Value Added Tax

There are special VAT rules that allow businesses to standard rate the supply of most non-residential and commercial land and buildings (known as the option to tax). This means that subsequent supplies by the person making the option to tax will be subject to VAT at the standard rate.

The ability to convert the treatment of VAT exempt land and buildings to taxable can have many benefits. The main benefit is that the person making the option to tax will be able to recover VAT on costs (subject to the usual rules) associated with the property including the purchase and refurbishment of the property.

However, any subsequent sale or rental of the property will attract VAT. Where the purchaser or tenant is able recover the VAT charged this is not normally an issue. However, where the purchaser / tenant is not VAT registered or not fully taxable (such as bank), the VAT can become an additional (non-recoverable) cost. Once an option to tax has been made, it can only be revoked under limited circumstances so proper consideration of the issue is important.

Once an option to tax has been made, it can only be revoked under limited circumstances. This includes within a specified 'cooling off' period in the first 6 months, an automatic revocation where no interest has been held for more than 6 years and after 20 years has elapsed. There are strict rules and conditions which must be met for all these revocations. HMRC’s VAT Notice 742A – Opting to tax land and buildings has recently been updated.

The VAT treatment of land and property is one of the most complex areas of the VAT legislation. Under certain situations, supplies of building materials can be zero-rated or reduced-rated at 5% for VAT.

For the supplies of building materials to be zero-rated or reduced-rated, all of the following conditions must be met:

• the goods must be 'building materials'
• they must be supplied along with zero-rated or reduced-rated services
• those services must include the 'incorporation' of the building materials in the building concerned or its site.

For VAT purposes, ‘building materials’ are articles that meet the statutory definition namely the materials:

• are 'incorporated' in the building or its site
• would 'ordinarily' be incorporated by builders in 'a building of that description'
• are not explicitly excluded from the definition of 'building materials' (such as furniture, gas and electrical appliances, and carpets).

If a builder is working on a zero-rated project, they can still zero-rate the service of incorporating standard-rated goods in the building. But if they are working on a reduced-rated project, they cannot reduced-rate the incorporation of standard-rated goods that are not building materials.

The VAT system is policed by HMRC and there are penalties for breaches of the legislation.

There are four conditions that must be satisfied in order for an activity to be within the scope of UK VAT.

These conditions are that the activity:

1. Is a supply of goods or services
2. That the supply takes place in the UK
3. Is made by a taxable person
4. Is made in the course or furtherance of any business carried on or to be carried on by that person

The fourth point above is a condition that needs to be carefully considered when deciding if an activity is within the scope of VAT. This concept of 'business' is one of the less well-known rules. However, this is an important condition that drives the liability of a business to charge VAT on their sales, known as output VAT, and on its ability to recover VAT, known as input tax.

The VAT concept of business is currently taken to be the same as the concept of 'economic activity' set out in European legislation. Therefore, if an activity falls within EU definition of economic activity, it must be business in the UK. Both of these definitions are wide and, in some cases, have needed to be interpreted by the courts.

There is a special VAT refund scheme called the VAT Retail Export Scheme or Tax-Free Shopping that allows individuals not resident in the EU to obtain a VAT refund on goods bought in the UK and taken out of the EU. The scheme does not apply to services, for example hotel bills.

The scheme can be used to reclaim VAT on purchases from participating shops. It is important to note that not all retailers offer tax-free shopping and there is usually a fee (from the retailer) for making a claim. The retailer will usually request proof that the claimant is eligible to use the scheme, by presenting a passport or national identity card.

Claimants cannot get a VAT refund for items including:

• Mail order goods including internet sales, delivered outside of the UK.
• Goods which have been used, or partly used, in the EU.
• Motor vehicles and boats.
• Goods over £600 in value that will be exported for business purposes.
• Goods to be exported as freight and goods that need an export licence.
• Unmounted gemstones.
• A boat that is sailed to a destination outside the UK or EU.

There are a number of conditions that must be met in order to claim the VAT back including the requirement to leave the EU within three months of making the purchase. There is no minimum sales value specified in the legislation. However, most participating retailers have minimum purchase conditions. A special form (VAT 407) must be completed and qualifying conditions met.

If you have clients that have been adversely affected by the new 'limited cost trader' test that was introduced on 1 April 2017, you should consider whether it will be more beneficial for them to leave the VAT Flat Rate Scheme (FRS) and revert to using traditional VAT accounting.

Businesses can leave the FRS at any time by notifying HMRC. To save any additional complications this is usually done at the end of their next VAT accounting period but can be done at any time. 

Businesses must also leave the scheme:

• On the anniversary of joining the scheme if the previous year's VAT-inclusive turnover was more than £230,000;
• If they expect their VAT inclusive turnover in the next 30 days alone will be more than £230,000;
• They start to use one of the other special schemes such as one of the margin schemes for second-hand goods, art, antiques and collectibles, the tour operators margin scheme, or the capital goods scheme;
• The business becomes part of a larger VAT group or division or becomes eligible to do so.

Businesses that leave the FRS may be able to make a stock adjustment and claim input tax when they leave the scheme. They need to follow the steps set out in HMRC’s guidance to find out if and how they need to make an adjustment. This will require a stock valuation (but not a formal stock-take). Businesses that leave the flat rate scheme are unable to re-join for at least 12 months.

