Value Added Tax

There are three main special VAT schemes available to small businesses. These are the flat rate scheme, the annual accounting scheme, and the cash accounting scheme. The turnover levels for joining and leaving these schemes vary.

The flat rate scheme is open to businesses that expect their annual taxable turnover in the next 12 months to be no more than £150,000, excluding VAT. However, businesses that are already using the scheme can continue to do so until their turnover threshold exceeds £230,000 when they must leave the scheme. The purpose of this VAT scheme, is to simplify the way a business accounts for VAT and so reduce the cost of complying with their VAT obligations. With the scheme you pay VAT as a fixed percentage of your VAT inclusive turnover. The actual percentage you use depends on your type of business. Before using the scheme, it is important to check if it will be beneficial for your business.

The annual accounting scheme is also aimed at smaller businesses. It can either be combined with the flat rate scheme or used by a business, which uses standard VAT accounting. Businesses that use the scheme are only required to file one VAT return at the end of each year. The scheme is open to businesses with a taxable turnover up to £1.35 million. Businesses can then continue to use the scheme until their turnover exceeds £1.6 million.

Another popular small business scheme is the cash accounting scheme. A business can enter this scheme provided the estimated VAT taxable turnover for the next VAT year is not more than £1.35 million. It can continue to use the scheme until the VAT taxable turnover exceeds £1.6 million. Under standard VAT accounting, VAT is payable on sales whether or not the customer has paid and can lead to a need to claim bad debt relief. Under this scheme VAT does not need to be paid over until the customer has paid. If the customer does not pay, then any VAT due does not need to be paid to HMRC.

The introduction of Making Tax Digital (MTD) for VAT is fast approaching.

From April 2019, some 1 million businesses with a turnover above the VAT threshold (currently £85,000) will have to keep their records digitally (for VAT purposes only), and provide their VAT return information to HMRC through MTD compatible software. The deadlines for sending VAT returns and making payments are not changing.

Businesses with a taxable turnover below the VAT threshold can also opt to use MTD for VAT if they so wish. Businesses will not be asked to keep digital records, or to update HMRC quarterly, for other taxes until ‘at least’ 2020.

HMRC launched a private beta pilot of MTD for VAT in April 2018 and the pilot is now open to most VAT registered businesses and their agents. It is important that businesses are aware of these upcoming changes, and are preparing for the fast approaching deadline and considering whether it would be beneficial to join the MTD pilot.

HMRC has also deferred the introduction of MTD for VAT for a small minority (circa 3.5%) of businesses that have more complex requirements until 1 October 2019. This includes trusts, ‘not for profit’ organisations that are not set up as a company, VAT divisions, VAT groups and those required to make payments on account and annual accounting scheme users.

Planning note

HMRC has also agreed to give businesses until 31 March 2020 to make sure there are digital links between software products. This means that during the first year of MTD for VAT, businesses who use more than one software programme to keep their VAT records and prepare and file returns, will not be required to have digital links between those software programmes. From March 2020, bridging or MTD-compatible software will be required so that this information can be digitally sent to HMRC with no manual intervention.

A new Revenue and Customs Brief (6-2018) entitled VAT exemption for all domestic service charges has recently been published by HMRC. The brief explains changes to the Extra Statutory Concession (ESC) 3.18 VAT: exemption for all domestic service charges may be applied. The ESC was introduced in February 1994 to enable the same VAT treatment on mandatory service charges to a freehold occupant as to a leaseholder or tenant living on the same common estate.

In the Brief, HMRC identified a number of scenarios where ESC 3.18 has been applied incorrectly. This in part followed a decision by the Upper Tribunal that confirmed if a landlord is contractually obliged to provide services to the occupant of a property, and uses a property management company or similar, to provide these services, the property management company cannot use the concession. This means that the concession does not apply to management fees charged by a management company, accordingly, their fees will be taxable at the standard rate of VAT.

HMRC is reminding all property management companies, and companies supplying similar goods and services in similar situations, who have not correctly applied ESC 3.18, that since 1 November 2018, they must correctly account for VAT. VAT information sheet 07/18 provides further guidance on this subject. Property management companies must ensure that the right amount of VAT incurred on costs and overheads is recovered.

Planning note

Residents affected by these changes could see an increase in their service charges of between say 10% to 20%. The actual amounts involved will depend on the VAT status of individual managing companies. Management companies taking care of small developments should not be affected.

The VAT paid in other EU countries is often recoverable by VAT-registered businesses in the UK, who bought goods or services for business use. The amount of VAT that is refundable depends on the other countries’ rules for claiming input tax. It is important to note that VAT incurred in foreign countries can never by reclaimed on a domestic UK VAT return.

There are special rules for businesses established outside the EU submitting a claim for VAT incurred in the UK. The deadline for the submission of a refund request for expenses incurred in the UK by non-EU businesses during the period 1 July 2017 – 30 June 2018, is 31 December 2018. There are a number of conditions which must be met in order for a claim to qualify.

The form that should be used by these businesses to submit a claim is called a VAT65A form. The accompanying notes explain how the form should be completed and includes details of what other alternative versions can be used in place of a VAT65A.

The VAT Flat Rate Scheme (FRS) has been designed to simplify a 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.

