REGISTRATION

In this section we give an overview of the VAT registration process, including when your business must register, as well as situations where you don’t have to register, but may wish to anyway.

 

What is VAT registration?

VAT registration is simply the term given to the process by which a business informs HMRC of its requirement (or voluntary wish) to obtain a VAT number. Registration can be compulsory or voluntary.

 

When does a business need to register?

The main VAT registration test for an unregistered business is based on checking historic sales on a rolling twelve-month basis to ensure they have not exceeded £85,000. Where this is exceeded, your business must register within 30 days of the month end. HMRC will send you a VAT Registration Number and you will need to start charging VAT on your sales from the first of the next month.

But there is also a second test to consider, namely that registration is required if taxable sales are expected to be more than £85,000 in the next 30 days alone. The registration date is the beginning of the 30-day period, i.e. immediately. This test ensures that large businesses have to register as soon as they start trading in the UK, e.g. a major overseas retailer opening a UK branch.

 

Example

French Perfume, a major retailer based in Paris, is opening its first UK store in London on 1 June 2023. Monthly sales are expected to be £200,000. The business will need to be VAT registered in the UK by 1 June 2023 because it knows its taxable sales in the 30 days thereafter will exceed £85,000.

 

Can I register early?

Your business can apply to be VAT registered as soon as there is an intention to make taxable sales in the future - there is no time limit regarding the date of the first sale. This is known as an intending trader application. HMRC might want proof of business intentions before accepting the registration, e.g. business plans, contracts with potential suppliers and customers etc.

 

What income counts for the purposes of the £85,000 tests?

The key phrase is “taxable” sales and not “total” sales as far as VAT registration is concerned. This means that any sales made by your business which are exempt or outside the scope of VAT are excluded from the calculations. It is important to be clear about the difference between exempt, outside the scope and zero-rated sales because the latter are included in the calculations.

However, in a bizarre twist to the rules, most services purchased from abroad by your business are also included as taxable sales as far as the threshold is concerned. These are known as “deemed supplies”. For example, if a firm of accountants has annual income of £80,000 from UK clients and uses the services of an India-based bookkeeper to help with its work, paying the Indian firm £10,000 each year, then its total taxable sales are £90,000, triggering compulsory registration.

Additionally, if your business takes over a business as a going concern, you must take into account the annual taxable sales of the seller by treating them as your own sales for the previous twelve months.

It may be possible to avoid registration if you can convince HMRC that exceeding the threshold was a “one-off” event, perhaps due to an unusually large order. However, in this Special Report we are assuming you are already registered (or wish to be).

 

Why would I register voluntarily?

Perhaps the most common reason for registering before hitting the £85,000 threshold is where you are about to start spending money on a property, or incur other large expenditure in the setting up of the business and want to recover the input tax. In the absence of registration, the VAT would be an additional cost to your business. Being VAT registered may also give your business an air of respectability.

You may want to register for VAT if you sell to other registered businesses which are fully taxable. They can recover the VAT which is charged to them. The costs of the business are reduced by the input tax, which it can recover. However, you probably won’t want to register for VAT if you sell mostly to the public, and charging VAT means that you either must increase your retail prices or reduce your profits. The same applies if you mainly sell to businesses that mainly make exempt supplies, or unregistered businesses.

 

What VAT planning is possible when registering?

It is possible for you to reclaim some of the VAT you incur before you register on the first VAT return (when you eventually do). VAT can be reclaimed on pre-registration purchases of both goods and services, but there are restrictions. VAT can be reclaimed:

• on goods if the purchase was incurred during the four years prior to registration
• on services if the purchase was made during the six months prior to registration.

In both instances, there is a further condition that the goods or services must not have been fully “consumed” before the registration date. This might prove tricky with services, for example rent, which apply to specific periods. Stock items that have been sold will also be excluded.

 

Can I backdate a registration to maximise recovery?

HMRC’s VAT Notice 700/1 says “We may allow you to backdate your registration voluntarily by up to four years when you apply to register. This will allow you to claim back VAT as per the time limits above.”

A business that is registering for VAT could apply for the effective date of registration (EDR) to be backdated by four years, thereby allowing VAT to be recovered on goods purchased up to eight years before the application to register is submitted. The backdating is at HMRC’s discretion.

