Effect of VAT Deregistration

Where your business deregisters it can trigger hidden VAT charges. What are they and what steps can you take to avoid them?

Unregistered advantage

Not having to add VAT to their prices can give non-registered traders a competitive edge in the market, mainly where they are selling to the public or other businesses that can?t reclaim some or all of the VAT they pay on purchases. Alternatively, they keep their prices the same and increase their profit by keeping the amount they would have had to pay over to HMRC. But if your business turnover is below the deregistration limit, currently £81,000, you need to watch out for one or two things before actually deregistering.

Temporary deregistration pitfalls

If the VAT on the current value of the business assets, e.g. stock and equipment, at deregistration is more than £1,000, it has to be repaid to HMRC. This extra cost could wipe out any potential savings from deregistering from VAT unless the deregistration is going to be permanent. This trap is particularly significant where capital goods are involved.

Capital goods

The capital goods scheme (CGS) applies to the purchase of land or buildings and the refurbishment or extension of existing buildings where the cost is more than £250,000 and you?ve reclaimed VAT on it. If you deregister from VAT within a ten-year period (the ?adjustment period?), you?ll have to repay some of the VAT you originally reclaimed.

Example. Mr and Mrs Fawlty bought a small seaside hotel in 2010, when the VAT rate was 17.5%, for £400,000 and the previous owners had opted to tax it, i.e. decided to charge VAT on the sale. This meant the total sale price was £470,000. But because the Fawltys were running a VAT-registered business on which all the supplies they made were chargeable to VAT, they were entitled to reclaim all of the £70,000 VAT they paid on the property. So far so good.

Turnover trouble

The Fawltys? turnover was originally about £100,000 per year but has fallen slowly; their turnover is now only £62,000. They are considering deregistering but keeping their prices the same to increase their profits by £10,333, i.e. turnover of £62,000 x 20/120 = a saving of £10,333.

Trap. Once deregistered they wouldn?t be able to reclaim input VAT on purchases and this would eat a little into their saving.

The ten-year catch

If they deregister now, the CGS will mean that they will be treated as having sold the hotel which would be an exempt supply in year four of the CGS ten-year adjustment period, resulting in a clawback of VAT of £42,000 (£70,000 x 6/10 (60%)).

Deregistration disincentive

The Fawltys would be extremely unhappy to find that they owe HMRC £42,000 on the property, let alone VAT on the value of stock, fixtures and fittings in the business. Based on this, they would be much better off to remain registered.

Tip. Take into account VAT due on deemed supplies of assets the business owns. You could reduce this by running down stock and waiting out the CGS period.

Is Flat Rate VAT Scheme Suitable For You?

If you sign up to HMRC?s flat rate scheme for VAT and find that it?s costing you money, can and should you opt out?

The flat rate VAT rate

The VAT flat rate scheme (FRS) allows companies and other businesses to pay VAT at a lower rate in exchange for agreeing not to claim back VAT on most of their purchases. HMRC pushes the virtues of the scheme as a way to reduce administration for the smaller business.

Joining and leaving the FRS

HMRC usually won?t allow you to join or leave the FRS retrospectively, although by concession it can in exceptional situations. This discretionary practice was at the heart of the tribunal hearing of Brian Reynolds v Revenue & Customs (BR v HMRC). BR had been using the FRS scheme for some time before he realised that it was costing him more in VAT than using the normal system. He therefore wanted to leave the scheme with backdated effect so he could recover the VAT he reckoned he had overpaid. But HMRC refused.

What?s the point of the scheme?

HMRC suggests the only point of the FRS is to reduce the administrative burden of VAT returns. But the general view is that the FRS will save VAT, and in practice that?s why businesses sign up for it. HMRC can?t offically accept that view and so had to refuse to allow BR to backdate his withdrawal from the scheme. The tax tribunal had to decide whether HMRC was right to do this.

Theory over practice

It didn?t take long for the tribunal to decide that paying extra VAT as a result of joining the FRS wasn?t an exceptional reason that would allow a backdated withdrawal. In its opinion the FRS was there to simplify VAT, and is intended to be VAT cost neutral. That doesn?t mean that you?re not allowed to gain an advantage, just that it?s not the purpose of the scheme. BR?s claim was dismissed.

So which is it?