Where an error on a past VAT return is uncovered, you have a duty to correct the error as soon as possible. As a general rule, you can use your current VAT return to make any necessary adjustment. However, there are three important conditions that must be met:

1. The error must be below the reporting threshold.
2. The error must not be deliberate.
3. The error can only relate to an accounting period that ended less than 4 years ago.

Under the reporting threshold rule, you can make an adjustment on your next VAT return if the net value of the errors is £10,000 or less. The threshold is further increased if the net value of errors found on previous returns is between £10,000 and £50,000 but does not exceed 1% of the box 6 (net outputs) VAT return declaration figure for the return period in which the errors are discovered.

VAT errors of a net value that exceed the limits for correction on a current return or that were deliberate should be notified to HMRC using form VAT 652 (or providing the same information in letter format) and should be submitted to HMRC's VAT Error Correction team.

If you discover an error on your VAT return and are unsure of the correct way to handle it, we can help.

It is important that any errors are disclosed before they are discovered by HMRC, otherwise, higher penalties and interest may be payable. HMRC generally look favourably on taxpayers who are proactive in correcting any errors they discover. HMRC can also charge penalties and interest if an error is due to careless or dishonest behaviour.

The VAT Flat Rate Scheme (FRS) has been designed to simplify the way a business accounts for VAT and in so doing reduce the administration costs of complying with the VAT legislation. The scheme is open to businesses that expect their annual taxable turnover in the next 12 months to be no more than £150,000.

The limited cost trader test, introduced in April 2017, can increase the VAT flat rate percentage used by VAT registered businesses that use the Flat Rate scheme. Businesses that meet the definition of a 'limited cost trader' are required to use a fixed rate of 16.5%. The highest 'regular' rate is 14.5%.

A limited cost trader is defined as one whose VAT inclusive expenditure on goods is either:

• less than 2% of their VAT inclusive turnover in a prescribed accounting period;
• greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

For some businesses, for example, those who purchase no goods or who make significant purchases of goods, the outcome of the test will be self-evident. Other businesses need to complete a simple test, using information they already hold to work out whether they need to use the higher 16.5% rate. Businesses using the scheme are expected to check that they use the appropriate flat rate percentage for each accounting period.

For some business clients it may be more beneficial to leave the FRS and account for VAT using the normal rules. 

When a VAT registered business issues an invoice to their customer, they must seek to ensure that they charge the correct rate of VAT. Whilst most businesses in the UK charge VAT at the standard rate of 20%, there are a number of different VAT rates and exemptions to be aware of. These include the reduced VAT rate of 5% and the positive zero rate (0%).

There are two other categories that the supplies of goods and services can fall under:

• Exempt – where no VAT is charged on the supply. Examples of exempt items include the provision of insurance, postage stamps and health services provided by doctors. If a business only sells VAT-exempt goods and services, they cannot register for VAT.
• Supplies that are 'outside the scope' of the UK VAT system altogether. These supplies are beyond the realm of the UK VAT system and you cannot charge or reclaim VAT on these supplies. Examples include goods or services you buy and use outside of the EU, statutory fees – like the London congestion charge and goods you sell as part of a hobby.

If a business has made an error in charging VAT then this needs to be corrected. The timing of finding an error can impact on how the issue is resolved.

The VAT Flat Rate scheme (FRS) has been designed to simplify the way a business accounts for VAT and accordingly, reducing the administration costs of complying with the VAT legislation. VAT is calculated under the FRS by applying a flat rate percentage to the flat rate turnover. The flat rate percentage varies from 4% to 16.5%.

There are special rules that apply to expenditure on capital assets worth more than £2,000. These transactions must be dealt with outside the FRS with any input tax claimed using a traditional VAT Return. This is different to other transactions made using the FRS where the input tax has already been included in the calculation of the relevant flat rate percentage.

Businesses can only apply to use the FRS if they expect their annual taxable turnover in the next 12 months to be no more than £150,000, excluding VAT. The annual taxable turnover limit is the total of everything that a business sells during the year. It includes standard, reduced rate or zero rate sales and other supplies. It excludes the actual VAT charged, VAT exempt sales and sales of any capital assets. If a business leaves the scheme, they must wait 12 months before applying to re-join the scheme.

VAT retail schemes are a special set of schemes used by retail businesses to account for VAT.  The schemes are usually used by businesses that sell a significant amount of low value and/or small quantity items to the public with different VAT liabilities.

The use of the scheme can save businesses a significant amount of time in calculating the amount of VAT due to HMRC on each and every sale. In many circumstances it would be extremely difficult for these businesses to account for VAT using standard VAT accounting. By using the VAT retail scheme, retailers are able to calculate VAT due to HMRC at the standard, reduced and zero rates of VAT as a proportion of sales. Usually this is done on a day by day basis.

There are 3 standard VAT retail schemes:

• Point of Sale Scheme
• 2 x Apportionment Schemes
• 2 x Direct Calculation Schemes

There is also the option of using a bespoke scheme. The use of a bespoke scheme is obligatory for retailers with a turnover excluding VAT of £130 million or more. The decision as to which retail scheme to be used is usually driven by a combination of looking at the scheme that provides the best result for the business and the cost of using the scheme. Note, HMRC need to be of the opinion that the chosen scheme is fair and reasonable.