However, there is a further twist to this. Output tax will need accounting for on all supplies going back to the EDR. You will therefore need to weigh this against the potential input tax recovery. If most of your customers are VAT registered, you should be able to recover most of the output tax needed by issuing VAT-only invoices to them. They can then recover this as input tax on their own returns. Of course, this assumes that they are still in business and are contactable.

Don’t forget, the items purchased must still be owned by your business at the EDR. Looking at outgoings alone won’t give you enough information to make a qualified decision here.

 

How do I register?

Most businesses can register online via their Government Gateway account. Alternatively, a registration can be requested by filling in Form VAT1 (here), but generally it will be quicker to use the online service (by at least ten days according to HMRC).

There may be additional forms needed in some circumstances, e.g. certain business importing goods from the EU into Northern Ireland following Brexit. The VAT1 form makes this clear.

If you want to apply for a registration exception after exceeding the £85,000 threshold, you must still complete Form VAT1 and explain why you believe your VAT taxable turnover will not go over the deregistration threshold of £83,000 in the next twelve months.

If you want to apply for a backdated registration, you will be prompted to enter the desired date as part of the form filling process. You will also be asked to choose your preferred VAT return periods. Usually, these will be quarterly, and it makes sense to request periods that coincide with your financial year end.

In any case, HMRC will process your application and, subject to approval, notify you of your VAT number, VAT periods and EDR in due course.

 

When will I need to start charging VAT?

This depends on the reason for the registration. If you are registering compulsorily, you must charge VAT from the date you are required to be registered from. If you exceeded £85,000 in the previous twelve months, you have to register within 30 days of the end of the month when you went over the threshold. Your effective date of registration is the first day of the second month after you go over the threshold.

If using the future turnover test, you have to register by the end of the 30-day period. Your EDR is the date you realised, not the date your turnover went over the threshold. If you register voluntarily, you must charge VAT from the registration date you agree with HMRC. If you choose an earlier registration date, you have to account for VAT on all sales from that date, as discussed above.

 

What if I need to charge VAT before receiving my VAT number?

HMRC’s guidance says: “You cannot charge or show VAT on your invoices until you get your VAT number. However, you’ll still have to pay the VAT to HMRC for this period.” This implies that you might end up out of pocket if the date you register from is before HMRC notifies you of your registration number. However, that’s not necessarily the case.

If you’re registering voluntarily, you can ask HMRC for it to apply from a future date. We suggest a month in advance should be enough. You won’t need to charge your customers VAT until the date you’ve chosen. You won’t lose out on reclaiming VAT for most types of purchase while you’re waiting for HMRC to register you, due to the ability to claim pre-registration input tax as discussed earlier.

However, if you need to bill a customer after the date of registration has passed, but before your VAT number arrives, you have two options:

• send a bill without VAT and when you have the registration number send another for the VAT amount; or
• issue a bill but add an amount equal to the VAT, but don’t call it VAT (because the law says you must not). When you receive your registration number send an amended invoice showing the extra amount as VAT.

The first option could cause your customers confusion as they will seemingly receive two invoices from you for the same goods or services. Instead, add a separate amount to your bills equal to the VAT due and include a description against it which says: “This charge is in lieu of VAT pending registration. You cannot reclaim it on your VAT return until we send you a VAT invoice.” or words to that effect.

 

MAKING TAX DIGITAL: RECORD KEEPING

In this section, we look at the requirements your business will face following registration in respect of its record keeping and VAT reporting. We also give a brief introduction to the requirements of Making Tax Digital - compulsory for VAT reporting for all registered businesses since 1 April 2022.

 

What requirements do I need to adhere to once registered?

There are a number of requirements relating to your business records and VAT reporting. Broadly, you must keep sufficient records in order to satisfy HMRC that you are operating VAT correctly. This is also important to ensure you are protected from assessments that might be raised in the absence of supporting evidence. HMRC has wide ranging powers in respect of VAT and is entitled to raise assessments based on an officer’s best judgement where it’s not possible to ascertain the correct amount of VAT owing precisely.

You should retain your records for at least six years, and in some circumstances longer. This applies even if you deregister from VAT later on.

The type of things that you should retain are:

• your VAT account
• order copies, stock records, job cards etc.
• day books, cash books and other journals
• invoices, credit notes, and any paperwork relating to VAT schemes you have enrolled into
• bank statements and your annual accounts.

HMRC’s guidance regarding record keeping is useful as a reference point - see VAT Notice 700/21 (click here).

 

Is there a required form of VAT invoice?