The tribunal?s view is in contrast to HMRC?s policy which does allow for retrospective removal from the FRS where the financial disadvantage caused is disproportionately high.

Example. Eric is a surveyor using the FRS. The FRS VAT percentage for his type of business is 12.5%. He also personally owns a house that he rents out. He can?t charge his tenant VAT on the rent because this type of income is exempt, but the FRS rules mean Eric has to account for VAT on his entire turnover. Despite this he?s still better off using the scheme. But it also means that VAT would be due on the sale of the house, even though this too would normally be exempt. If he doesn?t realise this before the sale, for say £300,000, he?ll have to pay £37,500 in VAT (£300,000 x 12.5%). But as the VAT disadvantage is disproportionate, HMRC will allow Eric to retrospectively withdraw from the FRS and get his £37,500 back.

Tip 1. Don?t rush in. Before joining the FRS check the effect it will have on your VAT bill. Remember to take into account that VAT will be due on exempt income, e.g. residential letting.

Tip 2. Using a limited company to operate your business through will mean the FRS won?t apply to personal income such as from residential letting. It will only apply to the income of the company.

Lumpsum Pension Alternatives

The new pension rules allow for a variety of ways to take a lump sum from your pension fund. Each has different tax consequences. What factors should you consider before taking your money?

Lump sums

Our recent article about the new uncrystallised fund pension lump sums (UFPLS) ( yr. 15, iss.5, pg.1 , see The next step ) gave the impression that they would replace pension commencement lump sums (PCLS). That?s not the case and so to set the record straight we?ve explained in a little more detail the options available from 5 April 2015.

Lump sum options

The post-5 April 2015 options and the key tax consequences of each are:

Option 1. Withdraw the whole of your fund:

75% will be taxable as income, which means depending on how large your fund is and how much other income you have, a large chunk could go in tax at the 40% and 45% rates

income or gains you make from the money after withdrawing it, e.g. interest, dividends etc. will be taxed in the usual way

whatever?s left after income tax will be part of your estate for IHT purposes.

Option 2. Use a UFPLS and withdraw as much or as as little as you want with the option to take more lump sums when you want.

75% will be taxable as income

the balance of the money will remain in your pension fund and any income or gains generated by it is tax exempt

the money left in the fund will be outside your estate for IHT purposes.

Tip 1. UFPLS allow you to manage lump sums tax efficiently. For example, if your business had a poor year and you knew your income was going to be less than the basic rate band you take a UFPLS to make use of the basic rate band.

Tip 2. UFPLS will be available from pension funds which, because of their rules, don?t currently offer an income drawdown option. That is, taking regular money as income from your fund without buying a pension.

Option 3. Take the pension commencement lump sum, which can be up to 25% of your fund:

it will all be tax free; anything you draw after that will be taxable as income

the balance of the fund will remain in your pension fund and any income and gains generated by it are tax exempt

the money left in the fund will be outside your estate for IHT purposes, but depending on how the remaining money is taken a special tax charge could apply (see The next step ).

More than one fund

The lump sum options apply to each pension plan. So if you have two or three you could use different options for each. This potentially creates even greater flexibility and tax efficiency.

Get the right advice

After 5 April 2015 you?ll be entitled to free financial advice about your pension under a government scheme (see The next step ). It?s certainly worth considering. However, as we?ve said before, if you?re 55 or going to be by 5 April we recommend consulting a financial advisor before then.

Maximise Your Reclaimable VAT

Your company makes both VATable and exempt sales, which means it can?t recover the VAT it pays on some purchases. Working this out involves several steps. How can you ensure you maximise the VAT reclaimable?

Partial exemption

When tax experts give advice on partial exemption (PE) they tend to concentrate on finding the best formula that will maximise the input tax (VAT on purchases) you can reclaim (see The next step ). However, before you get to that stage there are important steps to be taken, and if you get them wrong you could cancel out the advantage before you start.

Direct attribution

A business that makes exempt and VATable sales must identify which purchases are used to make:

VATable sales (standard, zero and lower-rated and certain sales outside the scope of VAT)

exempt sales

a mix of VATable and exempt sales.

Where purchases are used solely for VATable sales, all the input tax can be reclaimed, but if they?re used wholly for exempt sales, none of it can. Allocating the VAT to each type of sale is known as direct attribution. After that, for whatever input tax is left, known as residual VAT, typically overhead costs, e.g. accountancy fees, office costs etc., a PE formula must be used to work out how much of it can be reclaimed.

