One of the most common problem areas in VAT is dealing with VAT on transactions with associated businesses. This includes sharing out the office rent or raising a management charge for directors’ services.
This is the first of 3 posts that I’m planning on the subject. Today, we’re dealing with one of the most important principles and this is the very basic aspects. What does this mean? For example, supplies you’re making any payment to an associated business, does that mean that the associated business should add VAT? And if they do add VAT, can you claim it from HMRC on your VAT return?
There’s the core business activities and the other stuff…….
Most businesses are pretty good at dealing with VAT on their main business activity; knowing when to charge VAT to customers and when they can claim VAT on costs. But it’s those non-core issues that often cause problems.
HMRC VAT officers often find errors in the VAT accounting of such transactions. This means that business owners often have to spend a disproportionate amount of time (and sometimes professional costs) sorting out non-core VAT issues. This is particularly frustrating where the value of the VATinvolved is a tiny fraction of the VAT on their core business activities.
I’ve run www.vatexchange.co.uk since 2008. EVERY SINGLE MONTH the most commonly visited page on the site is an article about VAT and management charges/intra-company payments and reimbursements. The VAT liability of such payments is also the most common sources of the queries I receive from clients and on the website forums, e.g. “do I add VAT when I charge for a share of staff costs?” or “I need to invoice for some telephone bills and directors costs – is it okay to call it a management charge and add VAT?”.
To answer the question you need to satisfy two criteria:
- You can only charge for services if the payment; or consideration, is for a supply of goods or services that are liable to VAT.
- You can only claim VAT on costs if you’re using the goods and/or services to make taxable supplies. Ideally you have to show that the goods and/or services are cost components in making those supplies.
I appreciate that the above clauses include technical terminology, but there’s really no other way of explaining the criteria without losing something in the translation. I’ll discuss these terms in the context of transactions with associated businesses in the next of these articles.
There is one other very important point: the act of “raising a management charge” doesn’t mean that services have been provided. And issuing a VAT invoice for such “charges” could be fraudulent if services have not been provided or if the value of the services is misrepresented.
Payments between associated parties can be made for a number of reasons; including payment for supplies, contributions towards costs, reimbursements for goods or services bought on behalf of the other party or even a profit share.
Either way, if the businesses are separate legal entities, you MUST define the VAT liability of any payments made between the parties before issuing a VAT invoice.
Once you’re certain that the payment IS consideration for a supply of goods or services, THEN you have to consider a number of issues:
- Is the charge made in the course or furtherance of a business? Charges made by holding companies to subsidiaries may not be regarded as being made “in the course of business”.
- What is the nature of that supply; e.g. management services, consultancy services or administration services?
- Can you provide evidence of the work carried out?
- Is there a written agreement? Does the agreement CORRECTLY represent the arrangements?
HMRC are increasingly vigilant about transactions between associated businesses. One particular issue is when the effect of the transactions gives a cashflow benefit due to the timing of VAT returns. You can understand why HMRC pay particular attention to these situations if the businesses are owned or controlled by the same individual or company. So it’s important to demonstrate that services have been supplied as though the transactions were between independent third parties.
I’m conscious that a lot of this article uses “VAT jargon”; for example, what is a “supply made in the course or furtherance of a business”.. At times, you might feel as though the VAT officer is talking a different language! So next time, I’ll talk a bit abouit VAT terminology to help you understand things a bit more easily.
Marie
August, 2021