The legislation requires that every VAT invoice you issue must be valid. This means it must contain certain information as a minimum. However, there is no prescribed format for this. A valid VAT invoice is your customer’s primary source of evidence to enable them to recover their own VAT.

Similarly, your own purchase invoices are a key requirement for you to be able to recover input tax on your costs. You should always check that invoices received are valid.

In order to be a valid VAT invoice, you must include the following details:

• a sequential number based on one or more series which uniquely identifies the document
• the time of the supply
• the date of issue of the document (where different to the time of supply)
• the name, address and VAT registration number of the supplier
• the name and address of the person to whom the goods or services are supplied
• a description sufficient to identify the goods or services supplied
• for each description, the quantity of the goods or the extent of the services, and the rate of VAT and the amount payable, excluding VAT, expressed in any currency
• the gross total amount payable, excluding VAT, expressed in any currency
• the rate of any cash discount offered
• the total amount of VAT chargeable, expressed in sterling
• the unit price
• the reason for any zero rate or exemption.

Retailers do not need to issue VAT invoices to unregistered persons, e.g. the general public. If you are a retailer you are permitted to assume no VAT invoices are required unless you are specifically asked for one. You are probably familiar with being asked if you need a VAT receipt at petrol stations.

If you are not a retailer, and you make a supply where the value does not exceed £250, it is permissible to issue a simplified invoice showing your name, address and VAT registration number the time of supply (tax point), a description which identifies the goods or services supplied, and for each VAT rate applicable, the total amount payable, including VAT shown in sterling and the VAT rate charged - exempt supplies must not be included in this type of VAT invoice.

 

What is the VAT account?

Every registered trader must keep a VAT account. This is a summary of the total output and input tax each VAT period. The amounts calculated in the VAT account are then transferred to the VAT return at the appropriate time. Since the advent of Making Tax Digital, this must happen automatically.

A VAT return is required for each VAT period, which are usually quarterly.

 

When is the VAT return due?

Almost all businesses are required to file their VAT returns electronically. The due date is seven days after the end of the month following the VAT period end.

Example

Parvinder is VAT registered. She has a VAT quarter ending 30 June 2023. The deadline for the return for that period is 7 August 2023.

The return includes a declaration that the content is true and complete. If your business is unable to include the exact amount of input or output tax on the VAT return, agreement should be sought from HMRC to include an estimate. Permission will be given, provided that an adjustment is made for the estimate in the next VAT period or, if the exact amount is still not known then, in the next but one VAT period.

Where permission is granted before the due date of the return, you will not be liable to penalties, provided that the return is submitted and VAT is paid by the due date. If, however, permission is sought retrospectively, any default recorded will stand.

3.5. What if I make a mistake?

If you make an error in a VAT return, it should be corrected or notified as soon as possible.

If the net error is less than the higher of £10,000, or 1% of turnover (up to a maximum of £50,000), you may adjust the VAT account for the period in which the error occurred and include the value of the adjustment on your next VAT return; no interest will be charged for errors corrected in this way; alternatively, you may choose to notify HMRC in writing.

If the net error is greater than or equal to the above limit, it must be disclosed to HMRC in writing, generally using Form VAT 652 (here). No adjustment should be made to the VAT account or return. HMRC will issue an assessment to collect the VAT. Interest will be charged in respect of errors notified in this way from the due date of the return to the date of the notification.

 

What is Making Tax Digital?

Making Tax Digital (MTD) is HMRC’s plan to remove, as far as possible, paper documents from the tax system. The headline features include new obligations for businesses and business owners to maintain and transmit their business records for direct tax purposes to HMRC far more frequently than under the current regime, which only requires annual accounts and tax returns. Essentially, the days of keeping books in manuscript will end.

Since 1 April 2022, all VAT-registered businesses have had to comply with MTD. Previously, it was only those with turnover above the compulsory registration threshold. If you are new to VAT, you will need to get to grips with MTD at the same time as the VAT system.

Under the previous system, with only a few exceptions, VAT returns were submitted using HMRC’s online services. For most businesses this involved logging on to HMRC’s VAT portal and entering the figures into return form boxes manually.

With very few exceptions, it is no longer possible to do this. Instead, you must use compatible software to submit your returns. This means no more typing in figures; instead when you click the submit button in your MTD software figures will be uploaded to HMRC’s site.

Broadly, once figures are initially input into your accounting system, e.g. when raising an invoice, there should be no further human input between that input and it being reported to HMRC electronically.