Trap. If you attribute input tax incorrectly you?ll either lose out on some of it or reclaim more than you should. The latter might drop you in hot water with HMRC and result in penalties.

How good is your bookkeeping?

Good bookkeeping is essential to ensure correct attribution of input tax. If you don?t keep the records for your business, it?s vital that whoever does knows which type of purchase an invoice relates to, i.e. exempt, VATable or residual. You might know at a glance, but your bookkeeper might not.

Example. You?re a residential property developer who also lets out homes on short terms. Selling the properties is VATable while letting is exempt. You buy large quantities of building material, so unless your bookkeeper knows which properties they are to be used for they can?t be sure to allocate the VAT shown on the invoice correctly.

Tip. Make sure someone with knowledge of the purchase marks invoices to show what type of supply they relate to. Alternatively, provide a comprehensive list to your bookkeeper that will enable them to identify it.

Mixed supplies

A problem arises where a supplier?s invoice covers items you?ll use for VATable and exempt supplies. HMRC says the input tax isn?t directly attributable and so the PE formula must be used to work out the VAT that is reclaimable, even where, say, 90% was used for taxable supplies. If the formula gives a lower rate of recovery, you?ll lose out. Conversely, if it allows a greater reclaim it?s OK to use it.

Tip. If it?s in your favour to do so ask the supplier to split the purchase between two invoices; one for the supplies you?ll use for VATable sales and the other for exempt material. That way the VAT can be attributed precisely.

No Class 2 NI on buy to let

Sudden rise in Class 2 NI demands. There’s been an increase in letters from HMRC contending that property investor clients owe six years? Class 2 NI. Worryingly, no copy of this letter is being sent to the agent so you may be unaware that your client has even received a demand and paid it. Buy to let has always been classed as an investment and not a trade so isn?t this a case of HMRC sending the letter in error? One of our subscribers wrote back to HMRC advising that no Class 2 NI was due as the client had no self-employment and thought that was the end of it. But HMRC then wrote saying that ?the person may be considered self-employed through property income? and therefore Class 2 NI was still due. But is it right?

Case law says different. Whether a portfolio of properties constitutes a business was addressed in Rashid v Garcia [2002] UKSC SpC 348 (see Follow up ). In this case, the taxpayer argued that Class 2 NI was due on rental income as he was trying to claim some benefits. The taxpayer owned four let properties, one of which was let to DSS tenants for just a few weeks at a time. It was estimated that the taxpayer spent two to four hours per week on managing the properties and members of his family acting on his behalf spent 16 to 24 hours per week. The Special Commissioner considered this was insufficient activity to constitute a business so no Class 2 NI was due.

Pro advice. When responding to the demand try to nip it in the bud by quoting the Rashid v Garcia case and explaining that your client spends considerably less time managing their properties than Mr Rashid and his family did.

Tax Relief on Rent Free Periods

You’ve signed a new lease on your premises and negotiated a rent-free period with your landlord. How will this affect the timing of tax relief over the term of the lease?

Tax timing

The timing of a tax deduction can affect your company?s cash flow, especially if it?s for a major cost like renting your business premises. Ask most people in business when they think you can claim a tax deduction for an expense and they?ll probably say when you spend the money, or maybe when you receive an invoice. Ask an accountant or HMRC the same question and you?ll probably be asleep before they?ve finished their answer. But don?t be too hard on them, it really isn?t that simple.

Nothing to report

Two years ago Acom leased a factory. It had been vacant for a while and as an incentive the landlord offered the first year rent free and lower than current market rate for rents over the next two years. Acom?s bookkeeper listed no rents in the company?s records for the first financial year under the new lease, and only the rent actually paid in the following year?s accounts. No adjustment to these figures was made before the accounts were submitted to HMRC. But should there have been one?

Accounting and tax standards

Over recent years HMRC has come around to the accountancy profession?s way of thinking, that expenditure should be set against the income it generates. This means that where you incur a cost for something which is going to be used in your business over a period of time, it should be spread over the life expectancy of whatever it is that you?ve purchased. But in the case of rent on your business premises doesn?t one month?s rent simply pay for one month?s occupation?

