VAT – The Capital Goods Scheme

By Marcus Ward 8 January 2021

A brief guide to the Capital Goods Scheme (CGS)

If a business acquires or creates a capital asset it may be required to adjust the amount of VAT it reclaims. This mechanism is called the CGS and it requires a business to spread the initial input tax claimed over a number of years. If a business’ taxable use of the asset increases it is permitted to reclaim more of the original VAT and if the proportion of the taxable supplies decreases it will be required to repay some of the input tax initially claimed. The use of the CGS is mandatory.

How the CGS works

Normally, VAT recovery is based on the initial use of an asset at the time of purchase (a one-off claim). The CGS works by applying a longer period during which the initial recovery may be adjusted if there are changes in the use of the asset. Practically, the CGS will only apply in situations where there is exempt or non-business use of the asset. A business using an asset for fully taxable purposes will be covered by the scheme, but it is likely that full recovery up front will be possible with no subsequent adjustments required. This will be the position if, say, a standard rated property is purchased, the option to tax taken, and the building let to a third party. The CGS looks at how capital items have been used in the business over a number of intervals (usually, but not always; years). It adjusts both for taxable versus exempt use and for business versus non business use over the lifetime of the asset. Example; a business buys a yacht that is hired out (business use) and it is also used privately by a director (non-business use). However, a more common example is a business buying a property and occupying it while its trade includes making some exempt supplies.

Which businesses does it affect?

Purchasers of certain commercial property, owners of property who carry out significant refurbishment or carry out civil engineering work, purchasers of computer hardware, aircraft, ships, and other vessels over a certain monetary value who incur VAT on the cost. (As the CGS considers the recovery of input tax, only VAT bearing assets are covered by it).

Assets not covered by the scheme

The CGS does not apply if a business;

acquires an asset solely for resale
spends money on assets that it acquired solely for resale
acquires assets, or spends money on assets that are used solely for non-business purposes.

Limits for capital goods

Included in the CGS are:

Land, property purchases – £250,000 or over
Refurbishment or civil engineering works costing £250,000 or over
Computer hardware costing £50,000 or over (single items, not networks)
From 2011, aircraft, ships, and other vessels costing £50,000 or more.

Assets below these (net of VAT) limits are excluded from the CGS.

The adjustment periods

Five intervals for computers
Five intervals for ships and aircraft
Ten intervals for all other capital items

Changes in your business circumstances

Certain changes to a business during a CGS period will impact on the treatment of its capital assets. These changes include:

leaving or joining a VAT group
cancelling your VAT registration
buying or selling your business
transferring a business as a going concern (TOGC)
selling an asset during the adjustment period

Specific advice should be sought in these circumstances.

Examples

A retailer purchases a brand new property to carry on its fully taxable business for £1 million plus £200,000 VAT. It is therefore above the CGS limit of £250,000. The business recovers all of the input tax on its next return. It carries on its business for five years, at which time it decides to move to a bigger premises. It rents the building to a third party after moving out without opting to tax. Under the CGS it will, broadly, have to repay £100,000 of the initial input tax claimed. This is because the use in the ten year adjustment period has been 50% taxable (retail sales) for the first five years and 50% exempt (rent of the property for the subsequent five years).
A company purchases a helicopter for £150,000 plus VAT of £30,000. It uses the aircraft 40% of the time for hiring to third parties (taxable) and 60% for the private use of the director (non-business). The company reclaims input tax of £12,000 on its next return. Subsequently, at the next interval, taxable use increases to 50%. It may then make an adjustment to increase the original claim: VAT on the purchase £30,000 divided by the number of adjustment periods for the asset (five) and then adjusting the result for the increase in business use: £30,000 / 5 = 6000 50% – 40% = £600 additional claim

Danger areas

Overlooking CGS at time of purchase or the onset of building works
Not recognising a change of use
Selling CGS as part of a TOGC
Failing to make required CGS adjustments at the appropriate time
Overlooking the option to tax when renting or selling a CGS property asset
Sale during adjustment period (not a TOGC)
Complexities re; first period adjustments and pre-VAT registration matters
Interaction between CGS and partial exemption calculations

Summary

There is a lot of misunderstanding about the CGS and in certain circumstances it can produce complexity and increased record keeping requirements. There are also a lot of situations where overlooking the impact of the CGS or applying the rules incorrectly can be very costly. However, it does produce a fairer result than a once and for all claim, and when its subtleties are understood, it quite often provides a helpful planning tool.

