Value Added Tax

Value Added Tax

VAT For The Fainthearted

REBECCA BENNEYWORTH supplies an introductory tour of VAT for those who are of a nervoud disposition.

VAT IN THE smaller practice is regarded by many as the remit of specialists. I am often told that general practitioners do not attend VAT courses, because they use the services of a VAT consultant. However, perhaps more so than with any other tax, unless the practitioner has a good understanding of the basic principles potentially disastrous errors can be made without anyone even having identified the need for specialist advice. In fact, many of the problems that arise with smaller clients do not require the skills of specialist VAT consultants, just a good basic appreciation of the ground rules of this potentially complex but fascinating tax. Come with me then, on a short accompanied tour of some of the basics of VAT.

Taxable supplies

VAT arises on taxable supplies. One of the best pieces of advice regarding VAT to give to a client is 'never assume anything'.

However, if one were to assume anything about VAT, it would be that it has been charged at standard rate on any supply made.

VAT is structured so that whenever it should have been charged, it has, so that it is impossible for your client to omit to charge VAT. Whatever the proceeds are, VAT is inclusive and is due to Customs. It is this, of course, which can give rise to such serious problems for the trader who unwittingly falls foul of the rules by believing that in some way VAT does not apply to his supplies, and he therefore fails to make a suitable price adjustment to allow for the VAT due.

Taxable person

Only supplies made by taxable persons are liable to VAT. However, the definition of taxable person is another trap for the unwary. The Value Added Tax Act 1994 (VATA 1994) states at section 3(1) that:

Clearly, a trader who is registered for VAT would expect to be liable to VAT on his supplies and adjust his prices accordingly, but the trader who 'is required to be' registered obviously is not registered by definition. Poor businessman — and many of us have had to advise clients in this situation — he did not realise it, but he was charging VAT all along on any taxable supplies he made. This amount is now due to Customs.

Unfortunately, the story does not improve for our now impoverished client. The period of adjustment for VAT errors is normally three years retrospectively from the date the error was discovered, but for what is called 'failure to notify' — that is a failure to submit the required registration notification — the time period allowed for an assessment to be raised retrospectively is set by VATA 1994, s 77 at 20 years! The penalty provisions imposing a penalty of up to 15% of the relevant VAT would seem superfluous at this point.

While on the subject of 'failure to notify', one of the most unpleasant situations to be consulted about is the trader who exceeded the mandatory registration limit some time ago, but is confident that he has escaped liability as his supplies are now below the current deregistration threshold.

This type of scenario is illustrated in Example 1 on the following page.

Example 1

Parker has been trading as a self-employed chauffeur for many years. During 2000, when the VAT registration threshold was £51,000, Parker exceeded the threshold when his supplies in the twelve months ended 28 February 2000 reached £51,878. However, on 1 April 2000 the limit increased to £52,000, and Parker has remained below the registration limit ever since, and is currently making average annual supplies of around £50,000. Parker has just become a client and explains that Customs have not identified this little slip up, and as it occurred more than three years ago he is 'safe'.

You explain that his VAT position is as follows.

 

• By making supplies in excess of the registration threshold he became 'required to be registered' for VAT, and as such is a taxable person.

 




 

• The deregistration threshold applies only to registered traders who apply to Customs for permission to cancel their registration on grounds of the value of their anticipated future taxable supplies. Such an application will be granted (if appropriate) from the date of application or agreed later date.

 




 

• Parker is therefore still required to be registered and still a taxable person making taxable supplies ever since 1 April 2000. His only hope is to throw himself on the mercy of a friendly Customs officer. You, of course, will be bearing in mind the provisions of the Proceeds of Crime Act 2002 if Parker refuses to take your advice!

 

Transfers of going concern

Life is further complicated for the innocent businessman when a trader starts out in business by purchasing an existing business. When a business is purchased as a going concern from a taxable person, the new owner is liable to register for VAT immediately and is not permitted to wait until his supplies reach the VAT threshold. This happens because VATA 1994, s 49(1)(a) treats the supplies made in the twelve months before the transfer of the business as made by the new owner with effect from the date of the transfer. He is therefore treated as if he has been in business for twelve months with taxable supplies equal to those made by the previous owner.

This legislation is notoriously difficult to apply, and there have been many appeal and tribunal cases that have sought to establish whether a transfer of a going concern (TOGC) has taken place. In simple terms, if the new owner is in the position of being able to commence business immediately, and is running the same type of business as the previous owner, then it is likely that a TOGC has occurred. However, every case must be considered on its specific facts, and advisers would be sensible to read Customs' Notice 700/9, Transfer of business as a going concern thoroughly, together with a selection of tribunal cases to obtain an appreciation of what the key factors are. (Notice 700/9 can be found on Customs' website, www.hmce.gov.uk.)

