Value added tax, part 1

This two-part article is relevant to those of you sitting the TX-UK exam in the period 1 June 2023 to 31 March 2024, and is based on tax legislation as it applies to the tax year 2022–23 (Finance Act 2022).

Standard rate of value added tax (VAT)

The standard rate of VAT is currently 20%.

EXAMPLE 1
Zoe is in the process of completing her VAT return for the quarter ended 31 March 2023. The following information is available:

• Sales invoices totalling £128,000 were issued in respect of standard rated sales.
• Standard rated expenses amounted to £24,800.
• On 15 February 2023, Zoe purchased machinery at a cost of £24,150. This figure is inclusive of VAT.

Unless stated otherwise all of the above figures are exclusive of VAT.

VAT Return – Quarter ended 31 March 2023

VAT registration

A business making taxable supplies must register for VAT if during the previous 12 months the value of taxable supplies exceeds £85,000. However, VAT registration is not required if taxable supplies in the following 12 months will not exceed £83,000. These figures are exclusive of VAT. And remember that both standard rated and zero-rated supplies are taxable supplies.

EXAMPLE 2
Albert commenced trading on 1 January 2022. His sales have been as follows

• Albert will become liable to compulsory VAT registration when his taxable supplies during any 12-month period exceed £85,000.
• This will happen on 28 February 2023 when taxable supplies will amount to £86,400 (3,300 + 5,700 + 2,700 + 4,100 + 4,100 + 5,600 + 4,300 + 13,100 + 7,600 + 8,500 + 9,700 + 17,700).
• Albert will have to notify HM Revenue and Customs (HMRC) by 30 March 2023, being 30 days after the end of the period.
• Registration is required from the end of the month following the month in which the limit is exceeded, so Albert will be registered from 1 April 2023 or from an agreed earlier date.

A business must also register for VAT if there are reasonable grounds to believe that taxable supplies will exceed £85,000 during the following 30 days. Again, the figure is exclusive of VAT.

EXAMPLE 3
Bee commenced trading on 1 October 2022. Her sales have been as follows:

Bee’s sales are all standard rated.

On 1 January 2023, Bee realised that her sales for January 2023 were going to exceed £95,000, and therefore immediately registered for VAT.

• Businesses must register for VAT if at any time they expect their taxable supplies for the following 30-day period to exceed £85,000.
• Bee realised that her taxable supplies for January 2023 were going to exceed £85,000. She was therefore liable to register from 1 January 2023, being the start of the 30-day period.
• Bee had to notify HMRC by 30 January 2023, being 30 days from the date when the expectation arose.

If a business continues to trade after the date when it should have registered for VAT, output VAT will still be due from this date.

It is important that you appreciate the distinction between making standard rated supplies, zero-rated supplies and exempt supplies. Only standard rated supplies and zero-rated supplies are taxable supplies.

EXAMPLE 4
Cathy will commence trading in the near future. She operates a small aeroplane, and is considering three alternative types of business. These are (1) training, in which case all sales will be standard rated for VAT, (2) transport, in which case all sales will be zero-rated for VAT, and (3) an air ambulance service, in which case all sales will be exempt from VAT.

For each alternative, Cathy’s sales will be £80,000 per month (exclusive of VAT), and standard rated expenses will be £15,000 per month (inclusive of VAT).

Standard rated supplies

• Cathy will be required to register for VAT because she is making taxable supplies.
• Output VAT of £16,000 (80,000 x 20%) per month will be due, with input VAT of £2,500 (15,000 x 20/120) per month recovered.

Zero-rated supplies

• Cathy can apply for exemption from registration for VAT because she is making zero-rated supplies; otherwise she should still register as these are taxable supplies.
• Output VAT will not be due, but input VAT of £2,500 per month will be recovered.

Exempt supplies

• Cathy will not be required or permitted to register for VAT because she will not be making taxable supplies.
• Output VAT will not be due and no input VAT will be recovered.

Voluntary VAT registration

A business may decide to voluntarily register for VAT where taxable supplies are below the £85,000 registration limit, or where it is possible to apply for exemption. This will be beneficial when:

• The business makes zero-rated supplies. As seen in example 4, output VAT will not be due but input VAT will be recovered.
• The business makes supplies to VAT registered customers. Input VAT will be recovered and it should be possible to charge output VAT on top of the pre-registration selling price. This is because the output VAT will be recovered (as input VAT) by the customers.