VAT: Interaction of Clawback and the Capital Goods Scheme – The Stichting Schoonzicht case

By Marcus Ward 10 March 2020

Latest from the courts

The difference between intended use and first actual use of an asset.

In the Dutch case of Stichting Schoonzicht (C‑791/18) the AG was asked to provide an opinion on the interaction between clawback and the Capital Goods Scheme (CGS) via Directive 2006/112/EC, Articles 185 and 187. Details of the CGS here. In the UK clawback is set out in The General Regulations 1995, Reg 108.

Background

Stichting Schoonzicht constructed a number of apartments which it intended to sell on completion. This would have been a taxable supply and afforded full input tax recovery on the costs incurred on the development. Unfortunately, due to market conditions, the business was unable to find buyers at the appropriate sale price. Therefore, a decision was made to let some of the flats on a short-term basis until the market picked up. This was done and created an exempt supply. The intention to make taxable supplies remained, but in the meantime, exempt supplies had actually been made. This could affect the original input tax claim. Details of partial exemption here.

Technical

The Dutch referring court entertained doubts about the compatibility of the ‘first-use full adjustment’ requirement provided for under Netherlands law and the CGS.

So the issue was whether the CGS (Article 187 of the VAT Directive) applied such that any required adjustments to the initial input tax claim could be made via a CGS calculation, or whether, as the Dutch authorities contended, there should be a one-off clawback of the input tax previously claimed.

Decision

In the AG’s opinion, the Dutch tax authorities could clawback 4/7 of the input tax on the construction (as four of the flats were let and three remained unoccupied). The AG decided that the CGS could co-exist with clawback and that EU Member States are allowed to adjust the initial deduction of input tax using clawback where actual use varies from intended use. A distinction was made between clawback and the CGS. The CGS is intended to adjust input tax claims as a result of fluctuations in the taxable use of capital assets over a period of time (ten years for buildings in the UK).

Commentary

In the UK, there are published easements for input tax recovery in similar circumstances: “VAT: Partial Exemption – adjustments when house builders let their dwellings”. However, this is an interesting AG opinion, is worth a read and it will be interesting to see how this develops. However, with prior planning, this situation may be avoided in the UK (where new house sales are zero rated).

VAT Latest from the courts – Application of Capital Goods Scheme

By Marcus Ward 10 November 2016

Should the costs of a phased development be aggregated, and if so, do the anti-avoidance provisions apply?

In the case of Water Property Limited (WPL) the First Tier Tribunal was asked to consider the application of; the Capital Goods Scheme (CGS) and the anti-avoidance provisions set out in the VAT Act 1994, Schedule 10, para 12.

A helpful guide to the CGS is here

Background

WPL purchased land and buildings formerly used as a public house, subject to planning permission to convert the ground floor into a children’s day care nursery and the upper floor into residential flats. The planning permission was subsequently granted. WPL paid £210,000 plus £37,500 VAT on the acquisition of the ex-pub in March 2013. The children’s nursery business was kept separate from the property development business to enable the children’s nursery business to be sold at a date in the future and for the leasehold reversion to be retained as an investment by WPL. The value of the building contract for the nursery was £209,812.34 including VAT. The value of the contract for the residential flats was £161,546.42 including VAT. The consideration for the acquisition and each phase of development was below £250,000 (the threshold at which land and buildings become CGS items) but combined, they exceeded the £250,000 limit. WPL exercised an option to tax on the property and entered into a lease with Smile Childcare Limited (SCL). SCL was established to carry on a business of the provision of nursery care for infant children. It was jointly owned by Mr and Mrs Waters. Mrs Waters as the operator of the children’s nursery.

WPL recovered input tax on costs incurred in respect of the nursery, but not the flats. It was accepted by the appellant that SCL and WPL were “connected” within the meaning of VAT Act 1994, Schedule 10, para 13 and that the activity of carrying on the business of a nursery was an exempt activity.

Issue

HMRC formed the view that the option to tax should be disapplied by virtue of the anti-avoidance legislation meaning that no input tax was recoverable. This is because the property was, or was intended to become, a CGS item and the ‘exempt land test’ is met. This test is met if, at the time the grant is made, the grantor, or a person connected with the grantor expects the land to be used for an exempt purpose.

So the issue was whether the land constituted a CGS item. That is, whether the value of the two elements forming the phased development should be aggregated.