Lease or no lease

The answer to the question above is ?yes?, but only for short-term (a year or less) occupation. Where the rent is payable under a lease or other type of rental agreement over a longer period, the money you pay is in instalments against the cost of the lease as a whole. Accountancy/tax rules say you should spread this cost evenly over the tax years which the lease covers.

Tip. Where you don?t know the total cost of the lease, because the rent is only set for, say, three years of a ten-year lease, spread the rental payments equally over the period for which the rents are known.

Example. Acom signs a lease on the factory on 1 January 2015. The lease is for ten years, and the first year is rent free. The annual rent for the second and third years is £21,360 and is then subject to review. The company should include an expense in its accounts for the year of £14,720. This is worked out by adding together the rent from the start of the lease to the first review point and then dividing it equally between each year up to the rent review date, i.e. £0+£21,360+ £21,360÷3=£14,720. HMRC is happy to follow suit and allow a tax deduction of £14,720 in its 2014/15 accounts, even though it paid nothing in rent during that year.

Conclusion. This is good news for Acom; it corrected the earlier accounts and claimed corporation tax relief on an extra £14,720. In the long run it would have got the same tax relief, but in the short term it has extra money in the bank.

The Statutory Residence Test

The statutory residence test was introduced in 2013/14 to provide certainty to those who need to determine their tax residence for a given year. But how do the rules work in practice and what traps might be lurking to catch out the unwary?

BACKGROUND

Until 2013/14 the question of whether an individual was resident or not in the UK for tax purposes was based on a supposedly simple day count in any one year. There was no statutory legislation governing this, only HMRC?s published guidance in booklet IR20 .

One particular individual, Robert Gaines-Cooper, took great pains to ensure he stayed below the limits for days present in the UK and claimed that he was non-resident for several decades. HMRC disagreed, pursuing him for unpaid tax dating back to 1982, despite his not meeting any of the conditions for residence set out in IR20. HMRC eventually won the case (which was appealed unsuccessfully in the Supreme Court), citing amongst other things that IR20 was only ever intended to be guidance and (conveniently) did not represent the law (see Follow up ).

Pro advice. The Gaines-Cooper case is a useful reminder that HMRC?s guidance can be and often is successfully challenged.

The saga directly led to the development and eventual introduction of the statutory residence test (SRT) in the Finance Act 2013 . The aim of this is to give certainty to individuals in respect of their residence status in any given tax year. How does it work?

Example. Ieuan is a UK-domiciled individual who has spent several years outside the UK. However, he has spent the 2013/14 year living and working in a number of countries, including the UK. He is confused by the SRT and, with the 2013/14 tax return deadline fast approaching, has approached you for advice as to whether he is resident or not for the year. He has given you the following key information:

Occupation: Self-employed civil engineer

Number of days in the UK: 98 (none in the prior five years)

Number of work days in the UK: 53

Number of work days in Dubai: 104

Number of work days in Hong Kong: 13

Ieuan typically works ten hours a day when working, and took an initial six-month lease on a flat in Cardiff when he undertook a contract there in September 2013. As he is hoping to work in the UK again in the future, he kept the flat on and is renting it indefinitely. He is single and owns an apartment in Dubai, where he spends most of his non-working time.

A THREE-STAGE TEST

The SRT is potentially a three-stage logical process. It first seeks to determine whether an individual is definitively not resident for any given tax year. If a definitive answer cannot be reached, then the second test – that for definitive UK residence – is undertaken. If this does not provide a conclusive answer, then the third ?tiebreaker? test must be applied, which considers the number of connecting factors the individual has to the UK. These tests can be confusing so we?ve summarised them in three flow charts (see Follow up ).

TEST 1. DEFINITIVE NON-RESIDENCE

The first consideration is whether the individual was tax resident in the UK in any of the previous three tax years. Dependent on the answer to this, the next consideration is whether the individual has been present in the UK for fewer than either 46 days (if ?no?) or 16 days (if ?yes?). If the individual has been present for less than the relevant day count for the tax year in question, they are classed as definitively not UK resident for that year. If these day counts are exceeded, the individual can still be definitively non-resident if they are working full-time abroad, is present in the UK for no more than 90 days, and has no more than 30 UK work days in the tax year. If these considerations are not met, we move on to the second test.

