Making a VAT-related mistake can be costly. Not only will HMRC expect any outstanding VAT to be paid, but they might also levy penalties and interest.
A recent story involving an aesthetic clinic demonstrates the ways in which VAT mistakes can prove expensive.
In the July 2023 case, Illuminate Skin Clinics Ltd (ISC), a private clinic that offered aesthetic treatments, misinterpreted the rules and didn't charge VAT to clients, thinking that its treatments were VAT exempt (Lowery 2023 Jul 27). HMRC then visited the clinic and subsequently disagreed. They then raised an assessment for standard rate VAT at 20%.
The case went before the First-tier Tax Tribunal and HMRC won. The clinic was then left to pay VAT on treatments it had supplied without charging VAT to clients.
There are many common VAT mistakes that could easily get a business into hot water. In this piece, we will look at some examples and offer advice on how to avoid them.
Not registering
A fundamental, but surprisingly common, error is not registering for VAT when required to.
In broad terms, a UK-based business is required to register for VAT if the total VAT taxable turnover in the last 12 months was over the VAT registration threshold (currently £85,000); or is expected to go over the threshold in the next 30 days.
The first ‘backwards looking’ test has to be considered at the end of every month – something which can be easily missed if a business is not up to date with its records, or only speaks to its accountant once a year.
The second ‘forward looking’ test has to be considered every day, and is one that many people forget about entirely. In practice, it is probably less likely to be met than the backwards look. However, it is worth keeping in mind if, for example, the business receives a particularly large order or contract.
Once either of the tests is met, the business needs to register for VAT with HMRC within 30 days. If it is late, HMRC will not only ask the business to pay VAT on any sales made since the date it was supposed to be registered, but can also charge a penalty of up to 100% of the unpaid VAT. This can be reduced if the oversight was an honest mistake, and if the business makes HMRC aware of the mistake in a timely fashion.
Not deregistering
At the other end of the spectrum, businesses may not spot when they are able to, or indeed have to, deregister from VAT.
Once registered for VAT, if a business ceases to trade or make VAT taxable supplies, it has to tell HMRC to cancel its registration within 30 days. As with failure to register on time, failure to deregister can result in a penalty of up to 100% of any lost VAT revenue.
If the business continues, but shrinks so that it falls back below the VAT registration threshold, it can also choose to voluntarily deregister from VAT. Whilst deregistering may bring advantages in terms of not having to charge VAT and file VAT returns, there are downsides as well. For example, it may need to account for any VAT on stock or assets in hand at the date of deregistration, and will lose the ability to reclaim any VAT it incurs on purchases. The pros and cons should be carefully considered before deciding on whether or not to stay VAT registered, as getting it wrong could be an exorbitant error.
Claiming without a valid invoice or not issuing a valid invoice
Generally, a business cannot reclaim any VAT it has paid unless it has a valid VAT invoice. This needs to contain specific information, including the amount and rate of VAT charged and the VAT registration number of the supplier. Importantly, a business cannot claim VAT back using an invalid invoice, a pro-forma or a delivery note. It is therefore important to check that it is receiving the right kinds of invoices from its suppliers. Otherwise, HMRC could ask the business to pay them back any VAT it has reclaimed, along with interest and penalties. VAT registered businesses also have a legal requirement to provide a valid VAT invoice to their VAT registered customers. However, general retailers like shops do not have to issue a VAT invoice, unless specially requested.
Keep track of points and payments
In January 2023, the previous ‘default surcharge’ regime which applied to late VAT return filing and late payment of VAT was replaced by a new penalty system.
Broadly, under the new late filing penalty regime, a business will receive a penalty point each time it files a VAT return late. Once the points reach a certain threshold (four points for quarterly returns) a £200 penalty will be charged. Each subsequent late submission will also incur a further penalty, until the points expire following a period of good behaviour. The way these new penalties work means that, unlike under default surcharge, a business can now receive a late filing penalty even if it usually files nil returns, or claims a repayment of VAT.