Decision

The FTT allowed the taxpayer’s appeal against HMRC’s decision. It was decided that the acquisition and development costs were financed through different means; there were separate contracts for each phase; there was no overlap in the works* and HMRC had not identified any evasion, avoidance or abuse and considered that the costs did not need to be aggregated. In addition, it was concluded that WPL had relied on HMRC guidance in determining that there was no requirement to aggregate the cost of the phased development provided that there was no overlap in time.

As a consequence, as each part of the development fell below the £250,000 limit, there were no CGS items. Therefore the fact that the parties were connected was irrelevant and the anti-avoidance provisions did not apply such that the option to tax could not be disapplied meaning that the recovery of the input tax was appropriate. The Chairman also commented that the appellant had a legitimate expectation to rely on the guidance provided by HMRC (in this case the provision of a copy of Public Notice 706/2).

Commentary

There is often uncertainty on the VAT position of land and property developments of this kind, and the interaction with the CGS is rarely straightforward. This is not helped by HMRC’s interpretation of the rules.

Action

If any business or advisers with clients which have been;

forced to use the CGS as a result of aggregation
subject to the application of the anti-avoidance provisions
assessed despite relying on HMRC’s published guidance

they should seek advice and review their position. We can advise in such circumstances.

* As per PN 706/2 Para 4.12 as follows

“What if the refurbishment is in phases?

If you do this you will need to decide whether the work should be treated as a whole for CGS [capital goods scheme] purposes or whether there is more than one refurbishment. If you think that each phase is really a separate refurbishment then they should be treated separately for CGS purposes. Normally there is more than one refurbishment when:

· There are separate contracts for each phase of work, or;

· A contract where each phase is a separate option which can be selected, and;

· Each phase of work is completed before work on the next phase starts…”

VAT – The Capital Goods Scheme (CGS)

By Marcus Ward 13 April 2016

The CGS

How the CGS works

Which businesses does it affect?

Assets not covered by the scheme

The CGS does not apply if a business;

acquires an asset solely for resale
spends money on assets that it acquired solely for resale
acquires assets, or spends money on assets that are used solely for non-business purposes.

Limits for capital goods

Included in the CGS are:

Land, property purchases – £250,000 or over
Refurbishment or civil engineering works costing £250,000 or over
Computer hardware costing £50,000 or over (single items, not networks)
From 2011, aircraft, ships, and other vessels costing £50,000 or more.

Assets below these (net of VAT) limits are excluded from the CGS.

The adjustment periods

Five intervals for computers
Five intervals for ships and aircraft
Ten intervals for all other capital items

Changes in your business circumstances

Certain changes to a business during a CGS period will impact on the treatment of its capital assets. These changes include:

leaving or joining a VAT group
cancelling your VAT registration
buying or selling your business
transferring a business as a going concern (TOGC)
selling an asset during the adjustment period

Specific advice should be sought in these circumstances.

Examples

A retailer purchases a brand new property to carry on its fully taxable business for £1 million plus £200,000 VAT. It is therefore above the CGS limit of £250,000. The business recovers all of the input tax on its next return. It carries on its business for five years, at which time it decides to move to a bigger premises. It rents the building to a third party after moving out without opting to tax. Under the CGS it will, broadly, have to repay £100,000 of the initial input tax claimed. This is because the use in the ten year adjustment period has been 50% taxable (retail sales) for the first five years and 50% exempt (rent of the property for the subsequent five years).
A company purchases a helicopter for £150,000 plus VAT of £30,000. It uses the aircraft 40% of the time for hiring to third parties (taxable) and 60% for the private use of the director (non-business). The company reclaims input tax of £12,000 on its next return. Subsequently, at the next interval, taxable use increases to 50%. It may then make an adjustment to increase the original claim: VAT on the purchase £30,000 divided by the number of adjustment periods for the asset (five) and then adjusting the result for the increase in business use: £30,000 / 5 = 6000 50% – 40% = £600 additional claim

Danger areas

Overlooking CGS at time of purchase or the onset of building works
Not recognising a change of use
Selling CGS as part of a TOGC
Failing to make required CGS adjustments at the appropriate time
Overlooking the option to tax when renting or selling a CGS property asset
Sale during adjustment period (not a TOGC)
Complexities re; first period adjustments and pre-VAT registration matters
Interaction between CGS and partial exemption calculations

Summary

VAT: How long do I have to keep records?

By Marcus Ward 26 June 2023

Time limits for keeping records

Record keeping is a rather dry subject, but it is important not to destroy records which HMRC may later insist on seeing! I have looked at what VAT records a business is required to keep here, but how long must they be kept for?

