Accounting Issues
There are several VAT issues that are actually driven by the accounts or the accounting procedures and we’ve summarised some of the most important ones in this section.
And even though VAT officers aren’t accountants, some now receive specialist accounting training as well as training in IT accounting systems. This means that they are better equipped to ask the right questions about traders’ accounting systems.
Their main concern is to ensure that the systems are fit for purpose. But even though they might not be concerned about minor accounting reconciliation issues, these are taken into account when considering the business’s overall compliance.
Year End Issues
Two issues that regularly crop up when annual accounts are being reviewed are management charges and “balancing” journal entries. I’ve lost count of the amount of times over the years when I’ve asked the FD or the auditors to explain what the journal entries represent and they can’t! And if the figures can’t be explained, the officer has to assume that they represent undeclared income and will issue an assessment for the underdeclared VAT.
As far as management charges are concerned, there are now special rules that establish when the VAT
liability (ie the tax point) arises even if no actual cash payment takes place. So don’t forget to account for VAT at the right time when putting such charges through in the future.
Groups of companies and partial exemption
Some of the most complicated VAT legislation concerns VAT group registrations which are partly exempt. In the past, HMRC didn’t really appreciate how VAT group registrations could be used to minimise VAT costs. Some very clever VAT accounting schemes cost the Exchequer hundreds of millions of pounds in “lost” VAT and as a result, there are now several anti-avoidance rules to combat such practices.
Possibly the most important is a very simple provision whereby HMRC can refuse permission for a company to join or leave a VAT group at the time requested. This usually puts paid to any clever timing ideas to manipulate VAT costs.
Intra-group Transactions
The other major group issue is the treatment of transactions between associated companies which have separate VAT registrations. It is quite common for large corporate groups to keep certain exempt activities in one company which is not part of the group registration so that any exempt input tax can be ring-fenced. This actually makes a lot of common sense as it simplifies the VAT accounting by avoiding partial exemption issues for the rest of the group, even if the exempt company looses a little more input tax than necessary.
However HMRC is particularly vigilant nowadays about transactions between group companies in such cases where they believe that tax avoidance is involved. A good example is the recent case of the Community Housing Association which involved transactions between a partly exempt company and an associated company which was fully taxable. The transactions generated a significant VAT saving for the CHA and HMRC believed that the transactions were only carried out to make the VAT saving and were not genuine commercial transactions.
In this case, the Court ruled in favour of the CHA. But the case is a reminder that there must be a genuine commercial reason for such transactions with proper documentation and substance to the events. So it’s even more important nowadays that any such transactions are supported by legal agreements and that there is a good commercial reason for arranging the transactions in this way other than a potential VAT benefit.
Basic checks and reconciliations
The majority of VAT assessments are generated as a result of the basic compliance checks carried out by the officer. These include reconciling declared sales to the annual accounts or bankings and making sure that the business has the correct evidence to support input tax claims. This is part of the officer’s primary purpose ensuring that the business has the necessary procedures in place to ensure that the VAT returns are correct – for example ensuring that the business has a procedure for verifying VAT invoices and approval for payments.
Expenses
And one of the easiest areas for assessments is the treatment of expenses. Many multi-million turnover businesses get right through the normal checks of their voluminous sales and purchase records, but come a cropper when it comes to updating the fuel scale mileage rates each year and how much VAT they can claim for the cost of the staff Christmas party.
This is hardly surprising – if you have a multi-million turnover business then it’s difficult to justify spending a lot of time making sure that the expenses claims, which are a couple of thousands of pound each quarter are correct.