It is therefore important to keep track of any penalty points to ensure the business does not end up with a penalty. This can be done by logging into the business' online HMRC Business Tax Account.
The new late payment regime for VAT applies graded penalties based on how late the business is in paying, or arranging extra time to pay with HMRC. Until 31 December 2023, HMRC will not impose any late payment penalty, provided full payment is made within 30 days of the deadline – however, this grace period drops to 15 days from 1 January next year. It is therefore important that businesses make sure they pay their VAT (or get in touch with HMRC if they are struggling to pay) within the correct timeframe to avoid a penalty. Even if no penalty applies, HMRC will still charge interest at base rate plus 2.5% on any late payment made, so it is always worth paying as soon as possible.
» If the business is a sole trader or partnership, it also needs to watch out for the rules on personal use «
Reclaiming more than the business is entitled to
A common error made by VAT registered businesses is to assume that they can reclaim VAT on all of their expenses. However, some expenses won't have VAT charged in the first place because they are zero rated or exempt. Common examples include insurance, as well as bus and train travel. There are also special rules which block the business claiming VAT back on certain expenses – for example, it cannot claim VAT incurred on entertaining clients.
Motoring expenses is an area with a plethora of industry-specific rules, making it an easy place to make a mistake. As a general rule, a business cannot claim VAT back when it buys a car (unless it bought the car to sell on or hire out as part of the business, are a taxi driver or driving instructor, or can prove that the car is never available to employees or anyone else for private use). If instead of buying a car it is leased, then generally only 50% of the VAT charged on the lease payments can be recovered. Recovering VAT on petrol or diesel is also tricky – broadly, the business can either choose to only claim the VAT back on fuel used for business miles (it will need mileage records to support this), or it can claim all the VAT back and pay a fuel scale charge to account for any private use. Whichever option is chosen, it must be applied across the whole business fleet.
If the business is a sole trader or partnership, it also needs to watch out for the rules on personal use. If an expense has both business and personal use, it can only claim the VAT on the business element. For example, if there is a mobile phone where a quarter of the calls are personal, it can only reclaim the VAT on 75% of the costs associated with that phone.
Fundamentally, when VAT is claimed that the business is not entitled to, it will have to repay HMRC, and may be liable to penalties and interest.
Missing bad debt claims
In a time when businesses are feeling the squeeze, it's important to make sure they don't miss out on the chance to claim VAT bad debt relief.
If a business has supplied a customer with goods or services and the customer has not paid, the business may be able to claim the VAT back from HMRC. It must have already paid the VAT over to HMRC and written the debt off in its books. If there is a good chance that the business might still be paid, it is unlikely to be entitled relief. The debt also has to have gone unpaid for at least six months.
These rules cut both ways, which is easily overlooked. If the business has purchased goods or services and still not paid the supplier six months after the due date, HMRC will expect the repayment of any VAT recovered on that purchase. Failure to do so could result in interest and penalties.
Getting groups wrong
Forming a VAT Group can have distinct advantages. For example, a VAT group only submits a single VAT return covering all members, and supplies between VAT group members can generally be disregarded for VAT purposes.
However, there are a number of complications VAT group members need to be aware of.
Once the group is in place it should be kept in mind that the various thresholds and limits for VAT will apply to the group as a whole, and not the individual members. For example, the £10,000 limit for correcting an error on the next return and the payments on account threshold of £2.3m. This could see these rules taking effect earlier than expected.
Finally, whilst the general rule is that supplies between group members are ignored for VAT purposes, there are special rules to be aware of if the business is a UK VAT group member and acquires services from an overseas member of the group.
Summary
VAT is a quagmire ready to swallow up all who come across it. With so many quirks, foibles and traps set up, it is important to heed good advice; even those who consider themselves au fait with VAT can make mistakes which are expensive to resolve.