The Flat Rate Scheme and Bank Interest. Certain bank interest should not be regarded as turnover for the FRS. This follows a recent decision by the First-Tier Tribunal about the treatment of bank interest.
In January, the Tribunal handed down a decision in the case of Thexton/Fanfield (TC00919) which dealt quite specifically with the issue of when interest from bank accounts should be regarded as “business” income for the purposes of calculating turnover for FRS calculations. The chairman ruled that in the cases concerned, the interest did not constitute income from a “business activity” of the companies concerned and therefore was not income for the purposes of the FRS.
In these particular cases, the companies concerned had very specific business activities (one an IT consultant and the other a professional firm which provides accountancy and tax training and advice) which did not involve any active investing of funds to generate interest income. The interest was earned on accounts that existed to hold long term or short term funds to enable the companies to carry on their business activities.
It’s important to understand the reasons that the Tribunal ruled in favour of the appellants in this case as there are, of course, several situations when businesses earn interest from bank deposits or other investments. In these cases the interest was not earned from business activities and should not be included in their relevant income for the purposes of the FRS. In other words, if the bank interest is passively earned from accounts whose main purpose is to enable the business to retain money on deposit and have the use of the banking facilities to enable the business owners to carry out their business activities, then it’s not income that is generated from business activities. To use the Tribunal’s words, it isn’t “a direct, permanent and necessary extension of the Appellants’ business”.
The Tribunal distinguished certain other situations where interest would be regarded as earned from business activities, such as a property management company who funded activities from cash advances from clients, or a solicitor who holds clients’ funds on account.
I understand that HMRC have accepted this decision, although they haven’t commented about it publicly. Also the most recent edition of VAT Notice 733: Flat Rate Scheme (April 2011) doesn’t reflect the decision. So while I can’t give a definitive list of situations where bank interest income should or shouldn’t be treated as income for FRS purposes, based on my reading of the Tribunal’s judgement, it seems to me that if the following circumstances apply, then the income can be excluded:
- The primary reason that the income is in the bank is for safekeeping and to enable the business to have access to the bank’s banking facilities.
- The deposits and/or interest isn’t linked to any specific aspect of the business – eg solicitors’ clients funds or for the purpose of funding ongoing property management activities.
- The business owner doesn’t actively manage the deposits, eg by shopping round for better interest rates.
Of course this means that your clients using the FRS may have overdeclared VAT on previous returns as a result of including interest in their income and can claim the overdeclared VAT. I would imagine that any such amounts would be relatively low – maybe not even £100 per annum – and therefore well within the limit that can be included on the current return, so there would be no need to make any specific claim to HMRC.
I’ll keep an eye out for any comments from HMRC about this development and confirm any guidance they have about the circumstances in which bank interest can be excluded from FRS calculations.
June 2011