VATDIGITAL.COM
VATDIGITAL.COM
Demystifying VAT
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Introduction
VAT (Value Added Tax) is a tax on consumption and is added to the sale of goods and services supplied by VAT Registered businesses. Not all products and services sold attract VAT and there are a number of VAT rates or categories as follows:
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Standard Rated 20% (taxable)
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Reduced Rate 5% (taxable)
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Zero Rated (taxable)
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Exempt
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Outside The Scope
Depending on the goods being sold or services being provided, one of the categories above will be applied to the sale.
Standard Rated Goods and Services
Standard Rated goods and services are goods sold or supplied by VAT registered businesses and include 20% VAT. Therefore invoices to customers will include 20 % VAT.
Standard Rated services fall into the taxable services bucket and where businesses make taxable sales and exceed or are likely to exceed £90,000, they are required by law to Register for VAT.
Examples of Standard Rated goods and services include:
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Fuel
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Professional Services such as Legal and Accountancy
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Computers and Mobile phones
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Hotel Accommodation
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No Domestic Energy
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Alcohol
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Restaurant food and hot takeaways
Goods and Services with Reduced Rate VAT of 5%
Reduced rate VAT of 5% is mainly applied within the domestic fuel and construction industry.
Examples of Reduced Rate VAT at 5% include:
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Domestic / residential energy bills (Gas & Electric)
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Gas fired boiler installation
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Radiator
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Connection or re-connection to the gas mains
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Renovating a dwelling that has been empty for at least 2 years
Zero Rated VAT
Goods and services supplied as Zero Rated VAT are taxable supplies but without VAT applied. Therefore invoices generated and sent to customers for zero rated supplies will not include VAT.
Examples of Zero Rated goods and services include:
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Children's clothing
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Books
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Sewerage services supplied to domestic or industrial customers
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Water supplied to domestic households
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Insulation
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Take away - cold food
Note: where businesses make sales of goods and services to non UK business customers, these can also be treated as Zero Rated in some instances as they are deemed outside the scope of UK VAT but are classed as taxable services which carry the right to deduct Input VAT. (Please see place of supply button)
Exempt Goods and Services
Exempt supplies of Goods and Services unlike standard rated and zero rated are not taxable supplies. Exempt supplies are listed in the VAT Act 1994 Sch 9 and include the following:
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Postal Services
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Insurance
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Land and Property Rental
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Education
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Financial Services
Tax Point Rules
Tax points are the specific points in time when sales of goods or services take place and are governed by rules set out by HMRC.
VAT registered businesses must account for VAT within the period the tax points for their sales occur. So if a tax point occurs in March and the businesses next VAT return period is January to March then the VAT on the sale will have to be included within the quarter ending March VAT return.
Basic Tax Point
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Goods - The date when you send them to your customer or the customer takes them away or for goods assembled at a suppliers premises, when the goods are made available to the customer
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Services - The date when the service is performed — it’s normally taken as the date when all the work except invoicing is completed
Actual Tax Point
The basic tax point will be overridden if an actual tax point is created.
An actual tax point is created when:
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An invoice is issued or payment is received (whichever is first) before the basic tax point.
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An invoice is issued up to 14 days after the basic tax point
You do not have to follow the 14 day rule, but if you decide not to you must tell HMRC by writing to the VAT Written Enquiries Team.
If you wish to have an extension of the 14 day rule, then you must apply to HMRC by writing to the VAT Written Enquiries Team, giving your reasons.
Note: Failure to tell HMRC about extending the 14 day rule will result in the tax point reverting to the basic tax point.
Continuous Supplies of Services
If you supply services on a continuous basis and receive payments regularly or from time to time, there’s a tax point every time you issue a VAT invoice, or receive a payment, whichever happens first.
If payments are due to be made at regular intervals (for example, by banker’s order or direct debit), you can issue a VAT invoice at the start of any period of up to one year (provided that more than one payment is due in the period) to cover all the payments due in that period.
For each payment you should set out the:
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VAT-exclusive amount
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Date on which the payment is due
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Rate of VAT
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VAT payable
If you decide to do this, you do not have to account for tax on any payment until the date on which it is due, or date you receive it, whichever happens first.
Your customer must not reclaim, as input tax, any VAT shown on the VAT invoice until the date on which the payment is due, or you have received the payment, whichever happens first.
The same procedures apply to continuous supplies of goods, in the form of water, gas and electricity.
