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Introduction

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VAT Risk - Failure to introduce and continually develop robust controls in relation to VAT within the E2E processes in an organisation and can result in:   ​

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• The over-payment of VAT to HMRC

• Under recovery of VAT From HMRC

• Fraud

• HMRC Penalties and Fines

• Reputational Damage with HMRC

• Increase in VAT P&L Cost

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 VAT Risk Areas 

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​Client On-boarding Risks (know your Client)

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• Failure to document and verify a client's residence or their businesses country of operation resulting in incorrect VAT determination within billing systems and thus incorrect VAT applied on invoices. Potential fines and penalties from HMRC. 

• Failure to obtain and verify a clients VAT registration number or determine if they are in business resulting in incorrect billing for VAT and potentially aiding fraud.  Potential fines and penalties from HMRC. 

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Note - Issues such as above can usually be identified during HMRC audits where samples of client details are requested along with their country of residence or operation which HMRC will then test against VAT applied to their Invoices.

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Supplier On-boarding Risks

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• Failure to obtain and verify a suppliers VAT registration details and number, potentially resulting in the invalid recovery of input VAT 

• Failure to obtain and verify a suppliers VAT registration details and number resulting in carousel fraud where fraudulent suppliers do not pay the VAT to HMRC.  Note: Domestic reverse charging in some industries like Telecoms (mobile phones etc) and the construction industry were introduced to combat this problem. 

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Accounts Payable Risks

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• Invalid VAT Invoices - Failure to review and validate supplier invoices to ensure they are compliant from a HMRC perspective and thus risking recovering VAT on invoices that are invalid resulting in HMRC claw-back and penalties 

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• Poorly Trained Staff  - Staff with little or no understanding of VAT can result in incorrect coding of invoices for VAT and potential under or over recovery of VAT.  Mistakes caused by incorrect coding will result in repeated Error Correction Notices (ECN's) having to be raised and submitted to HMRC which will attract penalties and damage the organisations reputation with HMRC

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• Failure to Reverse Charge Non UK Supplier Invoices for Services - Invoices received from non UK suppliers for services in the majority of cases (exceptions hotels, admissions to events, overseas property transactions, non UK transport) are required to be reverse charge and thus the organisation will be required to self account for output VAT to HMRC.  This is a common problem.

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• Failure to Reverse Charge UK Supplier Invoices Subject to the Domestic Reverse Charge Rules - Supplier invoices in certain industries are subject to the domestic reverse charge where the customer is responsible for accounting for the output VAT to HMRC.  This is normally the case in the construction industry, wholesale electricity and gas sales, mobile phone and computer chip industry.​

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• Processing Invoices Issued in a Foreign Currency where the VAT is not Translated to GBP  - Supplier invoices issued in the UK in a foreign currency are required to display the VAT amount in GBP along with the exchange rate used. Invoices where the VAT is not translated into GBP should not be processed as they are invalid from a HMRC perspective.

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• Application of Reverse Charge to Goods that have been Imported to the UK - Where goods have been imported into the UK and import VAT has been levied at the border or via the Postponed VAT Accounting (PIVA) procedure (where VAT is paid and recovered via the VAT return), there is no need to account for reverse charge VAT  again.  Procedures should be in place in Accounts Payable to identify and distinguish between invoices for goods and those for services to avoid such mistakes and potential VAT errors.

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• Input VAT Directly Attributable to Onward Supplies to Clients - Input VAT that is directly incurred (linked) to onward supplies to clients such as legal fees will often be recharged to the clients during billing. Where the underlying deal is a taxable supply in the UK or the supply is to a non UK counter-party then the associated VAT on such third party cost can usually be recovered in Full from HMRC .  If the underlying deal is a Financial Service provided to a UK counter-party and is Exempt from VAT, then the input VAT on such cost (legal fees etc) would normally be fully irrecoverable.  If an organisation does not have a process in place to identify and apply the correct VAT recovery to these costs then this can result in the under or over recovery of VAT from HMRC.

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• Third Party Costs Incurred  - Input VAT can only be claimed by the recipient company as addressed on the supplier invoice.  Therefore where a company pays for goods or services on behalf of a client or customer for example and the invoice is addressed to the client, then the company has no right to recover any input VAT shown on the invoice. (Even though it paid for the services).  Hence VAT recovery should be blocked in such cases.