This is seemingly a straightforward question, but as is usual with VAT there are some ifs and buts.

The basic starting point

The usual answer is that VAT records must be kept for six years. However, there are circumstances where that limit is extended and also times when it may be reduced. Although the basic limit is six years, unless fraud is suspected, HMRC can only go back four years to issue assessments, penalties and interest.

Variations to the six year rule

One Stop Shop (OSS)

If a business is required to use the OSS then its records must be retained for ten years (and they should be able to be sent to HMRC electronically if asked).

Capital Goods Scheme (CGS)

If a business has assets covered by the CGS, eg; certain property, computers, aircraft and ships then adjustments will be required up to a ten year period. Consequently, records will have to be retained for at least ten years in order to demonstrate that the scheme has been applied correctly.

Land and buildings

In the case of land and buildings you might need to keep documents for 20 years. We advise that records are kept this long in any event as land and buildings tend to be high value and complex from a VAT perspective, However, it is necessary in connection with the option to tax as it is possible to revoke an option after 20 years.

Transfer Of a Going Concern (TOGC)

This is more of a ‘who” rather than a what or a how long. When a business is sold as a going concern, in most circumstances the seller of the business will retain the business records. When this happens, the seller must make available to the buyer any information the buyer needs to comply with his VAT obligations. However, in cases where the buyer takes on the seller’s VAT registration number, the seller must transfer all of the VAT the records to the buyer unless there is an agreement with HMRC for the seller to retain the records. If necessary, HMRC may disclose to the buyer information it holds on the transferred business. HMRC do this to allow the buyer to meet his legal obligations. But HMRC will always consult the seller first, to ensure that it does not disclose confidential information.

How can a business cut the time limits for record keeping?

It is possible to write to HMRC and request a concession to the usual time limits. HMRC generally treat such a request sympathetically, but will not grant a concession automatically. If a concession is granted there is still a minimum allowance period of preservation which is in line with a business’ commercial practice.

Computer produced records

Where records are stored in an electronic form, a business must be able to ensure the records’ integrity, eg; that the data has not changed, and the legibility throughout the required storage period. If the integrity and legibility of the stored electronic records depends on a specific technology, then the original technology or an equivalent that provides backwards compatibility for the whole of the required storage period must also be retained.

How to keep records

HMRC state that VAT records may be kept on paper, electronically or as part of a software program (eg; bookkeeping software). All records must be accurate, complete and readable.

Penalties

If a business’ records are inadequate it may have to pay a record-keeping penalty. If at an inspection HMRC find that records have deliberately been destroyed your they will apply a penalty of £3,000 (this may be reduced to £1,500 if only some of the records are destroyed). In addition, there will be questions about why they have been destroyed!

VAT – What records must be kept by a business?

By Marcus Ward 5 April 2023

VAT Basics: Requirements for VAT records by taxable persons

I thought that it may be useful to round-up all the record-keeping requirements in one place and focus on what HMRC want to see. It is always good practice to carry out an ongoing review a business’ records to ensure that they comply with the rules.

General requirements

Every taxable person must keep such records as HMRC may require. Specifically, every taxable person must, for the purposes of accounting for VAT, keep the following records:

business and accounting records
VAT account
copies of all VAT invoices issued
VAT invoices received
certificates issued under provisions relating to fiscal or other warehouse regimes
copy documentation issued, and documentation received, relating to the transfer, dispatch or transport of goods overseas and/or imported
credit notes, debit notes and other documents which evidence an increase or decrease in consideration that are received, and copies of such documents issued
copy of any self-billing agreement to which the business is a party
where the business is the customer party to a self-billing agreement, the name, address and VAT registration number of each supplier with whom the business has entered into a self-billing agreement

Additionally

HMRC may supplement the above provisions by a Notice published by them for that purpose. They supplement the statutory requirements and have legal force.

Business records include, in addition to specific items listed above, orders and delivery notes, relevant business correspondence, purchases and sales books, cash books and other account books, records of daily takings such as till rolls, annual accounts, including trading and profit and loss accounts and bank statements and paying-in slips.

Unless the business mainly involves the supply of goods and services direct to the public and less detailed VAT invoices are issued, all VAT invoices must also be retained. Cash and carry wholesalers must keep all till rolls and product code lists.