However, it will probably not be beneficial to voluntarily register for VAT where customers are members of the general public, since such customers cannot recover the output VAT charged. If selling prices cannot be increased, the output VAT will become an additional cost for the business.

EXAMPLE 5
Continuing with example 3, assume that Bee’s sales are all made to VAT registered businesses, and that input VAT for the period 1 October to 31 December 2022 was £12,400. This input VAT would not be recoverable were Bee to register for VAT on 1 January 2023.

• Bee’s sales are all to VAT registered businesses, so output VAT can be passed on to customers.
• Her revenue would therefore not have altered if she had voluntarily registered for VAT on 1 October 2022.
• As a result, it would have been beneficial for Bee to have voluntarily registered for VAT on 1 October 2022 because additional input VAT of £12,400 would have been recovered.

Whether or not output VAT can be passed on to customers is also an important factor when deciding whether to remain below the VAT registration limit, or whether it is beneficial to accept additional work which results in the limit being exceeded.

EXAMPLE 6
Danny has been in business for several years. All of his sales are standard rated and are to members of the general public. He is not registered for VAT.

At present, Danny’s annual sales are £82,500. He is planning to put up his prices, and this will increase annual sales to £88,000. There is no further scope for any price increases. Danny’s standard rated expenses are £15,700 per year (inclusive of VAT).

• Prior to putting up his prices, Danny’s net profit is £66,800 (82,500 – 15,700).
• If Danny puts up his prices, he will exceed the VAT registration limit of £85,000 and will have to register for VAT.
• Output VAT will have to be absorbed by Danny because sales are to the general public and there is no further scope for price increases.

The revised annual net profit will be:

• This is a decrease in net profit of £6,550 (66,800 – 60,250), so it is not beneficial for Danny to put up his prices.

Pre-registration input VAT

Input VAT incurred prior to registration can be recovered in certain circumstances.

EXAMPLE 7
Elisa commenced trading on 1 January 2023 and registered for VAT on 1 April 2023. She had the following inputs for the period 1 January to 31 March 2023:

On 1 April 2023, Elisa had an inventory of goods which had cost £13,800. The non-current assets were not used until after Elisa registered for VAT on 1 April 2023.

The above figures are all exclusive of VAT.

• Input VAT of £2,760 (13,800 x 20%) can be recovered on the inventory at 1 April 2023.
• The inventory was acquired in the four years prior to Elisa registering for VAT, and it was not sold or consumed prior to registration. The goods must have been acquired for business purposes.
• The same principle applies to non-current assets, so input VAT of £12,800 (64,000 x 20%) can be recovered on the non-current assets purchased during March 2023.
• Input VAT of £1,840 ((2,600 + 3,000 + 3,600) x 20%) can be recovered on the advertising services incurred from 1 January to 31 March 2023.
• This is because the services were supplied in the six months prior to VAT registration. The services must have been supplied for business purposes.
• The total input VAT recovery is £17,400 (2,760 + 12,800 + 1,840).

VAT deregistration

A business stops being liable to VAT registration when it ceases to make taxable supplies. HMRC must be notified within 30 days, and the business will then be deregistered from the date of cessation or from an agreed later date. 

A business can also request voluntarily VAT deregistration.

There is a deemed supply of business assets such as plant, equipment and inventory when a business ceases to be registered for VAT. 

However, the transfer of a business as a going concern does not normally give rise to any VAT implications.

EXAMPLE 8
Fang is registered for VAT but intends to cease trading on 31 March 2023. On the cessation of trading, Fang can either sell his non-current assets and inventory on a piecemeal basis to individual purchasers, or he can sell his entire business as a going concern to a single purchaser.

Sale of assets on a piecemeal basis

• Upon the cessation of trading, Fang will cease to make taxable supplies so his VAT registration will be cancelled on 31 March 2023 or an agreed later date.
• He will have to notify HMRC by 30 April 2023, being 30 days after the date of cessation.
• Output VAT will be due in respect of non-current assets and inventory on hand at 31 March 2023 on which input VAT has been claimed (although output VAT is not due if it totals less than £1,000).