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• Payments made Outside of the Accounts Payable System - Whereas the majority of payments made to suppliers by an organisation will usually be processed by its main accounts payable team,  there can be instances where payments are made by functions directly to suppliers and thus the usual checks and application of VAT may be bypassed unintentionally.  For example this can occur where front office functions pay for trading type costs direct or where self billing invoices are processed outside of the accounts payable function. The best way to monitor and mitigate against such risks is for tax teams to have regular catch-ups and with Finance, Front Office, Accounts Payable, Sourcing and other teams to identify such processes early. 

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Accounts Receivable (Billing) Risks

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• Manual Billing Processes - Where customer invoicing is carried out via manual  billing processes such as using MS Word or Excel, errors can occur where the VAT liability determination is not automated leaving staff to apply the correct VAT treatment.  If staff are inadequately trained in relation to VAT, then this can result in the issue of incorrect invoices .

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• Applying VAT to Inter- Company Invoices issued within a VAT Group - Companies within a VAT Group benefit from VAT free invoicing among group members and as such its imperative that there are controls in place to ensure VAT is not added to inter VAT group invoices resulting in additional costs for the recipient entity.

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• Not Applying VAT to Intercompany Invoices Issued to Non VAT Group Members - Whilst VAT will not normally be applicable to invoices issued to other entities within the VAT group, output VAT should always be applied to standard rated supplies on inter-company invoices where the UK recipient entity is not a member of the VAT Group that the issuing entity belongs to. 

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• Incorrect Static Data - It is common for billing systems to be fed with client data from static data systems to enable them to populate invoices with the name and address of clients, their VAT registration number and in some cases determine the correct rate of VAT to apply on invoices.  Where the static data held for clients is incorrect or not up to date, then this will inevitably result in invoices being issued with incorrect data and rates of VAT. 

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• Inadequately Trained Staff - the application of VAT is based on a number of factors such as product type, type of customer (business / non business), customer residence / country of operation etc.  If billing staff have a limited understanding of the application of VAT, then errors can occur during customer billing.  

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• Intervention and its Impact on Billing - A company may provide services to a non UK counter-party but its local branch may actually be heavily involved in providing the service.  Where this occurs, some countries (France for example) may have rules in place that state that local VAT should be applied to the transaction.  In such cases, even though the invoices are raised from the UK to the overseas customer, local VAT (French for example) should be applied to the invoice to ensure it complies with local VAT rules.  

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VAT Accounting Risks

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• Failure to Reconcile VAT Accounts - Accounting for and posting VAT correctly within the financial accounting system should always be followed up by preparing a monthly reconciliation of the output VAT,  input VAT and VAT control accounts to ensure all balances are fully supported by detailed and itemised lists showing what is items and actions are required to clear the balances. For example, the output VAT balance may contain VAT payable to HMRC next month or quarter, the input VAT balances may contain VAT recoverable amounts still pending for payment from HMRC.  Or both input and output VAT balances may contain amounts to be swept to the VAT control account for balancing with payments to and from HMRC.  Failure to carryout reconciliations regularly can result in significant uncleared balances being built up that are not fully understood or explainable by accounting staff and can result in errors going undetected.  This can also cause delays and the need to employ costly consultants to rectify when such issues are detected during annual external or internal audits.           

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• Failure to Book The VAT on Invoices Issued - There can be instances where invoices are issued and sent to customers but the VAT is not correctly booked to the output VAT account or worse booked to a revenue account which is contrary to the VAT accounting standard. This will result in the incorrect reporting of VAT to HMRC and possible penalties when the errors are detected.  Note such errors can be detected by HMRC when a customer includes an issued invoice within their VAT return to recover the VAT incurred. In such cases the errors will be categorised as careless by HMRC and result in severe penalties.   

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Sourcing / Procurement Risks 

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• Procurement for Major Contracts  -  There should always be a policy within an organisation for procurement teams to engage with both Legal and Tax teams prior to entering into contracts for the purchase of goods or services.  It is important that such contracts are efficient for VAT in terms of ensuring that the organisation does not incur unnecessary VAT costs.  A common example of this is where a firm enters into a contract with a supplier to provide global services to its organisation without considering how the contract should be formulated to ensure that local business contract for supplies directly.  Also where the UK head office is the main party to the contract and the supplier bills the UK, reverse charge VAT will be a significant cost which may not be fully recoverable.  VAT on such contracts will often not be budgeted for creating  large unexpected costs during the yea and impacting  the P&L account.   Also VAT registered companies importing goods should always ensure that they actually own the goods they are importing as import VAT is only recoverable where the goods are owned by the VAT registered entity.

