VAT queries I receive from accountants can usually be divided into two categories:
those queries where our favourite tax is considered before a deal takes place …
they are my favourites; the second type is where a client has not taken
professional advice and the VAT horse has bolted a long way from its stable and
things have gone wrong. Very wrong in some cases! I will share some examples in
Option to tax – forgetting to tell HMRC
Imagine the following situation: you have taken on a client who has rented out a
property for many years, charging VAT on the rental income and claiming input tax
on the related costs. You discover that they have never notified HMRC of the
decision to opt to tax. Is this a problem?
There are two stages to making a valid election:
•Decision – the person with the interest in the property has decided that it makes
sense to opt to tax a property, usually because there is an input tax benefit.
•Notify HMRC – this must be done within 30 days of the decision being taken.
The good news is that HMRC will accept a retrospective election as long as the
taxpayer has always acted as though an option to tax election has been made, i.e.
the officer is given proof of VAT being charged on, say, past rental income. In other
words, the taxpayer made an administrative oversight by failing to notify HMRC.
This is different to the situation where a taxpayer has never decided to opt to tax
and discovers that they have sacrificed input tax and want to back pedal to correct
the situation. Needless to say, this is not acceptable.
(HMRC Notice 742A, para 4.2.1)
If a business has made net errors of less than £10,000 on past returns, they can be
included on the next return rather than formally notified to HMRC as a separate
disclosure. In the case of a larger business, the threshold increases to a maximum
of £50,000 if the error is also less than 1% of the outputs figure in Box 6 of the
return where the correction is being made.
I recently got a question from an accountant about a client who had charged
£100,000 plus £20,000 VAT for a building job in December 2021 and included it on
the return for that period. It was belatedly discovered that the job was zero-rated
so the builder issued a VAT credit for £20,000 in March 2022 and reduced his Box 1
figure on that return. Was this correct?
The answer is ‘no’ because the original error of £20,000 should have been notified
to HMRC in writing as an error correction, an overpayment, usually on form
VAT652. The escape route is to belatedly do a VAT652 which declares an
overpayment of £20,000 in the period for December 2021 and an underpayment
for the same amount in March 2022. In other words, the client should consider
what should have happened if things had been done correctly and work towards
Management charges: are they genuine?
Here is one of my favourite VAT dilemmas: company A is VAT registered and
making trading losses; company B is an associated company and making healthy
profits; it is also registered for VAT but as a partially exempt business.
To share the profits, A has made an internal management charge to B at the end of
three successive financial years, with the charge being included as
income/expenditure on the profit and loss account of the respective companies,
also being processed through the inter-company loan accounts. VAT has been
As I write these words, I can hear subscribers shouting out ‘own goal’ about the
potential input tax restriction for company B when the VAT issues are corrected,
i.e. the management charges are treated as standard rated. You are right.
However, there is a potential escape route:
•HMRC make it clear in their published guidance that management charges
between connected companies should represent a genuine recharge of costs
incurred by one company on behalf of another (VAT Supply and ConsiderationVATSC06512). The management services provided by the supplying company
should reflect actual services provided, for example employee time;
marketing/advertising services; overheads recharged;
•if these conditions are not met, the charges do not relate to a taxable supply of
goods or services subject to VAT – they are book entries only. The recipient cannot
claim input tax.
To support the above approach, the case of Stirling Investments ( TC 00374)
considered HMRC’s attempt to treat income received by a husband-and-wife
partnership from a limited company which they owned – a partly exempt business
– as a management charge rather than a dividend. This treatment would have
produced a bad outcome for the company, i.e. irrecoverable input tax due to partial
exemption. The tribunal agreed with the taxpayer that the commercial reality was
that a share of profits was being paid to Stirling Investments, which was correctly
classified as a dividend and therefore outside the scope of VAT.
As a final tale, I always enjoy telling the story about the property owner who
decided to deregister from VAT because the annual rental income from the
warehouse he owned – and which he had opted to tax – was less than the
deregistration threshold of £83,000. The decision to deregister was fine but there is
an output tax liability on the final VAT return on any stock and assets which are
standard rated and where input tax has been claimed on the initial purchase of the
items. As the market value of the property on the deregistration date was
£650,000, this was a massive output tax liability of £130,000, which he had
completely overlooked. Fortunately, HMRC allowed him to re-register for VAT with a
registration date that was the day after he had deregistered, meaning there was no
time gap and therefore no output tax liability on the property asset. He had
escaped a major VAT crisis by the skin of his teeth!
Links to commentary, legislation and other resources concerning opting to tax can
be accessed via this Quick link.
For commentary on correction of errors, see In-Depth from ¶55-000.
If you have any comments on this article, please e-mail the editorial team at firstname.lastname@example.org.
Document downloaded on 29-08-2023 from Croner-i Navigate, the UK’s leading
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