 

Do I need to buy new software?

If you have been VAT registered for some time it’s likely that your software is capable of submitting returns via MTD. However, it is a good idea to check with your software provider, who may also provide training or links to a video showing you how to use it properly. The MTD functionality may require additional fees to be paid in order to be activated.

If you are new to VAT, you may well need to purchase new software.

Broadly, there are two types of software for submitting your VAT figures:

1. An additional function which is part of your bookkeeping software.
2. Bridging software, which is a standalone app into which your figures are entered - HMRC expects this to be automated.

Bridging software links data stored in spreadsheets to HMRC’s online platform. This allows the information in the spreadsheets to be submitted digitally with no need for further human intervention. However, while this makes the VAT return MTD compliant, there are further record-keeping requirements needed. Bridging software is not enough on its own.

MTD is complex. You should make yourself familiar with the contents of VAT Notice 700/22 (click here), or request advice.

 

OUTPUT TAX: WHAT SHOULD YOU CHARGE?

In this section we look at what you need to charge your customers and when. There are different rules depending on whether you are supplying them with goods or services, so it is important to be fully aware of what it is you are providing them with.

 

When do I charge output tax?

Output tax must be accounted for at the “time of supply”. This might sound obvious, and of course you will add the appropriate VAT to your invoice. But actually, there are rules which specify exactly when supplies are treated as being made. These are informally referred to as the tax point rules. Generally, there are two tax points that can apply:

• the basic tax point; and
• the actual tax point.

It is important to understand the tax point rules as they determine which VAT return period a particular supply must be accounted for in. This might not be the same as the period payment is actually received.

There are modified rules for certain types of business, and for certain types of goods and services, for example professional services that are supplied on a continuous basis, e.g. accountancy services. However, we will assume that only the general rules are applicable for the purposes of this Special Report.

By default, the basic tax point determines the time of supply unless it is overridden by the actual tax point. A summary of the rules is shown in the following table:

Type of supply	Basic tax point	Actual tax point
Goods	Date that the goods are removed by, or made available to, the recipient	Either the date of: a.) issue of a VAT invoice, if it is either: -  before the basic tax point; or -  up to 14 days* after the basic tax point; or
Services	Date that the services are performed	b.) payment, if it is before the basic tax point

 

How do the basic tax point rules work?

In practical terms, most supplies are subject to the actual tax point, but it is still important to understand the basic tax point rules. Under the basic tax point for goods, supplies are treated as made on the date that the goods are removed by, or made available to, the customer. Goods are treated as removed when physical possession is transferred. Goods are also said to be made available if they are provided in situ. A good example of this is a car made available on the dealer’s site, which is actually provided to the customer via a third-party finance company. It would be highly unusual for the finance company to take possession of the car, so the supply is treated as being made when the customer takes possession of the vehicle on site.

Services are treated as performed when all work except invoicing is complete. So, for example, if an interior designer spent three weeks working on a property, the basic tax point will be the end of that three-week period. However, it is not always easy to determine when performance of services is complete. In these circumstances, it may be that the rules for continuous supplies apply.

 

When does the actual tax point override the basic tax point?

The issue of a valid VAT invoice can override the basic tax point if it is for a supply subject to VAT at either the standard or reduced rate (so zero-rated or exempt supplies don’t count). However, it must be physically issued or delivered to the recipient before, or up to 14 days after, the basic tax point. This is known as the 14-day rule.

 

Can I opt out of the 14-day rule?

Yes - suppliers can notify HMRC in writing that they wish to opt out of the 14-day rule. Any opt-out will generally apply to all supplies but can apply selectively as follows:

• where a business has a genuine commercial need to treat some supplies differently and can easily distinguish those supplies;
• where supplies are made by separate companies within a group registration; or
• in order to permit supplies made under a self-billing arrangement to be treated differently from conventional supplies.

 

What about extending the period?

It is also possible to apply in writing for an extension to the 14-day limit, provided that you can demonstrate a genuine commercial need to do so (for example, because the price of the supply cannot be fixed until the supplier has been invoiced for materials). To create a valid tax point, the invoice must then be issued within the time allowed.

The length of any extension granted by HMRC will depend upon the individual circumstances but in general is unlikely to exceed three months.

 

What if the customer pays early?

Any payment made before the basic tax point moves the tax point to the date of payment, provided that the payment is received by the supplier of the goods or services. Payment will be treated as being received when the customer has done everything it can contractually do in order to make payment (that is, when the supplier no longer has the right to sue for payment). This applies even if payments are made under arrangements which restrict the recipient’s use of the money.

