This is a bit of a techie blog, but the subject is so fundamental that it deserves to be blogged about.
What is an obvious exam question about VAT? How about this:
“Explain the difference between VAT exempt supplies and taxable supplies. Please demonstrate with special reference to the difference between taxable at the zero rate and exempt.”
And it’s not that I want to give away trade secrets or do myself out of work. It’s just that it is a very basic principle of VAT and the difference can have quite a significant effect for the businesses concerned.
If you’re reading this blog, chances are that you know the important point which is the following:
In principle, businesses can recover VAT on the cost of goods and services that are used to make taxable supplies, but not on the cost of goods and services that are used to make exempt supplies.
And of course, taxable supplies include those at the standard rate of 15%, reduced rate of 5% and the zero rate, which is a rate of tax.
Like all tax rules, there are exceptions to the rule including the de minimis limits which are designed to help businesses with limited amounts of exempt income. But even these can catch out unsuspecting businesses.
The old property one……
A few years ago, a house building client bought some old ex-council houses to renovate and keep as investment rental properties. They were about a dozen houses in all and needed new bathrooms, kitchens, heating systems, decorating and basic furniture. He spent about £40,000 plus VAT altogether on the goods and services over a 10 month period.
Being a house-builder he was familiar with the zero-rating that applied to the freehold sales of new properties and the fact that his company was able to recover all of its input tax. His property agent (or maybe it was someone down the pub, I can’t remember the exact details!) confirmed that the rental income would be VAT free. He wasn’t aware of the fact that the rent was exempt rather than zero-rated and therefore the company might not be able to recover VAT on the costs relating to the exempt rental income.
At the time, the de minimis limit was £6,000 per annum – which meant that if the net expenditure was just over £34,000 in the VAT year, the VAT couldn’t be recovered. But he claimed it and the VAT officer issued an assessment for the VAT when he visited a year later.
The amount involved here might not have been huge, but the simple point is that with some relatively simple planning, it might have been possible for the company to recover all of the VAT. But the director never took the trouble to check it all out. Since that time, the company has invested in commercial property and the director has made a point of taking proper advice about opting to tax and VAT recovery to avoid similar costs in the future. The company now owns a couple of commercial property developments and the potential VAT cost of getting this lot wrong could be well into six figures.
And what about that application for the new business loan?
More recently I heard of a company planning to set up as an insurance broker which went right through preparing a business plan for the purpose of applying for a bank loan for IT equipment. All of the financial modelling was done on the basis that the company could claim the VAT back.
It was only when the newly engaged accountant did a final review of the figures that the issue of the VAT liability was raised – it turned out that the company would have to borrow an additional £5k to fund the irrecoverable VAT. But more importantly, all of the forecasting for the first 5 years profit and loss had to be redone because it was originally modelled on the basis that the company would be fully taxable, not fully exempt.
Is it rocket science?
I’m not trying to be clever here, it’s just that knowing how any tax issue – not just VAT – can affect a business’ financial affairs, I’m always amazed that people don’t check up on these things when starting a new business venture.
At the moment I’m revising my business plan (again!!!) and redoing my own forecasts. Even as a relatively small business, I know that I have to take advice about the direct tax issues as well as other financial stuff. Of course as a tax professional you’d expect me to be “financially aware” but to me it’s no different to doing the monthly household budget.
We all spend huge amounts of time with our marketing and selling and networking to get new clients or a new contract. Yet getting the VAT issues wrong on a new business venture can wipe out the profit. And sometimes checking the “rocket science” bit – or paying someone else to do it – can actually help to save money, not just identify additional costs.
I don’t usually blog about technical stuff but this issue is so fundamental that every now and again, it has to be “aired”. Partial exemption is one of the most complicated of VAT issues and just mentioning it has been known to turn grown men a rather putrid shade of green. It really is one of those subjects that should be dealt with by a VAT specialist. But if you can at least remember the fundamental difference between taxable and exempt supplies, it could save you an awful lot of money and hassle later on.
Marie