Pro advice 1. Full-time work abroad for this purpose broadly means employment or self-employment constituting at least an average of 35 hours per week (per the legislation), with no significant break.

Pro advice 2. A day in the UK for SRT means being present at midnight (subject to certain other rules such as the deeming rule (see Follow up )).

Example. Ieuan was not resident in the UK in any of the three preceding tax years, but spent more than 45 days in the UK. He does not meet the full -time work abroad conditions, averaging less than 35 hours per week (and presumably has a significant break), exceeds the 90-day count, and exceeds the 30-day work day count. He must therefore proceed to Test 2.

TEST 2. DEFINITIVE UK RESIDENCE

The second test begins by considering if the individual is present in the UK for at least 183 days in the tax year.

Pro advice. If you know this is the case, there?s no point proceeding with the SRT at all – an individual present in the UK for 183 days or more in a tax year will always be classed as resident.

Assuming the answer is ?no?, the test then looks at whether the individual has their only home in the UK for a period of 91 consecutive days, at least 30 of which fall in the tax year.

Pro advice. ?Home? can include any accommodation with sufficient permanence, and does not require ownership. It can potentially therefore include a house, flat, hotel or even a caravan or houseboat.

If the answer is ?yes?, the individual can be definitively classed as resident. If not, their UK work pattern must be looked at. The test seeks to ascertain whether the individual in the tax year averages 35 hours per week, has no significant break from this work and has more than 75% of their work days in the UK. If all three conditions are satisfied, the individual is resident, and if not, we must consider the third test.

Example. Ieuan is not present in the UK for at least 183 days, and does not have his only home in the UK. He clearly does not meet any of the UK working tests, and so must proceed to Test 3.

TEST 3. SUFFICIENT TIES

The third test is designed to be a tiebreaker where the first two tests do not provide a definitive result, and combines the day count for the year with the number of connecting factors the individual has in a matrix. The first consideration (as in Test 1) is whether the individual was resident in any of the three preceding tax years.

The answer determines whether there are four or five potential connecting factors to consider, and how many days the individual can subsequently spend in the UK given the number of factors which are present. These are presented in Tables 3A and 3B in the Test 3 flow chart (see Follow up ). The five ties are: family resident in the UK (spouse/civil partner/live-in partner and/or minor children); substantive UK work (at least 40 days of three+ hours? work in the tax year); accessible UK accommodation; spent more than 90 days in the UK in either of the prior two tax years; and more days in the UK than any other individual country (only a factor if answering ?yes? to the initial question on prior residence).

Pro advice. Accessible accommodation means anywhere that is available for at least 91 days with no breaks of 16 or more consecutive days. Whether the accommodation is occupied is irrelevant.

Example. Ieuan has not been resident in the UK in the previous three tax years. He has no family and has not spent 90 days in the UK in either of the prior two tax years. He does, however, have substantive UK employment and accessible accommodation in the UK. He has two connection factors. Per Table 3B, he would need three connection factors to be resident so he?ll be non-resident in 2013/14; however it?s worth noting that if his day split were the same in the next year, he would also have the 90-day connecting factor, and have three connecting factors. He would therefore be classed as resident – which is important as it would bring all his worldwide earnings into the UK income tax charge.

VAT Implications of Christmas Gifts

With Christmas approaching, clients are likely to start asking whether VAT can be reclaimed on seasonal gifts and staff parties. The rules on these can be confusing, so what should your advice be?

SEASONAL GIFTS

The cost of giving business gifts, for example to staff or customers, is a legitimate business expense and HMRC guidance at para2.2 VAT Notice 700/7 confirms that the VAT incurred can be recovered as input tax (see Follow up ).

The problem. By making a gift, the business is making a supply for VAT purposes so the general rule is that it will also have to account for output VAT on the value of goods given away (para 5(1), Schedule 4 VATA 1994) (see Follow up) . So this completely wipes out any cost saving from reclaiming the VAT. There is, however, an important exception to this general rule.

LESS THAN £50?

As long as the cost of the gift, or series of gifts, to the same person doesn?t total more than £50 excluding VAT in any twelve-month period, VAT can be reclaimed in full without the need to account for output tax (para 5(2), Schedule 4 VATA 1994) . Unlike direct taxes, you don?t need to have any form of advertising on the gift for it to qualify.