Where the new owner intends to reduce supplies made by the business to a level below the VAT deregistration threshold, and claims therefore that he does not need to register, the conditions for TOGC treatment are not then fulfilled, and unfortunately the new owner will therefore have to suffer VAT on the assets purchased, which of course will be irrecoverable as he has elected not to register. A very risky instance of these TOGC provisions is when a poorly advised trader purchases an unregistered business from a previous owner who has been trading at above the registration limit. The new owner unwittingly becomes a taxable person immediately and the previous owner has quite possibly vanished into the mist!

So who made the supply?

Still more traps for the unwary lie in the valuation of supplies made by a business and the extent or limit of the supplies made.

Here, a businessman may be mistaken or may have set out to minimise his exposure to VAT — including the liability to register for VAT by structuring supplies in a particular way. One of the most common of these, and the subject of a recent tribunal case is carpet fitting supplied at the same time a carpet is purchased. Cash and Carry Carpets and others (18235) is a classic example of how not to do this.

The stores sold carpets, but customers could ask for a fitting service. This was provided by self-employed fitters; they were independent of the store, but their services were arranged by the store in the customer's presence. However, invoices raised for customers described the supply as one of 'supply and fit': although the fitters were self-employed individuals, the tribunal considered that they made their supplies of fitting services to the store, for onward supply to the customer. This meant that the value of the fitting service which had been treated as made direct by the fitter to the customer — and would therefore not be liable to VAT — was aggregated with the value of supplies made by the store, and VAT was due on the fitting charges.

In this case, the trader was already registered for VAT and paying VAT on the sale of carpets, but imagine the impact on a smaller business which discovers that as a result it has failed to register at the appropriate time and therefore owes VAT on all of its supplies. Disaster indeed!

Business splitting

The last area to look at in determining liability to register based on taxable supplies is the difficult one of business splitting. It is a technique that even the most unsophisticated client can come up with, especially after 'a chat with a few mates in the pub'. Essentially the business is divided into two or more businesses, each turning over below the VAT threshold, and therefore not liable to register for VAT. A little more skill than just splitting the businesses up is required here, as the businesses must not be run by the same entity, otherwise it would still need to be registered for VAT, so the businesses are organised into separate legal entities such as a partnership and a limited company.

In some situations this is perfectly acceptable VAT mitigation, but great care is needed, together with a clear understanding of the potential risks should the plan fail.

Customs have two possible approaches to a business splitting case; one of these is potentially very damaging to the traders involved, the other is not quite as serious.

First the bad news. If Customs allege that the businesses are not really separate entities at all, and they are really a single business, then the supplies made by both are aggregated from the date the split took place. This could mean that the combined business has been trading at above the registration limit for some time, and as a consequence VAT is due on all of the taxable supplies throughout that period. Remember that if not registered you have a 'failure to notify' here, which could extend back by 20 years. If one of the businesses has been registered throughout, then VAT will (only) be due on the supplies made by the unregistered part of the business, and this time for only three years unless there is any suggestion of fraud. If there are truly two separate businesses that have been set up properly, the adequately advised client should not find himself in this situation. The tribunal's decision in Skelton Waste Disposal (17351) is an excellent illustration of this approach when properly executed.

The slightly better news comes when it is clear that Customs intend to issue a direction under VATA 1994, Sch 1 para 2. This requires a trader involved in the 'artificial separation of business activities' (Sch 1 para 1A) to register for VAT with immediate effect, or at such later date as is specified. This means that the past supplies cannot be affected by a direction under para 2, and the trader embarking on such a planning structure can sleep soundly in his bed at night, secure in the knowledge that Customs can only affect his future supplies. In fact, the grim reality of the direction is that the businesses which are subsequently 'aggregated' are treated as a partnership for VAT purposes, with a single VAT registration. The practical implications of this do not bear close consideration. The issue of a direction in these cases is covered by a Customs' Statement of Practice which appears in Notice 700/1. This Statement explains the statutory test of 'artificial', contained in Sch 1 para 1A(2), which is:

Customs' Statement of Practice indicates a number of structures which would call attention for further investigation and gives illustrations of the types of links considered under the three headings of financial, economic and organisational (see 'Business links' below). Further enquiries would be made in situations such as the following.

Business links

Again these will depend upon the specific circumstances, but the following examples illustrate the types of factors indicative of the necessary links.

It is difficult to come to an objective view on the likelihood of success in any given case, as so many cases differ in the way that the businesses are related. Suffice to say that the (by now) weary adviser will recommend that his client(s) have as few of these links as possible!

This ends a consideration of the dangers connected with registration for VAT based on taxable supplies. There are other provisions requiring compulsory registration, but they are unlikely to be encountered by the average (and indeed fainthearted) practitioner.

Rebecca Benneyworth is a lecturer and tax consultant and she can be contacted by e-mail at rebecca@rebeccabenneyworth.co.uk

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