Sale of business as a going concern

• If the purchaser is already registered for VAT, Fang’s VAT registration will be cancelled as above.
• If the purchaser is not registered for VAT, they can take over Fang’s VAT registration; though from a commercial point of view this may be inadvisable.
• A sale of a business as a going concern is not treated as a taxable supply, and therefore output VAT is not due.

Group VAT registration

Two or more companies can register as a group for VAT purposes if they are under common control (such as a parent company and its subsidiary companies) and each of them is resident in the UK.

A VAT group is treated for VAT purposes as if it was a single company registered for VAT on its own. Group VAT registration is made in the name of a representative member, and this company is then responsible for completing and submitting a single VAT return and paying VAT on behalf of the group. However, all the companies in the VAT group remain jointly and severally liable for any VAT liabilities.

EXAMPLE 9
Yung Ltd and its two 100% subsidiaries are considering registering as a group for VAT purposes.

• The advantage of group VAT registration is that there will be no need to account for VAT on goods and services supplied between group members. Such supplies are simply ignored for VAT purposes.
• It will also only be necessary to complete one VAT return for the whole group, so there should be a saving in administrative costs.

The tax point

It is very important to correctly identify the date of supply or tax point, as this determines when output VAT will be due.

EXAMPLE 10
Explain the VAT rules which determine the tax point in respect of (1) a supply of goods, and (2) a supply of services.

• The basic tax point for goods is the date when they are made available to the customer.
• The basic tax point for services is the date when they are completed.
• If an invoice is issued within 14 days of the basic tax point, the invoice date will usually replace that given above.
• If an invoice is issued or payment received before the basic tax point, this becomes the actual tax point.

With the supply of services there may be more than one tax point.

EXAMPLE 11
Denzil is a self-employed printer who makes standard rated supplies. For a typical printing contract, he receives a 10% deposit at the time that the customer makes the order. The order normally takes 14 days to complete, and Denzil issues the sales invoice three to five days after completion. Some customers pay immediately upon receiving the sales invoice, but many do not pay for up to two months.

• The tax point for each 10% deposit is the date when it is received.
• Invoices are issued within 14 days of the basic tax point (the date of completion), so the invoice date is the tax point for the balance of the contract price.

Output VAT and input VAT

There are several important points regarding output VAT and input VAT which should be remembered:

• For VAT purposes there is no distinction between revenue and capital expenditure or income as there is for income tax and corporation tax.
• Output VAT is charged on the actual amount received where a discount is offered for prompt payment. The supplier therefore has to either provide details of the potential discount on the sales invoice, or issue a subsequent credit note for the discount.
• Relief for an impairment loss is only available if the claim is made more than six months from the date when payment was due and the debt has been written off in the business’s books.
• Input VAT cannot be recovered in respect of business entertainment (unless it relates to the cost of entertaining overseas customers) or the purchase of a car (unless the car is used 100% for business purposes).
• Output VAT is charged where goods are taken from a business for non-business purposes, and similarly where services are used for non-business purposes.
• An apportionment is made where goods or services are used partly for business purposes and partly for private purposes.

EXAMPLE 12
Gwen is in the process of completing her VAT return for the quarter ended 31 March 2023. The following information is available:

• Cash sales amounted to £50,400, of which £46,200 was in respect of standard rated sales and £4,200 was in respect of zero-rated sales. All of these sales were to non-VAT registered customers.
• Sales invoices totalling £128,000 were issued in respect of credit sales to VAT registered customers. These sales were all standard rated, and none of these customers were offered a discount for prompt payment.
• On 20 February 2023, a credit sales invoice for £7,400 was issued in respect of a standard rated supply to a VAT registered customer. To encourage this previously late paying customer to pay promptly, Gwen offered a 10% discount for payment within 14 days of the date of the sales invoice. The customer paid within the 14-day period.
• Standard rated materials amounted to £32,400, of which £600 were taken by Gwen for her personal use.
• Standard rated expenses amounted to £24,800. This includes £1,200 for entertaining UK customers.
• On 15 March 2023, Gwen sold a car for £9,600 and purchased a new car at a cost of £16,800. Both cars were used for business and private mileage, but no fuel was provided for private mileage. These figures are inclusive of VAT where applicable.
• On 28 March 2023, Gwen sold machinery for £3,600, and purchased new machinery at a cost of £21,600. She paid for the new machinery on this date, but did not take delivery or receive an invoice until 6 April 2023. These figures are inclusive of VAT where applicable.
• On 31 March 2023, Gwen wrote off impairment losses in respect of three invoices which were due for payment on 15 August 2022, 15 September 2022 and 15 October 2022 respectively. The amount of output VAT originally paid in respect of each invoice was £340.
• During the quarter ended 31 March 2023, £600 was spent on mobile telephone calls, of which 40% relates to private calls.

