Can we raise a management charge to claim VAT on costs?
Ever since I announced that I am writing a book about intercompany supplies and management charges, I’ve received a lot of queries from businesses about the subject, so much so that I’ve been too busy advising those businesses that the book is still not finished!
What is interesting about the queries is that EVERY SINGLE ONE IS DIFFERENT. There are some common threads, of course, but it reminds me that every single business is unique and has its own way of doing things. But however you do things “in-house”, when it comes to VAT you have to deal with every situation in the same way as though the parties involved are completely unrelated.
Why does this matter so much?
There’s nothing in VAT law that stipulates how transactions between related businesses are organised, for example whether or not there is a formal agreement between the parties about the nature of the services; or the mechanism for calculating the value of the charges. However the simple point is that every VAT registered business must be able to demonstrate that it carries out its activities “in the course or furtherance of a business”, whether it is making sales to third parties or to associated businesses.
And when it comes to supplies of goods or services between associated businesses, it means that the arrangements between the parties are even more strictly managed than between third parties.
What do I mean by this?
Think about it this way. If you receive an invoice from any third party supplier, you’ll only be willing to pay it if they’ve provided goods or services that you’ve agreed to buy under some sort of agreement/contract and that you’re satisfied about the quality of the goods or services concerned. You can only claim VAT on those goods or services if you have a VAT invoice that includes a full description of the goods or services, the unit cost and the volume of the goods or services. 
Of course, each industry group has different ways of doing this. In the professional world, services are usually defined in contracts or engagement letters and the invoice typically refers to “completion of annual accounts”, “professional services in respect of your dispute with your neighbour”. HMRC are usually happy with this as long as the work is defined in the engagement letter and may ask to see correspondence or other documentary evidence to prove that the services have been carried out.
NOWADAYS HMRC EXPECT TO SEE A MUCH HIGHER LEVEL OF EVIDENCE WHEN SUPPLIES ARE MADE BETWEEN ASSOCIATED BUSINESSES.
Why is this? Well HMRC has to be sure that supplies between associated businesses have been made as though the parties were independent to ensure that there is no fraud involved.
A good example of this is where services are made to associated businesses that are partly exempt and can’t claim all of their input tax. For example, Company A may supply services to Company B at cost or even below rather than at third party rates. This means that Company B incurs less VAT on its costs than from a third party supplier.
In an ideal world, the associated companies would register for VAT in a single group registration so that VAT isn’t charged on transactions between the companies. But this isn’t always possible or practical. Also, you can only take advantage of group registration arrangements if you’re a company, not if you’re a sole proprietor or a partnership. So why should you create additional cost for recipient (in this case Company B) by adding a mark-up and creating additional irrecoverable cost?
Normally HMRC don’t object to this as long as the contractual arrangements are properly set up, there is evidence that the work has been done and that the services are at least supplied at cost. But because of the potential for manipulation of the value or timing of supplies between associated businesses to generate a VAT advantage, HMRC is now more vigilant than ever when validating claims for VAT on such supplies. Hence the wealth of anti-avoidance legislation to prevent the abuse of the VAT system.
But over the years, I’ve seen several situations where there is no written agreement for transactions between associated companies, even when the businesses are large, complex organisations, including those involving cross-border services.
You might think that the question I posed at the beginning of this blog was just written for the purposes of the blog. However, in the past couple of months, I’ve received emails from businesses which contain such queries, almost word for word, about claiming VAT on costs. They include such complex issues as cross-border transactions, VAT grouping arrangements, partial exemption and valuation. These come from large sophisticated businesses which regularly spend six figure sums on legal fees and other third party supplies relating to the whole of the corporate group.
In each case, there have been NO intra-group agreements for dealing with such transactions, or even any established procedures for calculating the value or timing for charges for supplies to associated businesses.
In the past, payment for management charges and other supplies between associated businesses was often done by adjustments made in the annual accounts at the year end, with VAT invoices issued almost as an afterthought.
This is no longer sufficient.
Supplies between associated businesses are now subject to a much stronger level of scrutiny by HMRC. Based on my experience, to support claims for VAT on such costs, especially if the payer has submitted a VAT claim, at the very minimum you should have:
- A clearly written and signed agreement between the parties, setting out the services to be performed and the arrangements for valuing those services, making payment and issuing VAT invoices. This does not have to be a lengthy document, nor written by a solicitor, it could be as simple as a list of daily tasks to be carried out by shared staff or how administration costs will be shared, e.g. receptionist services, sharing of telephone costs etc.
- Evidence that the work has been done, including timesheets which show the work carried out on a daily basis, such as the name of the project and, preferably, some written evidence of the actual services supplies – for example correspondence, notes of meetings, diary notes
- Accounting records showing how the charge for the work has been calculated
- An explanation for any differences; i.e. why the amount charged is more or less than expected as per the agreement
- A detailed VAT invoice showing the work done or accompanied by timesheets that can be cross-referenced to the original agreement between the businesses
- Ensure that payment is made within the terms of the agreement. Remember that the six month bad debt relief rules apply for late payment.
If you’re dealing with a complex arrangement involving partial exemption, cross-border transactions or other complex issues, I’d strongly recommend that you take specialist advice about the structuring of the arrangements to ensure that it takes into account all potential VAT issues. For example, the VAT treatment of costs relating to cross-border transactions is a complex area in its own account and each EU country applies those rules in its own unique way.
I’d also strongly recommend that agreements involving complex arrangements are drawn up by solicitors, in the same way as any third party contract is created.
But the agreement doesn’t have to written by a solicitor. If your business arrangements are relatively simple, you should be able to draft a simple agreement between the businesses. Just make sure that proper billing, invoicing and payment procedures are followed in the same way as any third party transactions.
And the answer is……..?
Can we raise a management charge to claim VAT on costs?
The short answer is maybe, but probably no. You can only claim VAT on professional costs, office costs and any other expenditure if the input tax is attributable to taxable supplies. If the supplies are made to associated businesses, the transactions must be arranged and carried out in the same way as transactions with a third party.
And it’s up to the business to demonstrate that the supplies have been made in this way.
Marie
March, 2015