 

Purchase of Goods from Overseas

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The importation of Goods from overseas will result in input VAT (20%) being levied at the boarder and paid to HMRC or included on the VAT return to pay and recover the VAT from HMRC under the Postponed Import VAT Accounting  (PIVA) process.  Input VAT is only recoverable by the owner of the goods and as such the legal owners of the goods should ensure that they are the importer of record and own the goods at the time of importation to ensure they can successfully recover the VAT paid to HMRC.

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New System Implementation

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• VAT Determination -  The introduction of new billing or accounts payable systems in an organisation will require close liaison with a VAT specialist or team to ensure the systems are correctly configured for VAT and more specifically to determine the correct VAT liability to apply to transactions.  Regular and continuous engagement here between IT, Finance and Tax teams is critical during the build or implementation process to ensure VAT is correctly set up within the system and to avoid costly reconfiguration.  

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• Making Tax Digital Requirement - All VAT registered businesses are required by HMRC to be MTD compliant by ensuring that their billing, AP and accounting systems are digitally linked (E2E) right up to filling their VAT return to HMRC via e-filler (API link).  Failure to do this will result in HMRC penalties and  possible reputational damage.  

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• Automation - Although automating processes within the VAT compliance area can result in significant benefits in terms of time saving, accuracy and data quality, it can also result in over engineering and create risks if the audit trail is lost and processes are subsequently changed.  It is therefore important that a complete integrity review of the existing  processes is carried out prior to automation. 

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Key Man Risk 

         

• Over Reliance on Key Individuals - Over reliance on individuals to manage specific processes in Finance or Tax brings with it the risk that key knowledge can simply evaporate if and when these individuals suddenly leave the business due to redundancy, illness, or simply move on to new role.  Organisations can then be left exposed to VAT risks due to the inability of existing staff to complete and file correct VAT returns.  Larger organisations with more complex operations may be forced to hire expensive contractors to plug the gap.  To prevent this, organisations                need to ensure they have robust and up to date process notes which include diagrams to illustrate key parts of processes.  Rotation of staff or work sharing can mitigate against such risks becoming embedded.   

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Changes in Business Structure

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• Partial Exemption Special Method -  PESM's are designed and agreed with HMRC to ensure there is a fair and transparent allocation of input VAT to different areas of the organisation and to ensure VAT is recovered in line with a prescribed recovery method.  To ensure PESM's are up to date it is essential that tax teams hold regular and annual meetings with both revenue generating product departments and accounts payable to ensure that any changes to the business structure or new products on boarded can be reviewed and the PESM amended and re agreed with HMRC.  Failure to do this will result in incorrect input VAT allocation and recovery and can be costly in terms of the P&L hit when VAT has been over-recovered and a repayment is required to HMRC.  

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Fixed Establishment 

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• Branches and Fixed Establishment - Where UK companies set up branches overseas for example in EU countries, they need to be aware of local rules sometimes driven by case law such as Skandia and Danskie Bank (see UK news page) which can impact the VAT liability of recharges between branches and their head office and visa versa.  Also where UK companies have subsidiaries overseas and those subsidiaries have UK branches that are a member of the head offices UK VAT Group, care must be taken to ensure those branches meet the criteria of having a fixed establishment in the UK.  That is, they are resourced with sufficient human and technical resources and are actually providing services in the UK.  Branches that are merely "brass plates"  where they have few or no employees or infrastructure and have no major trading activity and are mainly conduits of overseas recharged cost, may fall foul of HMRC fixed establishment and VAT grouping rules.  HMRC can de-group such branches.     

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Services Provided to Staff via Salary Sacrifice

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• Benefits Provided to Staff via Salary Deduction -  Benefits such as car parking, bikes for work where the cost is deducted from an employees salary are vatable and Standard Rated VAT at 20% is due to HMRC on such cost.  As these are not normally processed via the accounts payable team and are employee expense or payroll related, there is the risk that they will not be included in the VAT return process and overtime a significant VAT liability can build up which will eventually have to be declared to HMRC via an Error Correction Notice.  As a result HMRC can impose penalties and may lead to reputational damage.

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