And before I go any further, you need to know that this applies to EVERY VAT registered business. It’s nothing to do with partial exemption and all that palava, It’s a fundamental rule of VAT. Just as it’s essential that you charge the correct rate and amount of VAT on your sales, you can ONLY claim VAT on costs that has been correctly charged
You might think that it really doesn’t matter if you claim the VAT, as long as the supplier pays the VAT on the sale to HMRC. But, as I’ve explained below, you need to understand the VAT liability of your purchases and expenses just as much the VAT liability of your sales.
The VAT invoice really is the star of this show. It’s a legal document and must contain certain information. Suppliers have to show both the rate and value of VAT on their sales on their VAT invoices. At that point, the VAT becomes a “debt due to the crown” because the amount is shown as VAT on the invoice, even if the rate is wrong (e.g. 20% instead of “outside the scope” for international services; or 20% instead of 5% for residential renovations). And you probably assume that it doesn’t matter if you claim the VAT, as long as the supplier has included the VAT on their VAT return and paid the VAT to HMRC.
After all, neither the supplier nor the customer, nor HMRC, lose out.
But unfortunately, that’s not how VAT works.
If VAT is charged incorrectly on an invoice, then the invoice is not a valid VAT invoice and the customer cannot use the invoice to claim VAT. This applies even if the supplier has paid the VAT to HMRC. The customer, having claimed the VAT as input tax on their return, has submitted an “error” return.
If you have been charged too much VAT, the ONLY way to get it back is for the supplier to issue a credit note for the original amount and issue a new invoice showing the correct VAT rate/value.
Now this situation can give rise to a number of problems, which can include delays to repayment claims (both UK VAT and under the EC refund scheme) and may lead to penalties for the business that has included the VAT as input tax on their VAT returns.
You can find information about the specific rules for correcting errors on VAT returns in VAT Notices 700/45 http://tinyurl.com/y377rf82 and 700/42 http://tinyurl.com/vowm66t respectively. And it could be worse if HMRC believes that the error is deliberate or involves dishonesty.
I thought it would be helpful to give you a couple of examples that have recently arrived in my inbox.
- The first involves the manufacture and sale of goods under licence involving a UK company, a Swiss company and one based in the US and the final UK customer. The issue came up after one of the companies claimed VAT on UK costs under the Overseas VAT Refund Scheme.
- The second query was about the VAT liability of services provided by a property designer under “design and build” arrangements. As is typical in such arrangements, the “designer” acts as main contractor and is responsible for engaging and managing services from third parties suppliers, including sub-contractors and other professionals. However in this case, the “designer” charged VAT at 20% for the whole of the project, including construction services, which qualified for the zero-rate as new construction. The customer (a property developer) claimed all of the VAT on the basis that the new homes were to be sold as zero-rated supplies.
In each of these cases, the customers assumed that they could claim VAT because it was shown on the supplier’s invoice and they paid it in good faith. But not only did their mistake create an “error” VAT return, there were additional implications that, in one case particularly, cost the business a lot of money.
Example 1: Overseas VAT refund scheme
The incorrect VAT refund scheme claim was because a Swiss company, operating from a UK branch, issued a VAT invoice to a German business for a licence payment, relating to goods manufactured in the US under a licencing agreement. The Swiss company charged UK VAT on the licence fee. The German company claimed the VAT under the EC VAT refund scheme from HMRC. The claim was refused, because the service was “outside the scope” of UK VAT. The Swiss company should not have charged UK VAT, as the German company should have accounted for VAT under the reverse charge procedure. The German company then had to seek a refund from the Swiss company for the VAT that had been incorrectly charged.
This wasn’t a difficult issue for the parties to resolve, but it caused cashflow issues for the German company, as well as incurring professional fees for dealing with the issue. In practice, the companies involved should have checked the VAT liability before the invoice was issued or before claim was even submitted.
Example 2: Construction services
The case of the zero-rated construction services that were invoiced with 20% VAT was much more of a problem. In this case, the property developer had previously made errors on his VAT return for which he was subject to the “misdeclaration” penalty. In the most recent case, the penalty had been charged at 30% of the tax involved. HMRC had confirmed that penalties would be levied for further errors (subject to certain conditions) and may also lead to prosecution because of repeated errors.
In this case, the supplier was able to issue a credit note to refund the overcharged VAT. However, HMRC issued a further, even higher, penalty to the developer because the company had claimed VAT that was incorrectly charged.
Business MUST review VAT invoices to ensure VAT has been CORRECTLY charged.
Nowadays, when we submit our VAT returns, we have to tick a box confirming that, to the best of our knowledge, the return is correct. You might assume that your accountants should spot any errors if they do your VAT returns, or when doing your accounts, but accountants can’t know everything about VAT. I’ve been doing VAT for over 30 years and I know that I don’t know everything about VAT, though I’m pretty confident that I know enough to spot a mistake.
If you’re uncertain, check out HMRC’s list of zero-rated, reduced rated and exempt supplies http://tinyurl.com/p6s8r65.
Very few businesses have the need or the resources to check every suppliers’ invoices. If you use the same suppliers on a regular basis, you should do occasional checks just to be sure that the invoices are correct. But at the very least, you need keep an eye out for:
- the VAT liability of any unusual purchases or expenses, such as international transactions; and
- any purchases or expenses where the value/VAT amount is particularly high.
It’s also important to bear in mind that mistakes on your VAT returns can feed through your whole accounting system, affecting the value of your business’s sales, purchases and profits, which can affect your overall tax liability. You’d probably spot something as obvious as claiming VAT on a new car, but you need to keep an eye out for other errors, particularly if someone has charged you VAT incorrectly.
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