the payments made to a supplier. However, HMRC prefer to see a VAT invoices and therefore businesses should ensure their record keeping processes are robust and complete.
10. VAT claimed on non-vatable items
Finally, once registered for VAT many businesses make the mistake of assuming that VAT is chargeable on everything and therefore assume that all business expenses include VAT. A common mistake is therefore recovery of VAT on air fares, train fares and taxis. Passenger transport is zero rated as are most taxi fares that will be incurred, though in some cases taxi fares will be subject to VAT, where invoices are received from a taxi firm.