Goods supplied on sale or return, approval or similar terms
When you supply goods on sale or return, for example, they have not been sold and you still own them until such time as they’re adopted by your customer. Adoption means that the customer indicates a wish to keep them. Until your customer does so, your customer has an unqualified right to return them at any time, unless you have agreed a time limit.
You may have fixed a time limit of adoption of less than 12 months from the date when the goods were sent.
If a time limit has:
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Been fixed for a period of 12 months or less, then the Basic Tax Point is the date the time limit expires
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Not been fixed or fixed for a period of more than 12 months, then the Basic Tax Point is 12 months from the date when the goods were sent
Note: In either case if your customer adopts the goods before the time limit expires the date of adoption becomes the basic tax point. Also the basis tax point as mentioned above will be overridden by the actual tax point
on the date an invoice issued by the business providing the goods or the date payment is received for the goods, which ever is earlier.
If you receive a payment which is not returnable, this will normally indicate that the goods have been adopted. The payment of a deposit required as a condition of delivery — which is repayable if the goods are returned — does not constitute adoption.
Finally, It is a businesses responsibility to make sure that its customers notify them promptly when they have adopted goods.
Goods taken for personal or other non-business use
Goods that are taken out of a business:
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Permanently for non-business use will have a basic tax point on the date when the goods are taken or set aside for this purpose
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Temporarily for non-business use, but they’re still part of its stock or business assets, then a tax point is triggered each time they’re used or — if the non-business use continues over a period of time — on the last day of each tax period that the goods are used or made available for that purpose
VAT Returns
VAT Registered businesses that make supplies of goods and services are required to file their VAT returns to HMRC either monthly or quarterly (depending on VAT scheme) to pay over the Output VAT collected on sales to their customers and also to recover any Input VAT they have incurred on supplies they have purchased for operating their business.
The difference between the Output VAT collected and the Input VAT incurred will form the basis as to whether VAT is payable or recoverable from HMRC.
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VAT collected on Sales greater than VAT incurred on purchases = Payment due to HMRC
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VAT incurred on purchases greater than VAT collected from customers = Recovery of VAT from HMRC
Any exempt and zero rated supplies a firm makes to its customers or purchases from its suppliers also need to be included on the VAT Returns in boxes 6 and 7 respectively.
Partial Exemption - VAT Recovery
In addition to Output VAT that is collected by a business on its sales and then paid over to HMRC, businesses can also recover VAT on expenses they incur. The recovery of VAT depends highly on the nature of the supplies being made by the business.
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Business is only making Taxable Supplies (Standard rated, reduced rate or zero rated) - then the Input VAT incurred on its purchases is directly attributable to its taxable sales and can be fully recovered from HMRC.
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Business only makes Exempt Supplies - Then it cannot recover any of the input VAT incurred on purchases as the input VAT is directly attributable to supplies of exempt goods or services.
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Businesses making a mixture of Taxable and Exempt Supplies - This type of business is known as a partially exempt business and because not all of its supplies are taxable, it can only recover a calculated percentage of the input VAT it has incurred.
Partially Exempt Businesses - will be required to calculate their partial exemption recovery percentage or rate and then apply this rate to their pool of input VAT that they have incurred. The standard method for calculating the partial exemption recovery rate is as follows:
Taxable Sales (Standard, Zero, Reduced Rate) / Total Sales (Standard, Zero, Reduced Rate, Exempt) = VAT Recovery Rate Percentage %
Example - Standard Rated Sales £1,000, Zero Rated Sales £500, Reduced Rated Sales £200 and Exempt Sales £2,000
£1,000 + £500 + £200 / £3,700 = 46 % RR
If the input VAT pool is £20,000, then the business can recover £9,189 from HMRC via its VAT return.
Note: Many larger and more complex businesses (such as banks) will have Partial Exemption Special Methods which will have been formulated specifically for their business and agreed with HMRC. Many businesses will have multiple internal business areas and products and as such using the standard method may not be suitable. Once formulated businesses will be required to adhere to their agreed Partial Exemption Special Methods and keep HMRC up to date on any internal business restructures that might affect the agreed method.
HMRC - has the right to issue a Special Method Override where they believe the existing method in use does not produce a fair and reasonable level of VAT recovery.