Records must be kept of all taxable goods and services received or supplied in the course of business (standard and zero-rated), together with any exempt supplies, gifts or loans of goods, taxable self-supplies and any goods acquired or produced in the course of business which are put to private or other non-business use.

All records must be kept up to date and be in sufficient detail to allow calculation of VAT. They do not have to be kept in any set way but must be in a form which will enable HMRC officers to check easily the figures on the VAT return. Records must be readily available to HMRC officers on request. If a taxable person has more than one place of business, a list of all branches must be kept at the principal place of business.

Comprehensive records

In addition, we always advise businesses to retain full information of certain calculations such as; partial exemption, the Capital Goods Scheme, margin schemes, TOMS, business/non-business, mileage and subsistence claims, promotional schemes, vouchers, discounts, location of overseas customers, and OSS, amongst other records. The aim is to ensure that any inspector is satisfied with the records and that any information required is readily available. This avoids delays, misunderstandings and unnecessary enquiries which may lead to assessments and penalties.

If you have any doubts that your business records are sufficient, please contact us.

VAT: Doctors and healthcare professionals

By Marcus Ward 16 January 2023

Healthcare services – an overview

I have noticed that I am receiving more and more queries in this area and HMRC does appear to be taking an increased interest in healthcare entities. This is hardly surprising as it can be complex and there are some big numbers involved.

(This article refers to doctors, but applies equally to most healthcare professional entities including; opticians, nurses, osteopaths, chiropractors, midwives, dentists etc.)

The majority of the services provided by doctors’ practices are VAT free. Good news one would think; no need to charge VAT and no need to deal with VAT records, returns and inspections.

However, there is one often repeated question from practices; “How can we reclaim the VAT we are charged?” This is particularly relevant if a practice intends to spend significant amounts on projects such as property construction or purchase.

The first point to make is that if a practice only makes exempt supplies (of medical services) it is not permitted to register for VAT and consequently cannot recover any input tax. Therefore we must look at the types of supplies that a practice may make that are taxable (at the standard or zero rate). If any of these supplies are made it is possible to VAT register regardless of their value. Of course, if taxable supplies are made, the value of which exceeds the current turnover limit of £85,000 in a rolling 12-month period, registration is mandatory.

Examples of supplies of services and goods which may be taxable are:

drugs, medicines or appliances that are dispensed by doctors to patients for self-administration
dispensing drugs against an NHS prescription (zero-rated)
drugs dispensed against private prescriptions (standard-rated)
medico legal services that are predominantly legal rather than medical – for example negotiating on behalf of a client or appearing in court in the capacity of an advocate
clinical trials or market research services for drug companies that do not involve the care or assessment of a patient
paternity testing
certain rental of rooms/spaces
car parking
signing passport applications
providing professional witness evidence
any services which are not in respect of; the protection, maintenance or restoration of health of a patient.

So what does VAT registration mean?

Once you join the “VAT Club” you will be required to file a VAT return on a monthly of quarterly basis. You may have to issue certain documentation to patients/organisations to whom you make VATable supplies. You may need to charge VAT at 20% on some services. You will be able to reclaim VAT charged to you on purchases and other expenditure subject to the partial exemption rules – see below. You will have to keep records in a certain way (see MTD) and your accounting system needs to be able to process specific information.

Because doctors usually provide services which attract varying VAT treatment, a practice will be required to attribute VAT incurred on expenditure (input tax) to each of these categories. Generally speaking, only VAT incurred in respect of zero-rated and standard-rated services may be recovered. In addition, there will always be input tax which is not attributable to any specific service and is “overhead” eg; property costs, professional fees, telephones etc. VAT registered entities which make both taxable and exempt supplies are deemed “partly exempt” and must carry out calculations on every VAT return.

Partial Exemption

Once the calculations described above have been carried out, the resultant amount of input tax which relates to exempt supplies is compared to the de-minimis limits (broadly; £625 per month VAT and not more than 50% of all input tax). If the figure is below these limits, all VAT incurred is recoverable regardless of what activities the practice is involved in. More details here.

VAT registration in summary

Benefits

recovery of input tax; the cost of which is not claimable in any other way
potentially, recovery of VAT on items such as property, refurbishment and other expenditure that would have been unavailable prior to VAT registration
only a small amount of VAT is likely to be chargeable by a practice
may provide opportunities for pre-registration VAT claims

Drawbacks

increased administration, documentation and staff time
exposure to penalties and interest
may require VAT to be added to some services provided which were hitherto VAT free
likely that only an element of input tax is recoverable as a result of partial exemption
uncertainty on the VAT position of certain services due to current tax cases
potentially dealing with the Capital Goods Scheme (CGS)
possible increased costs to the practice in respect of professional fees.