Unless stated otherwise all of the above figures are exclusive of VAT.

VAT Return – Quarter ended 31 March 2023

• If the late paying customer had not paid within the 14-day period, output VAT on the discounted sale would have been £1,480 (7,400 at 20%).
• Input VAT would not have been recovered in respect of the car sold because it was not used exclusively for business purposes. Therefore, output VAT is not due on the disposal. Similarly, input VAT cannot be recovered in respect of purchase of the new car.
• Output VAT is charged on the materials which Gwen has taken out from the business for her personal use.
• Input VAT on business entertainment is not recoverable unless it relates to the cost of entertaining overseas customers.
• Gwen can recover the input VAT in respect of the new machinery purchased in the quarter ended 31 March 2023 because the actual tax point was the date when the machinery was paid for.
• Relief for an impairment loss is not given until six months from the time when payment is due. Therefore, relief can only be claimed in respect of the invoices due for payment on 15 August 2022 and 15 September 2022.
• An apportionment is made where a service such as the use of a telephone is partly for business purposes and partly for private purposes.

Refunds

The refund of VAT which has been overpaid is normally subject to a four-year time limit.

EXAMPLE 13
Hedge Ltd is completing its VAT return for the quarter ended 31 March 2023. The company has discovered that it has not been claiming for the input VAT of £35 which it has paid each quarter for the rental of coffee machines since 1 January 2013.

• Claims for the refund of VAT are subject to a four-year time limit.
• In addition to the input VAT incurred during the quarter ended 31 March 2023, Hedge Ltd can also claim for the input VAT incurred during the period 1 January 2019 to 31 December 2022.
• The total amount of input VAT refunded on the VAT return for the quarter ended 31 March 2023 will therefore be £595 (35 x 17).

Goods supplied free of charge

When goods are supplied free of charge, output VAT must normally be accounted for on the cost of the goods. However, there is an exemption for the gift of goods where the cost of the gifts does not exceed £50 per customer over a 12-month period.

Free samples given to customers are not treated as a supply of goods for VAT purposes, so no output VAT will be due.

Car expenses

Provided there is some business use, the full amount of input VAT can be reclaimed in respect of repairs.

Where fuel is provided all the input VAT (for both private and business mileage) can be recovered, but the private use element is then normally accounted for by way of an output VAT scale charge. This is based on the car’s CO₂ emissions, and will vary according to the length of the VAT period. The scale charge can apply to sole traders, partners, employees or directors. The scale charge will be given to you in the exam if required.

EXAMPLE 14
Vanessa is self-employed, and has a car which is used 70% for business mileage. During the quarter ended 31 March 2023, Vanessa spent £1,128 on repairs to the car and £984 on fuel for both business and private mileage. The relevant quarterly scale charge is £402. All figures are inclusive of VAT.

Vanessa will include the following entries on her VAT return for the quarter ended 31 March 2023:

However, if an employee or director is charged the full cost for the private fuel provided, output VAT will instead be calculated on this charge to the employee or director.

EXAMPLE 15
Ivy Ltd provides one of its directors with a company car which is used for both business and private mileage. For the quarter ended 31 March 2023 the total cost of petrol was £720, with the director being charged £216 for the private use element. Both figures are inclusive of VAT.

Ivy Ltd will include the following entries on its VAT return for the quarter ended 31 March 2023:

Where a leased car is available for private use, 50% of input VAT on leasing costs is non-deductible.

EXAMPLE 16
During the quarter ended 31 March 2023, Jimi, a sole trader, leased a car at a cost of £960 (inclusive of VAT). The car is used by Jimi and 70% of the mileage is for private journeys.

The car is available for private use, so £80 (960 x 20/120 x 50%) of the input VAT is non-deductible.

The second part of the article will cover VAT returns, VAT invoices, penalties, overseas aspects of VAT and special VAT schemes. It also includes a test of your understanding.

Written by a member of the TX-UK examining team