The time at which a payment can be said to be received depends on the method used, as follows:

Type of payment	Time of receipt
Cheque	When cheque has cleared into the recipient's account (normally five working days)*
Credit card/charge card, etc.	When sums are paid over to the supplier by the card company*
Bank transfer	When payment is actually transferred to the recipient's account
Book entry (“set-off”)	When entries are made in the accounting records (provided that the debt is also settled when making these entries)

 

Are there any planning opportunities with the tax point rules?

It is possible to delay the payment date for your output tax by carefully applying the tax point rules. This doesn’t actually save any money but can improve your cash flow. By delaying invoices for the sales made in the last 13 days of a VAT quarter you can move the tax point into the next quarter - moving the payment date back by three months.

Example

Acom Ltd’s next VAT quarter ends on 30 June. It sells and supplies £50,000, excluding VAT, of goods between 17 June and 30 June. If it dates the invoices for these on or before 30 June it will have to account for the VAT of £10,000 (£50,000 x 20%) to HMRC by the end of July. But if instead Acom dates the invoices 1 July, payment of the VAT will be pushed back to the next return period due, i.e. the end of October.

You only have to account for VAT when a sales invoice is actually sent out, not when it’s produced. Where you produce tax invoices on the last day of your VAT period and don’t post them until the next, stamp them with the actual issue date to push the VAT date into the next quarter and so delay the time you have to pay over VAT by three months.

 

What amount do I add the VAT to?

You add the VAT to the “value of supply”. In most cases, this will simply be how much your customer pays, but any non-monetary consideration should be valued in order to establish how much VAT must be accounted for, since the value of the supply is the value of the consideration given for it.

If your supply is made wholly for monetary consideration, the amount of VAT chargeable is calculated by applying the appropriate rate to the VAT-exclusive value of the goods or services. If the price charged is VAT-inclusive, the appropriate VAT fraction is applied to determine the amount of VAT chargeable. The total value of the consideration is the VAT-exclusive amount plus the VAT chargeable.

Example

Ms A purchased standard-rated goods from Mr B for a VAT-inclusive price of £100 in cash:

• the VAT element is £16.67 (1/6 × £100)
• the value for VAT purposes is £83.33; and
• the total consideration is £100.

Ms C purchased standard-rated goods from Mr D for a VAT-exclusive price of £100 in cash:

• the VAT element is £20 (20% × £100)
• the value for VAT purposes is £100; and
• the total consideration is £120.

HMRC can sometimes substitute market value in place of actual consideration, but this generally only happens if the payment is artificially low and made between connected persons.

 

How do I value non-monetary consideration?

In some circumstances, goods or services may be provided instead of, or in addition to, monetary consideration. For example, a builder may negotiate an agreement with their accountant for a discount in exchange for carrying out some structural repairs.

“Services” here could include the giving up of a right, refraining from doing something, or agreeing to suffer some loss, etc. in return for the supply.

The way you value non-monetary consideration depends on whether or not there is a clearly identifiable monetary equivalent that would have otherwise been paid. If there is, the valuation is simple. For example, A provides goods with a retail price of £100 to B in return for services. The non-monetary consideration (the services) will be valued at £100 and VAT accounted for accordingly, as there is a clearly identifiable monetary equivalent.

If there is no clear monetary equivalent, the non-monetary consideration (the services) will be valued at the cost price to you of supplying the goods and VAT accounted for accordingly.

 

What if there is no consideration?

If there is no consideration, the value of the supply is the amount that would be payable if the person making the supply were to purchase goods identical to those supplied (or, where this cannot be determined, goods similar to those supplied) at the time of the disposal.

If it is not possible to establish this figure, the fall-back value is the cost of producing the goods if they were produced at the time of disposal.

 

Can HMRC can impose VAT where there is no commercial supply?

There are some transactions that aren’t sales, but are “deemed supplies” and so VAT must be accounted for. These are:

• gifts of business goods and services
• self-supplies of certain goods and services
• private use of goods or services originally acquired for business purposes; and
• the retention of business assets on deregistration from VAT.

Gifts of business goods are supplies that are subject to VAT; output tax should be accounted for on your VAT return.

However, gifts of goods made in the course or furtherance of a business are not supplies if the cost of acquiring or producing all gifts made to the same person in any twelve-month period is less than £50.