Please contact us if any of the above affects you or your clients.

Deregistration – When a business leaves the VAT club

By Marcus Ward 6 December 2022

This article considers when and how to deregister from VAT and the consequences of doing so.

General points

Deregistration may be mandatory or voluntary depending on circumstances. Although it may be attractive for certain businesses too deregister if possible, this is not always the case. The main reason to remain registered is to recover input tax on purchases made by a business. This is particularly relevant if that business’ sales are:

to other VAT registered businesses which can recover any VAT charged
supplies are UK VAT free (eg; zero rated)
made to recipients outside the UK

Businesses which make sales to the public (B2C) are usually better off leaving the VAT club even if this means not being able to recover input tax incurred.

A business applies for deregistration online through its VAT account, or it can also complete a form VAT7 to deregister by post.

NB: These rules apply to businesses belonging in the UK. There are different rules for overseas business which are outside the scope of this article.

The Rules

Compulsory deregistration

A business must deregister if it ceases to make taxable supplies. This is usually when a business has been sold, but there may be other circumstances, eg; if a business starts to make only exempt supplies, or a charity stops making business supplies and continues with only non-business activities or when an independent body corporate joins a VAT group. In such circumstances there is a requirement to notify HMRC within 30 days of ceasing to make taxable supplies.

We have seen, on a number of occasions, HMRC attempting to compulsorily deregister a business because either; it has not made any taxable supplies (although it has the intention of doing so) or it is only making a small amount of taxable supplies. In the first example, as long as the business can demonstrate that it intends to make taxable supplies in the future it is entitled to remain VAT registered. This is often the position with; speculative property developers, business models where there is a long lead in period, or business such as exploration/exploitation of earth resources.

Voluntary deregistration

A business may apply for deregistration if it expects its taxable turnover in the next twelve to be below the deregistration threshold. This is currently £83,000. It must be able to satisfy HMRC that this is the case. Such an application may be made at any time and the actual date of leaving the club is agreed with HMRC. It should be noted that when calculating taxable income, certain supplies are excluded. These are usually exempt supplies but depending on the facts, other income may also be ignored.

Consequences of deregistration

Final return

A deregistered business is required to submit a final VAT return for the period up to and including the deregistration date. This is called a Period 99/99 return.

Output tax

From the date of deregistration a business must stop charging VAT and is required to keep its VAT records for a minimum of six years. It is an offence to show VAT on invoices when a business is not VAT registered.

Input tax

Once deregistered a business can no longer recover input tax. The sole exception being when purchases relate to the time the business was VAT registered. This tends to be VAT on invoices not received until after deregistration, but were part of the business’ expenses prior to deregistration. Such a claim is made on a form VAT427

Self-supply (Deemed supply)

An often overlooked VAT charge is the self-supply of assets on hand at the date of deregistration. A business must account for VAT on any stock and other assets it has on this date if:

It could reclaim VAT when it bought them (regardless of whether such a claim was made)
the total VAT due on these assets is over £1,000

These assets will include items such as; certain land and property (usually commercial property which is subject to an option to tax or is less than three year old), un-sold stock, plant, furniture, commercial vehicles, computers, equipment, materials, etc, but does not include intangible assets such as patents, copyrights and goodwill. The business accounts for VAT on the market value of these assets but cannot treat this as input tax, thus creating a VAT cost.

We usually advise that, if commercially possible, assets are sold prior to deregistration. This avoids the self-supply hit and if the purchaser is able to recover the VAT charged the position is VAT neutral to all parties, including HMRC. It is worth remembering that the self-supply only applies to assets on which VAT was charged on purchase and that there is a de minimis limit. We counsel that care is taken to ensure planning is in place prior to deregistration as it is not possible to plan retrospectively and once deregistered the position is crystallised.

Re-registration

HMRC will automatically re-register a business if it realises it should not have cancelled (eg; the anticipated turnover exceeds the deregistration threshold). It will be required to account for any VAT it should have paid in the meantime.

Option To Tax

An option to tax remains valid after a registration has been cancelled. A business must monitor its income from an opted property to see whether it exceeds the registration threshold and needs to register again.

Capital Goods Scheme (CGS)

If a business owns any capital items when it cancels its registration, it may, because of the rules about deemed supplies (see self-supply above) have to make a final adjustment in respect of any items which are still within the adjustment period. This adjustment is made on the final return.