What?s included in the cost? The £50 limit for the cost of goods does not include any administrative costs such as post and packaging.

Nothing in return. In order to be a ?gift? there must be no obligation on the business to provide it or on the recipient to do anything in return. For example, if a business offers potential customers an item described as a ?free gift? in return for attending a sales presentation, it?s not a free gift for VAT purposes and output tax should be accounted for on the value of the item.

Watch out! The twelve months is a rolling period starting on the day the first gift is made rather than a fixed calendar or financial year (para 2.3 VAT Notice 700/7) .

Pro advice 1. If the client intends to give gifts in excess of £50 in a year, then VAT Manual VIT25600 confirms that HMRC accepts businesses can avoid the hassle of creating a notional sale in their accounting records by not reclaiming the VAT on the initial purchase (see Follow up ).

Pro advice 2. If the cost of the goods exceeds the £50 limit and there?s a reasonable time between your client purchasing the free gifts and giving them away, the client may want to consider claiming the VAT back to take advantage of the cash flow benefit.

WHO IS ?THE SAME PERSON??

Previously, HMRC?s view was that the £50 per year limit for small business gifts applied to gifts made to any one organisation. HMRC changed its view following the European Court?s decision in EMI Group v HMRC (see Follow up ).

What are the case facts? EMI Group distributed free copies of CDs to disc jockeys working for the same broadcasting company. A point the Court considered was whether the monetary limit applied to each individual recipient or to the organisation they worked for and decided it applied at an individual level. As a result of this decision, HMRC now accepts that the phrase ?the same person? in paragraph 5(2), Schedule 4 VATA 1994 means ?the same individual? and not ?the same organisation?.

Example. Addit & Co Accountants has a client with six employees who all like fine wine. It could give each of them a £50 bottle of wine without exceeding the monetary limit, providing this was the only gift the firm gave those individuals in the same year. If the six bottles are to be delivered in a crate, Addit & Co should ensure it?s clearly specified that a bottle is intended for each employee.

As it?s a business gift, Addit & Co can recover the VAT on the cost of the wine as input tax. Providing it is the only gift in the year, Addit & Co is not required to account for output tax on the gift.

Pro advice. If a client is providing small gifts to several individuals within the same organisation, ensure that it?s your client, rather than their main contact at the organisation, that decides how the gifts are allocated.

VAT AND STAFF PARTIES

No recovery limit. Article 5 of SI 1992/3222 effectively blocks the recovery of most input tax on business entertainment but then specifically excludes VAT on employee entertainment from the general input tax block (see Follow up ). The effect of this exclusion is that the VAT rules for staff parties are very generous because, unlike with direct tax, there?s no limit to the amount of input tax that can be recovered. Plus, as long as the employer does not charge for providing the entertainment, no output tax is due.

What is a staff party? A staff party is one organised for entertaining staff, in contrast to a party organised for entertaining business contacts. In the latter situation, there can be no recovery of input tax (not even an apportionment), even if most of the people in attendance are employed by the business that organised the party. HMRC?s view is that employees who attend a party to entertain business contacts are there as hosts so the block on recovering input tax on business entertainment will apply.

WHAT ABOUT GUESTS?

Many employers encourage staff to bring their spouses etc. to the Christmas party as guests. In this situation, the input tax should be apportioned between employees and guests, assuming no charge is made for the guests to attend.

Example. Addit & Co organise a Christmas party for its partners and employees at a cost of £40 plus VAT per person. In total 60 people attend, 30 of whom are guests. When it comes to preparing its VAT return the partnership will only be able to recover 50% of the VAT incurred on the party as input tax.

Note. The input tax relating to the partners can be recovered because it?s not a partner-only event. If, however, the partners go out for a Christmas lunch on their own then as per para 3.2 VAT Notice 700/65 the VAT incurred on the lunch is not input tax and cannot be recovered (see Follow up).

Solution. If Addit & Co charged guests who attended the event, it would need to account for VAT on the charge, but this would also allow it to recover the VAT on the related costs. The charge does not have to be so much that the £40 plus VAT cost of providing the entertainment to the guest is recovered, but it should not be so small that the entertainment is in effect provided for free. For example, if Addit & Co charged £24 per guest it would account for output tax of £4 (£24 x 20/120) but would be able to recover VAT of £8 (£40 x 20%) as input tax.