Annual Input VAT Adjustments
As part of the VAT return process partially exempt businesses are required to complete annual Input VAT adjustments to ensure the correct amount of VAT has been recovered from HMRC for the overall year. Normally businesses will file quarterly VAT returns which include VAT recoverable for the quarter. The recovery of VAT on the quarterly returns will be based on the input VAT allocated between Taxable and Exempt sales for the quarter or based on the previous years VAT recovery rates which are being provisionally used for the current year until the annual adjustment is completed. So VAT returns completed during the year are actually provisional in terms of the recovery of VAT.
As such at the end of the year input VAT recovery will need to be revisited to:
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Review how input VAT has been used in the business to see if there has been any change in use. (Taxable / Exempt)
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Recalculate VAT Recovery Rates based on the current years sales data
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Review input VAT allocations to different areas of the business
Once the above process has been completed, the recalculated input VAT recovery for the whole year will then be compared with the input VAT reclaimed on the quarterly returns. Any under or over recovery of VAT will then be refunded or repaid to HMRC normally via the first VAT return of the following year.
From a business perspective, it maybe important to carry out mid year reviews of the VAT recovery by looking at aspects such as actual VAT incurred and Actual VAT recovery rates so as to not have large swings in irrecoverable VAT which can affect P&L where the input VAT throughput is significant. (Most relevant to partially exempt businesses where VAT recovery is high).
Reverse Charges
Where firms purchase services from non UK suppliers that would normally have VAT applied in the UK, they will have to self account for reverse charge VAT in the UK. The purpose of this measure is to ensure UK companies have a level playing field competitively and as such ensure companies do not make their purchases abroad just to avoid paying 20% VAT.
The following purchases would attract Reverse Charge VAT
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Legal and Accountancy services
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Software
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Advertising
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Consultancy
For example if a UK company purchased legal services from a company in France for £1,000 then the UK company would have to include £200 on its UK VAT return as output VAT and will equally it will able to include £200 as recoverable input VAT. Note: as mentioned under partial exemption above, the level of input VAT recoverable by a business will depend on the type of sales it makes. If a firm only makes taxable (standard and zero rated supplies), then it will be able to recover the full £200 reverse charge VAT which is payable to HMRC. In this case, as the reverse charge VAT payable is equal to the reverse charge VAT recoverable and as such there is nothing to pay HMRC.
If the firm also made exempt supplies to it's customers and the French legal fee charge was not related to a specific taxable supply being made by the UK company, then it would only be able to recover a portion of the £200 reverse charge VAT based on its Partial Exemption Recovery rate.
On its VAT return the business would enter £200 in box 1 (Output VAT) and £200 in box 4 (input VAT recoverable) and thus box 5 ( VAT payable of recoverable from HMRC ) would be nil. The net values of the services would go in box 6 (net outputs) and (net inputs) respectively.
For more information on reverse charges, please click on reverse charge button on the home page.
Pre VAT Registration Expenses
Where a business buys goods or services before it registers for VAT, to support taxable business activities when it is registered, it can recover the tax provided that:
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in the case of goods (either stock for resale or fixed assets), the goods remain on hand at the date of registration and will be used in the newly registered business. These goods must have been bought within the time limits that are set out in regulation 111; for businesses with a registration date after 1 April 2010 the time limit will be 4 years
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in the case of services the supply was made not more than six months before the date of registration. Six months represents a period in which it is deemed that services obtained will relate to business activity carried on at the time of registration.
Tax incurred on goods on hand at registration (other than capital items - see below) cannot be deducted if the VAT was incurred outside of the time limits set out in regulation 111. This includes VAT incurred on services performed on those goods.
If a business is given a backdated registration date this becomes the relevant date for working out the extent of the time limits.
Businesses are not required to reduce the VAT deducted in respect of pre-registration use of fixed assets.
For example, VAT incurred on a van purchased three years before registration and used before and after registration would be recoverable in full, subject to the normal rules on VAT deduction.
You can only reclaim VAT on purchases for the business now registered for VAT. They must relate to your ‘business purpose’. This means they must relate to VAT taxable goods or services that you supply. Please see below HMRC link for more information.
Required VAT Records and Accounts
All taxable persons must keep and preserve certain records and accounts.
This VAT record-keeping requirements that anyone who is registered for VAT must comply with includes:
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The VAT account
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What records must be kept
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Maintaining and preserving records
For more information see Record keeping (VAT Notice 700/21).
-Contains public sector information licensed under the Open Government Licence v3.0.