In April 2017, HMRC introduced a ‘limited cost trader’ test that can increase the VAT flat rate percentage used by VAT registered businesses that use the Flat Rate scheme. It appeared that HMRC considered the benefits obtained by certain businesses to be excessive. 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 should use the 16.5% rate. Businesses using the scheme, will be expected to ensure that for each accounting period, they use the appropriate flat rate percentage. Any businesses adversely affected by the introduction of the limited cost trader test should consider whether it is more beneficial to leave the FRS.

The VAT DIY Housebuilders scheme is a special scheme, enabling homeowners building a home to benefit from the special VAT rules that allow the qualifying construction costs of new homes and certain conversion works to be zero-rated. The scheme has been designed to effectively put homeowners in a similar position to a property developer.

A claim can be made for qualifying building materials on which VAT has been charged. Qualifying materials include most materials incorporated into a new building or conversion which cannot be easily removed. There are a number of exceptions including fitted furniture, carpets, and some domestic appliances.

Homeowners can also claim for building materials purchased from another EU member state by converting the amount of VAT paid into the sterling equivalent, and providing proper evidence of shipping etc. It is not possible to claim the VAT for any professional or supervisory services associated with the development.

There are also time limits that should be adhered to when making a claim. A claim must usually be made within three months of the completion of the conversion or new building using the appropriate form. A repayment is usually made within 30 days of a claim being submitted.

There are two main forms for making a claim. The first form (VAT 431NB) is designed for new builds, and the second form (VAT431C) is designed for qualifying conversions i.e. the conversion of a non-residential property to residential. The VAT431NB form has recently been updated.

HMRC has begun a letter writing campaign to remind businesses that the way they keep VAT records and submit their VAT returns is changing. The letters are being sent to businesses who will be within the scope of the new Making Tax Digital (MTD) for VAT, which comes into effect from 1 April 2019.

A first wave of 20,000 letters was sent earlier this month with a further 180,000 letters sent last week. HMRC is planning to send letters to all affected businesses by the end of November, although this date may change. We are told that there are two versions being used to enable HMRC to monitor their impact. Both have the same core message including advice on how to prepare your business for the change but are written in slightly different styles.

The introduction of MTD for VAT will impact businesses with a turnover above the current VAT threshold of £85,000. These businesses will be required to keep digital records and provide regular digital updates to HMRC for VAT purposes using MTD for VAT. There will be some additional preparation time for a small number of businesses with complex requirements.

MTD will initially be for VAT purposes only. Businesses will not be asked to keep digital records, or to update HMRC quarterly, for other taxes until ‘at least’ 2020. A private beta pilot of MTD for VAT was launched in April this year, and last month this pilot extended to businesses whose affairs are up to date and straightforward. The letters from HMRC are being sent to businesses who are currently eligible to join the pilot. The pilot will extend to most other business types over the coming months.

A change to the VAT rules first announced at Budget 2018 will come into effect from 1 October 2019. This change will make the supply of construction services between construction or building businesses subject to the domestic reverse charge. The reverse charge will only apply to supplies of specified construction services to other businesses in the construction sector.

This move is part of the government’s measures to combat what is known as missing trader fraud in the construction sector, where VAT due to HMRC is never paid by the subcontractor. This type of fraud has been common in other business sectors such as cross-border trading in mobile telephones, computer chips and emissions allowances.

Using the reverse charge procedure changes the usual VAT treatment so that the customer is liable to account for the VAT due rather than the supplier. This will place the onus for dealing with the VAT charge due on subcontractors’ bills to the main contractor.

The new reverse charge will be most relevant to sub-contractors and contractors carrying out supplies reported through the Construction Industry Scheme. These changes will lead to administrative changes for some 100,000 to 150,000 businesses in this sector, including many small businesses.

Adopting accounting systems to cope with this change will cause accounting rather than cash flow issues for main contractors as they will add entries to their VAT returns to refect the subcontractors’ VAT, but then deduct the equivalent amount as input VAT on the same return.

There are less than 12 months until the new rules come into effect and businesses that will be impacted, need to begin making any necessary preparations.

The Chancellor confirmed in his Budget speech that the taxable turnover threshold that determines whether businesses should be registered for VAT, will be frozen at £85,000 for a further 2 years from 1 April 2020 until 31 March 2022. The taxable turnover threshold that determines whether businesses can apply for deregistration will also be frozen at the current rate of £83,000 for the same time period.

Businesses are required to register for VAT if they meet either of the following two conditions:

1. At the end of any month, the value of the taxable supplies made in the past 12 months or less has exceeded £85,000; or
2. At any time, there are reasonable grounds for believing that the value of taxable supplies to be made in the next 30 days alone will exceed £85,000.

The Chancellor was clear that the government had explored various options to address the cliff edge effect of VAT registration. This followed the publication of an Office of Tax Simplification report recognising the distortions the threshold causes and recommending the government review this area of tax. The ability to allow small businesses to stay outside the VAT system has many benefits, but there are concerns of the gap between businesses that have to charge VAT against those that do not. HM Treasury will continue to examine this issue, but the Chancellor has provided certainty for the time being on the VAT thresholds for the next number of years.