Cash Accounting

A business will have two months to submit its final return after it deregisters. On this return the business must account for all outstanding VAT on supplies made and received prior to deregistration. This applies even if it has not been paid. However, it can also reclaim any VAT provided that you have the VAT invoices. If some of the outstanding VAT relates to bad debts a business may claim relief.

Partial exemption

If a business is partly exempt its final adjustment period will run from the day following its last full tax year to the date of deregistration. If a business has not incurred any exempt input tax in its previous tax year, the final adjustment period will run from the first day of the accounting period in the final tax year in which it first incurred exempt input tax to the date of deregistration.

Flat Rate Scheme

If a business deregisters it leaves this scheme the day before its deregistration date. It must, therefore, account for output tax on its final VAT return for sales made on the last day of registration (which must be accounted for outside of the scheme).

Self-Billing

If your customers issue VAT invoices on your behalf under self-billing arrangements (or prepare authenticated receipts for you to issue) a deregistering business must tell them immediately that it is no longer registered. They must not charge VAT on any further supplies you make. There are financial penalties if a business issues a VAT invoice or a VAT-inclusive authenticated receipt for supplies it makes after its registration has been cancelled.

Bad Debt Relief (BDR)

A business can claim relief on bad debts it identifies after it has deregistered, provided it:

has previously accounted for VAT on the supplies
can meet the usual BDR conditions

No claim may be made more than four years from the date when the relief became claimable.

Summary

As may be seen, there is a lot to consider before applying for voluntary deregistration, not all of it good news. Of course, apart from not having to charge output tax, a degree of administration is avoided when leaving the club, so the pros and cons should be weighed up. Planning at an early stage can assist in avoiding in nasty VAT surprises and we would always counsel consulting an adviser before an irrevocable action is taken. As usual in VAT, if a business gets it wrong there may be an unexpected tax bill as well as penalties and interest.

Oops! – Top Ten VAT howlers

By Marcus Ward 2 November 2021

I am often asked what the most frequent VAT errors made by a business are. I usually reply along the lines of “a general poor understanding of VAT, considering the tax too late or just plain missing a VAT issue”. While this is unquestionably true, a little further thought results in this top ten list of VAT horrors:

Not considering that HMRC may be wrong. There is a general assumption that HMRC know what they are doing. While this is true in most cases, the complexity and fast moving nature of the tax can often catch an inspector out. Added to this is the fact that in most cases inspectors refer to HMRC guidance (which is HMRC’s interpretation of the law) rather to the legislation itself. Reference to the legislation isn’t always straightforward either, as often EC rather than UK domestic legislation is cited to support an analysis. The moral to the story is that tax is complicated for the regulator as well, and no business should feel fearful or reticent about challenging a HMRC decision.
Missing a VAT issue altogether. A lot of errors are as a result of VAT not being considered at all. This is usually in relation to unusual or one-off transactions (particularly land and property or sales of businesses). Not recognising a VAT triggerpoint can result in an unexpected VAT bill, penalties and interest, plus a possible reduction of income of 20% or an added 20% in costs. Of course, one of the basic howlers is not registering at the correct time. Beware the late registration penalty, plus even more stringent penalties if HMRC consider that not registering has been done deliberately.
Not considering alternative structures. If VAT is looked at early enough, there is very often ways to avoid VAT representing a cost. Even if this is not possible, there may be ways of mitigating a VAT hit.
Assuming that all transactions with overseas customers are VAT free. There is no “one size fits all” treatment for cross border transactions. There are different rules for goods and services and a vast array of different rules for different services. The increase in trading via the internet has only added to the complexity in this area, and with new technology only likely to increase the rate of new types of supply it is crucial to consider the implications of tax; in the UK and elsewhere.
Leaving VAT planning to the last minute. VAT is time sensitive and it is not usually possible to plan retrospectively. Once an event has occurred it is normally too late to amend any transactions or structures. VAT shouldn’t wag the commercial dog, but failure to deal with it at the right time may be either a deal-breaker or a costly mistake.
Getting the option to tax wrong. Opting to tax is one area of VAT where a taxpayer has a choice. This affords the possibility of making the wrong choice, for whatever reasons. Not opting to tax when beneficial, or opting when it is detrimental can hugely impact on the profitability of a project. Not many businesses can carry the cost of, say, not being able to recover VAT on the purchase of a property, or not being able to recover input tax on a big refurbishment. Additionally, seeing expected income being reduced by 20% will usually wipe out any profit in a transaction.
Not realising a business is partly exempt. For a business, exemption is a VAT cost, not a relief. Apart from the complexity of partial exemption, a partly exempt business will not be permitted to reclaim all of the input tax it incurs and this represents an actual cost. In fact, a business which only makes exempt supplies will not be able to VAT register, so all input tax will be lost. There is a lot of planning that may be employed for partly exempt businesses and not taking advantage of this often creates additional VAT costs.
Relying on the partial exemption standard method to the business’ disadvantage. A partly exempt business has the opportunity to consider many methods to calculate irrecoverable input tax. The default method, the “standard method” often provides an unfair and costly result. I recommend that any partly exempt business obtains a review of its activities from a specialist. I have been able to save significant amounts for clients simply by agreeing an alternative partial exemption method with HMRC.
Not taking advantage of the available reliefs. There are a range of reliefs available, if one knows where to look. From Bad Debt Relief, Zero Rating (VAT nirvana!) and certain de minimis limits to charity reliefs and the Flat Rate Scheme, there are a number of easements and simplifications which could save a business money and reduce administrative and time costs.
Forgetting the impact of the Capital Goods Scheme (CGS). The range of costs covered by this scheme has been expanded recently. Broadly, VAT incurred on certain expenditure is required to be adjusted over a five or ten year period. Failure to recognise this could either result in assessments and penalties, or a position whereby input tax has been under-claimed. The CGS also “passes on” when a TOGC occurs, so extra caution is necessary in these cases.