Gifts of supplies are generally not subject to VAT - unless a third party supplies them.

 

What counts as a gift?

A gift is defined by HMRC as the voluntary transfer of property for no consideration. Examples are:

• brochures, posters and advertising matter
• long-service awards and retirement gifts
• goods supplied to employees under attendance or safety at work schemes
• items distributed to trade customers
• prizes dispensed from amusement and gaming machines; and
• prizes of goods in betting, gaming and free lotteries.

 

What if I make occasional gifts to my employees?

In general, the rules are the same as described above. There are special rules that apply in relation to supplies of catering and accommodation that block input tax from being recovered. For example, if you provide restaurant meals as a staff reward the supply is between the restaurant and the employee, so input tax cannot be recovered.

There may also be income tax and NI considerations with employee gifts.

 

What is a self-supply?

A self-supply takes place where eligible supplies are taken possession of, or produced, by a person in the course of business and they are then consumed by that person. In other words, the supplies are neither provided to another person, nor incorporated into goods produced in the course or furtherance of the producer’s business.

Where there is a self-supply, the goods or services are treated as being supplied both by and to the trader. Accordingly, the trader:

• must account for output tax on the goods or services; and
• is treated as having incurred input tax on the same supply, which the trader may be able to recover.

If you only make taxable supplies, the net cost is nothing as you can recover the input tax in full. It’s only a problem if your business is partially exempt.

Example

You are a partly exempt self-employed trader and use your own employees to make alterations to your home. In the absence of special rules, you would avoid VAT on this as you and the business are the same legal entity, i.e. you are supplying yourself. The rules ensure this is not the case so you must account for output tax on the deemed supply and restrict your input tax recovery according to your partial exemption method.

 

Do these rules apply to all self-supplies?

No. The self-supply rules only apply to property services, cars, assets (including stock) on hand when withdrawing from the flat rate scheme, and where a business is sold as a qualifying transfer of a going concern.

 

I’ve reported all my output tax, but the customer isn’t paying the invoice. What can I do?

There is protection within the legislation for bad debts. If your customer never pays, you are entitled to claim a refund of any output tax you have accounted for in respect of their invoice. However, there are a number of conditions.

A business can only claim bad debt relief (BDR) on a VAT return when the following conditions are met:

• the sales invoice(s) in question is more than six months overdue for payment
• the invoice has been written off in the business records and accounts, i.e. the customer’s sales ledger account has been credited and a bad debt expense also created
• output tax must have been accounted for on the original sales invoice and declared and paid to HMRC on a VAT return; and
• the debt must not have been sold, factored or paid under a valid legal assignment.

Example

If a sales invoice is issued to a customer on 31 March 2023 on 60-day payment terms, then the earliest date for a possible bad debt claim is the VAT return that includes 30 November, i.e. six months after the due payment date of 30 May.

The latest time BDR can be claimed is four years and six months after the later date of the time of the supply (usually invoice date) or due date for payment. The VAT amount claimed is included within the Box 4 input tax figure of a return.

Note. If you claim BDR and subsequently receive payment from a customer, output tax must be declared on the return that coincides with the payment date.

 

Is there a way to speed up relief?

You could consider joining the cash accounting scheme (click here), meaning you only account for output tax when you are actually paid.

 

INPUT TAX: WHAT CAN YOU RECLAIM?

Perhaps the most attractive feature of VAT registration is the ability to claim input tax on your purchases. However, it is not as simple as just reporting the VAT you have paid on your VAT return. In this section we look at the rules regarding input tax in more detail.

5.1. What is input tax?

Input tax is the VAT incurred by your VAT-registered business in respect of supplies of goods and services which it uses, or intends to use, for the purposes of its business.

Any VAT incurred for non-business purposes, or by a non-registered business, is not input tax and is usually not recoverable.

One of the biggest incentives for businesses to register for VAT voluntarily is to recover VAT paid on its business costs. In particular, the ability to reclaim VAT prior to registration can be very valuable, especially if significant costs have been incurred prior to making any turnover.

For this pre-registration VAT to be recoverable, it must meet the following conditions:

• it must have been incurred for business purposes
• it must be wholly or partly attributable to taxable supplies
• recovery must not be specifically blocked
• the supply must have been made to the claimant
• input tax must have been correctly charged; and
• sufficient evidence of all the above must be retained.

 

What counts as a business purpose?