Pro advice. Introducing a (not unrealistically) small charge for guests means that the supply of entertainment to them is a taxable supply so input tax can be recovered on the related costs.

NO TIME FOR A CHRISTMAS PARTY?

The good news for you (or your staff) is that even if it?s too late to organise a Christmas party, or your staff are too busy with tax returns to enjoy one, the VAT rules on employee entertainment apply throughout the year. HMRC gives the following examples of entertainment:

  • provision of food and drink
  • provision of accommodation, e.g. hotels
  • provision of theatre and concert tickets
  • entry to sporting events and facilities
  • entry to clubs and nightclubs
  • use of capital assets such as yachts and aircraft for the purpose of entertaining.

Perhaps you could think about organising a tax return filing celebration in February to reward your hardworking staff?

10 reasons why SME’s should use Cloud Accounting

Shop-owner, builder or photographer – whatever the business, it can be very difficult to keep on top of finances while making sure customers are happy and bills are paid.

It is all too easy to file invoices away into a glove compartment or forget to keep on top of tax.

Before too long the result is limited credit control and a battle to play catch-up on invoicing. By the end of the year, profit and loss figures can be a long way from what was anticipated, with further shocks in store when tax returns or annual accounts are submitted.

Now, however, the combination of simple accounts software and cloud connectivity is making it easier than ever for even the very smallest businesses to achieve complete control over their finances, no matter where they are.

Here are ten reasons why small or medium-sized businesses should switch to cloud accounting:

  1. Financial data becomes visible in real time for any authorised person using a tablet or smartphone
  2. Small businesses can keep track of accounts with daily or weekly finance checks, making it far less likely that they will plummet into the red
  3. It is no longer necessary to manually note down accounts information in notebooks or spread sheets and then do the books with the accountant at the end of the year
  4. Bank balance feeds can be pumped into the accounts system automatically
  5. Accountants and financial advisers can look at a firm’s books whenever they need to, enabling them to provide more timely financial advice to small business owners
  6. With more time to act and more data, accountants are better able to advise the business on how it could improve
  7. Collaborating online with staff is easy
  8. Worry-free maintenance and free updates bring peace of mind, while system administration costs and server failures become the responsibility of the cloud service provider
  9. The ability to invoice as soon as a job is complete, radically reduces debtor days and improves cash flow
  10. An invoice can be automatically set to go out on a set date and time, eliminating the chance it will be late or forgotten about altogether

Recovering VAT incurred before registration

A 2015 VAT case considered the rules regarding recovering VAT incurred before the effective date of registration. What can clients do to maximise the amount of pre-registration VAT they are entitled to claim, and are there any traps to consider?

EARL REDWAY V HMRC

Redway (R) (trading as “Loktonic”) buys and sells security locks. On his first VAT return he included a claim to recover VAT incurred on security locks he had bought prior to his effective date of VAT registration (EDR). HMRC allowed the claim in part, but disallowed it to the extent that it related to security locks that he had already sold before his EDR. R appealed against HMRC’s decision to restrict his claim in this way (see Follow up ).

The legislation at SI 1995/2518 Reg 111 (see Follow up ) allows VAT to be recovered on goods bought before the EDR, subject to certain conditions being met, one of which is that the goods are still owned by the business at the EDR. R’s argument was that this condition is not a correct application of the EU Principal VAT Directive (PVD), which UK VAT law is required to comply with. The tribunal disagreed and dismissed the appeal.

THE REG. 111 RULES

The UK legislation at SI 1995/2518 Reg 111 refers to exceptional claims for VAT relief. This includes details of when VAT incurred on goods and services before the EDR can be treated as input tax and included on the first VAT return.

The rule for services is that the costs must have been incurred no more than six months before the EDR. Recovery is affected by any partial exemption and non-business restrictions that would have applied had the business been registered for VAT at the time the costs were incurred. It is not, however, possible to use the partial exemption de minimis limits referred to in a previous article ( yr.1, iss.5, pg.8 , see Follow up ) to recover VAT incurred before the EDR.

GOODS

The restrictions referred to above also apply to goods. The general rule for goods is that the costs must have been incurred no more than four years before the EDR.