So, you may ask: “How do I make sure that I avoid these VAT pitfalls?” – And you would be right to ask.

Of course, I would recommend that you engage a VAT specialist to help reduce the exposure to VAT costs!

VAT: Intention is crucial – The Sonaecom case

By Marcus Ward 18 May 2020

We cannot control the future…

The Sonaecom case

In the opinion* of the CJEU AG (C-42/19) the importance of a taxpayer’s intention was of utmost importance, regardless of whether that intention was achieved.

Background

Sonaecom intended to acquire a telecoms provider company. As is usual in such cases, input tax was incurred on consultancy received, from, amongst others; accountants and legal service providers. The intention post acquisition was for Sonaecom to make certain charges to the acquired co. These would have been taxable supplies.

Unfortunately, the intended purchase was aborted.

The issue

The issue before the AG was; as no taxable supplies took place as the deal fell through – to what should the input tax incurred on advice be attributed?

Opinion

In the AG’s view the fact that the acquisition was aborted was no reason for the claim for input tax to denied. This was based on the fact that:

Sonaecom was not a “pure holding company”
There was a genuine intention to make taxable supplies (to the acquired co)
There was a direct and immediate link between the costs and the intended supplies
Although the acquisition costs would exceed the proposed management charges, this was not a reason to invalidate the claim
The above analysis was not affected by the fact that the transaction did not take place

Commentary

There are often issues in relation to intentions of a taxpayer. It is clear, and was emphasised in this case, that intention is all important. Of course, intentions can change over a period of time and commercial and political events may thwart or cause intentions to be re-evaluated. There is often an issue about evidencing an intention. HMRC usually require comprehensive documentary evidence to demonstrate an objective. Such evidence is sometime not available for various reasons. Consequently, it is prudent for businesses to record (board meeting minutes etc at the very least) the commercial reasons for taking a certain course of action. This issue quite often arises in transactions in land and property – which can create additional technical issues.

There is legislation in place to cover situations when intentions, or actual events change and which affect the original input tax position: The Capital Goods Scheme (CGS) and The Value Added Tax Regulations 1995, Regs 108 and 109.

Other areas of VAT which often to raise issues are management charges and holding companies. HMRC apparently continue to be eager to attack taxpayers in these areas and I have looked at the role of holding companies and the VAT treatment here, here and here.

I think it is useful to bear in mind a question which, in itself does not evidence an intention, but provides commercial coherence – Why were the costs incurred if there was no intention to make the acquisition? This does leave aside the future management charges position but goes some way to provide business logic.

It will be interesting to see how this case proceeds, but I would find it very surprising if the court diverges from this AG opinion.

* AG’s Opinion

The Court of Justice of the European Union (CJEU) consists of one judge from each Member State, assisted by eleven Advocates General whose role is to consider the written and oral submissions to the court in every case that raises a new point of law, and deliver an impartial opinion to the court on the legal solution.