In order to recover the VAT on a purchase it must have been made for the “purposes of the business”. In most cases this would be clear; for example, a printer buying paper or a garage buying car parts. However, there are circumstances where the business purpose isn’t clear, in which case HMRC may start enquiring about the real purpose of the purchase.

Some businesses have ended up in disputes with HMRC because they have tried to claim input tax on activities that fall outside the boundaries of their business. Typical examples include: (1) costs related to domestic accommodation; (2) costs in the pursuit of personal interests such as sporting and leisure-orientated activities; (3) spending for the personal benefit of company directors, proprietors, partners; and (4) spending in connection with non-business activities.

Where there is no obvious relationship between the business activity and the ownership of items such as yachts or aircraft, HMRC will normally take the view that the purchase is principally for the private use of the business owner and disallow the input tax claim.

Where the connection between the expenditure and the business purpose is not clear, it is up to your business to explain to HMRC how the purchases in question play a valid part in the business. When checking a claim HMRC will have to think about the intent of the business when making the expenditure in question. This is a subjective test which requires the officer to look into the mind of those running the business at the relevant time.

HMRC then has to decide whether there is a clear connection between the actual or intended use of the purchase and the activities of the business. In other words, think about what the business does to earn income. So, if a legal firm buys gardening equipment it’s not likely to be used in its legal practice.

Input tax incurred on a cost can be claimed if it relates directly to the function and carrying on of the business. If it merely provides an incidental benefit, it’s unlikely that input tax can be claimed. It’s important to establish a clear link between the expenditure and the actual sales carried out by the business. If this link does not exist, then the VAT can’t be recovered.

Example

John the builder joined his local private golf club last year. He has made several connections which have led to additional work for his business as a result of this. However, John cannot reclaim the VAT on his membership fees as the primary purpose of the expenditure is not business related, even though there is a clear incidental benefit to the business.

 

What if there is a mix of business and non-business expenditure?

Your business may acquire goods or services which are only partly for business purposes. In this case, only the portion of the VAT relating to the business should be recovered on the VAT return. There are two methods available to do this.

1. Apportionment. Make a reasonable apportionment and only include the input tax relating to business use.
2. Lennartz method. Claim the full amount of input tax and account for output tax on any non-business use. This is only available in certain circumstances.

The Lennartz method can’t be used for goods which are subject to an input tax block. Neither can it be used in respect of land purchases.

Example - apportionment

Your business acquires a new double cab pick-up for £36,000 (including VAT of £6,000). It will serve as your main vehicle for work and private use. You estimate 60% business use and 40% private. You can reclaim 60% of the VAT (£3,600). If the proportion of business to private use changes, there’s no need to adjust your original claim.

Example - Lennartz

This allows you to reclaim all the VAT, so in our example of a van that’s the whole £6,000. But you must pay HMRC for any private use. This is calculated by applying the following formula: A/B x (C x U%), where A is the number of months in the VAT return period (usually three), B is 60 months unless you intend to sell or transfer the van sooner, in which case you use the number of months until then, C is the cost of the van (excluding VAT), i.e. £30,000, and U is the percentage of private use in the VAT period. It sounds a bit fiddly, but in practice it’s simple. For example, if in the VAT period you purchased the van you estimated your private use at 45%, the amount of VAT you must account for is 3/60 x (30,000 x 45%) = £675, which at 20% VAT is £135. The only variable you need to review for each VAT return is the private use percentage (45% in our example).

When 60 months have passed you stop accounting for VAT even where you continue to use the van privately.

 

Which is better?

The clear advantage of using the Lennartz calculation is cash flow. In our examples you would initially be better off because you could reclaim £6,000 VAT instead of £3,300 (£6,000 x 45%) using the other method. A second advantage is that the VAT payable will more accurately reflect your private use compared with the other method which requires you to guess the proportion of private use from the time of purchase until you sell or transfer it. In our view the cash flow advantage and accuracy of Lennartz trumps the alternative method.

 

What does “attributable to taxable supplies” mean?

Input tax incurred on goods or services used in the course of making exempt supplies is not recoverable (subject to de minimis rules) and is known as exempt input tax. A person who makes only exempt supplies is not able to register or recover any input tax. A person who makes only taxable supplies can recover all input tax incurred, subject to satisfying the relevant criteria. A business making both taxable and exempt supplies and whose exempt input tax is over the de minimis limit is said to be partly exempt; in this case a special calculation is required to determine the recoverable proportion of input tax. We look at partial exemption in the next section.