Providing goods have been bought within the time limits referred to above, and subject to any partial exemption or non-business restrictions that may be relevant, VAT on goods that have not been sold or consumed before the EDR can be recovered.

CAPITAL GOODS SCHEME

The exception to the general four-year rule is capital goods scheme (CGS) assets. Details of what constitutes CGS assets and the relevant ten and five year adjustment periods are explained in a previous article ( yr.2, iss.5, pg.10 , see Follow up ).

If a CGS asset is bought prior to registration, a year is deducted from the relevant adjustment period for each complete twelve-month period that has elapsed between the date of first use and the EDR. The CGS rules then determine how much of the VAT incurred on the asset can be recovered over the remainder of the relevant adjustment period.

THE “CONSUMED” CONTROVERSY

The word “consumed” is used in UK legislation at SI 1995/2518 Reg 111 :

“No VAT may be treated as if it were input tax under paragraph … in respect of … (ii)save as the Commissioners may otherwise allow, goods which had been consumed.”

This is not in itself controversial. The controversy relates to the way HMRC appears to interpret and apply the word in VAT Manual VIT32000 (see Follow up ). This provides a number of examples, one of which relates to a business that acquires a van three years before its EDR. The business still owns the van at the EDR, having previously used it to make supplies that would have been subject to VAT had the business been registered at the time. The guidance suggests that the amount of VAT that should be recovered in relation to the purchase of the van should be restricted to reflect use of the van to makes supplies that were not subject to VAT before the EDR. This may appear to produce a fair result, but whether it is a correct application of the current wording of SI 1995/2518 Reg 111 is another matter.

EU DIRECTIVE

The EU PVD appears to support HMRC’s interpretation, but the way in which the PVD has been implemented into UK legislation, on which UK taxpayers are entitled to rely, is not straightforward.

The UK’s implementation of the PVD was considered by the tribunal in the Redway case. However it concerned stock that had already been sold by the business before its EDR, rather than fixed assets that are used in a business before and after its EDR. Unless a business carries a lot of old stock, the main category of goods bought years before the EDR and held at the EDR is likely to be fixed assets.

Pro advice 1. The distinction between goods and services is not always obvious, particularly in the context of refurbishment and the fitting out of premises. Advising clients on the distinction between goods and services and the different time limits that apply to each can help them to choose the most appropriate EDR for their business.

Pro advice 2. Helping a client choose the most appropriate EDR is particularly important when they have already incurred a significant amount of VAT. In some cases choosing to backdate the EDR may produce the best result for the client, allowing them to recover VAT that would otherwise be irrecoverable.

BACKDATING THE EDR

HMRC is familiar with the concept of backdating a VAT registration in order to maximise VAT recovery. An extract from paragraph 5.2 of the 25/02/14 edition of VAT Notice 700/1 (see Follow up ) says: “We may allow you to backdate your registration voluntarily by up to four years when you apply to register. This will allow you to claim back VAT as per the time limits above.”

The reference to the time limits here is consistent with the legislation at SI 1995/2518 Reg 111 . It does not suggest any restriction on VAT recovery to reflect any use of assets to make supplies that were not subject to VAT before the EDR. A business that is registering for VAT could apply for the EDR to be backdated by four years to allow VAT to be recovered on goods purchased up to eight years before the application to register is submitted.

Example. On 1 October 2015 a business submits an application to register for VAT, requesting a backdated EDR of 1 October 2011. Providing HMRC agrees to an EDR of 1 October 2011, it should be possible to recover VAT on goods purchased for use in the business from 1 October 2007 onwards, i.e. up to four years before the EDR, providing they were still owned by the business on 1 October 2011.

Pro advice. Maximising VAT recovery is only one point to be considered when helping a client choose the most appropriate EDR. The need to account for output tax on supplies made from the EDR is another point that should be considered and is particularly relevant in situations when the client’s customers cannot recover VAT or when the terms of the contract do not allow VAT to be added to the price that has been agreed.

FLAT RATE SCHEME (FRS) USERS

Paragraphs 7.5 and 7.6 of the 03/05/13 edition of VAT Notice 733 (see Follow up ) confirm that VAT on goods and services bought before the EDR can be recovered by a business using the FRS to the same extent as a business not using the FRS.

Pro advice. The timing of expenditure and the choice of EDR is particularly important for clients who intend to use the FRS.