 

When is input tax blocked?

Some input tax is attributable to the fully taxable supply, but the VAT legislation prevents recovery of it regardless. Input tax is blocked in respect of:

• most business entertainment
• most cars and related supplies
• domestic accommodation provided for a director or owner of a business
• some items installed in new dwellings
• goods sold under a second-hand goods scheme; or
• items sold under a tour operators margin scheme.

Business entertainment includes any entertainment or hospitality of any kind that is incurred for business purposes to anyone other than an employee. In most cases, recovery of input tax on staff entertainment is permitted as it is a legitimate business expense.

If you “entertain” people who are not employees but are contractually obliged to do so, it does not count as entertainment for these purposes and input tax on related costs can be recovered.

Recovery is also allowed if a charge is made for attendance. This does not need to reflect the true cost of the event.

For example, if staff contribute to the cost of entertaining their partners, the input tax on the partners’ meals is recoverable, and output tax is due on the sums paid. The possible planning point is obvious when, for example, the annual Christmas dinner costs £70 per head and you charge the partners £10 per head to attend you get to recover all of the input tax on the £70 but only have to account for VAT on £10. HMRC has challenged this at the tax tribunal and lost.

This works in other circumstances too.

Example

You invite several clients to a hospitality box you have taken at a race day. By default, you cannot recover any of the input VAT, but if you required your clients to pay a modest charge to attend you would be able to recover it all.

In order to be effective, the charge must be compulsory not optional and it cannot be, e.g. a charitable donation. It has to be an attendance charge.

 

What about cars?

The availability of an input tax deduction on the acquisition, or hiring, of cars is very restricted. It is therefore vital to know whether a particular vehicle is a car, as defined by the VAT provisions, since input tax can be fully deducted on other types of vehicle used for taxable business purposes.

Input tax is deductible on the following types of qualifying car:

• stock for resale
• those acquired for the purpose of a car-related trade; and
• those acquired wholly for business use.

A qualifying car is one that has never been purchased by a non-taxable person, or on which input tax recovery has not been blocked for a taxable person. Normally, a qualifying car will be a new or a used car where the previous owners were able to recover all the VAT incurred on their purchase. This definition includes, for example, cars sold by leasing companies.

HMRC will usually only accept the following situations as constituting wholly business use:

• valid pool cars
• a car-leasing business; and
• vehicles that are unsuitable for private use, such as marked emergency cars, or those where steps have been taken to prevent private use.

If there is any element of private use, however small, no deduction is available. The input tax cannot be apportioned between business and private elements. If it is intended that the car be made available for private use it will not be acquired wholly for business use. Traders are assumed for this purpose to intend the likely consequences of their actions.

 

What about fuel for vehicles?

Where your business purchases road fuel, it has three options with regard to VAT:

• reclaim all input tax and pay a scale charge via its VAT return for any private mileage
• keep a mileage log and only reclaim input tax on the business miles; or
• make no claim for input tax on any road fuel (especially if total mileage is low).

A scale charge is essentially an amount of output tax that reduces the input tax claim. The scale charge is fixed and depends on the CO₂ emissions of the vehicle being used. HMRC’s online tool is available to help with this (click here).

The scale charge is likely to be most useful where total mileage is relatively high due to its fixed nature.

 

When is a supply made to the claimant?

We have discussed circumstances that constitute a supply being made. However, in order for input tax to be recoverable the supply must have been made to you as the claimant. Therefore, if the supply is made to a third party, no recovery can be made.

This rule is relaxed in certain circumstances where the supply is made to an employee of the business, provided that the supply is for business purposes. In this situation, the supply is treated as being made to the business and not the employee. This would include items such as subsistence and removal expenses incurred as a result of business relocation, but not perks such as gym membership.

 

How do I know if VAT has been correctly charged?

The amount of input tax recoverable is the sum correctly chargeable in respect of the supply. Therefore, where the supplier asks for an incorrect amount of VAT, the business may only claim credit for the amount that should have been charged.

If a non-registered person incorrectly charges VAT, by concession HMRC may allow you to recover it as input tax, provided that you acted in good faith and did not have close knowledge of your supplier’s business. The supplier must account to HMRC for the amount charged as VAT.

As this is a concession, you should always take all reasonable steps to ensure that your supplier has issued you with a valid VAT invoice, and is actually registered for VAT. You can use the online VAT number checker to do this (click here).