Ensuring VAT is charged correctly - Landlords Financial | Landlords Bookkeeping Accountants

VAT is often thought of as a relatively simple tax; if a business is VAT registered, 20% VAT is usually charged. However, in practice, the VAT system is more complicated. What is being supplied, who is doing the supplying/buying, where the supply takes place and whether particular conditions and evidence requirements are met determines whether a transaction is standard-rated, reduced-rated, zero-rated, exempt or outside the scope of VAT. Getting the distinction wrong can result in VAT being underpaid or overpaid and, potentially, interest and penalties being charged to the supplier.

Standard rate – 20%

The 20% standard VAT rate is the default tax rate. However, a business should not assume that a particular product or service is standard-rated simply because similar products are. Small differences in composition, presentation or use can mean a different tax rate or combination of tax rates should be charged. Such a distinction was considered in the famous ‘Jaffa case’ where HMRC challenged the VAT treatment of McVitie’s Jaffa cakes. The issue itself was simple – were Jaffa cakes cakes or biscuits? The distinction mattered because cakes are zero-rated for VAT, whereas a biscuit wholly or partly covered in chocolate is standard-rated. The Tribunal decided that Jaffa cakes had sufficient characteristics of cakes to be treated as cakes and therefore zero-rated.

Reduced rate – 5%

The reduced rate is 5% and applies to specifically defined goods and services. Common examples include certain domestic electricity and gas supplies. This reduced rate can also apply to certain qualifying work on existing buildings, such as particular conversions and the renovation or alteration of qualifying residential premises that have been empty for at least two years. In contrast, the construction of a qualifying new building can generally be zero-rated provided the detailed conditions are met.

Zero-rated – 0%

The important point to note regarding zero-rated supplies is that they are still taxable, but the rate is 0%. Examples include children's clothing and books and newspapers. The main

advantage of making zero-rated supplies is that VAT on purchases can generally be reclaimed. Therefore, a business making entirely zero-rated supplies can be VAT registered and reclaim VAT on its purchases, despite charging its customers no VAT.

Exempt

With an exempt supply, VAT is not charged because the supply is specifically exempt from VAT. Examples include certain financial services and insurance. The crucial difference between a zero-rated supply and an exempt supply is that input VAT incurred in making the exempt supplies is generally not recoverable. Also, supplies do not count towards taxable turnover for the VAT registration threshold. Therefore, a business whose supplies are entirely exempt but with more than £90,000 turnover does not have to be VAT registered.

If a business makes both taxable and exempt supplies, it may be partially exempt, creating potentially complex rules for determining how much input VAT is recoverable.

Outside the scope

Transactions deemed ‘outside the scope’ are those which are not within the VAT system, so VAT does not apply. A typical example is a tip left by a customer in a restaurant. No VAT is due as it is not consideration for the restaurant's supply. However, the situation is different should a restaurant levy a compulsory service charge as it forms part of the consideration for the meal.

Getting it wrong

Getting the VAT rate designation wrong can affect the amount of VAT charged to customers, the amount of reclaimable VAT, whether the business needs to register for VAT and how figures are reported on the VAT return. Getting it wrong does not automatically result in a penalty where the business took reasonable care in preparing their VAT returns. However, where an error results from carelessness, the penalty can be up to 30% of the VAT underpaid, rising to 70% for a deliberate error and a maximum of 100% where the deliberate error was concealed. Interest may also be payable.

Ensuring VAT is charged correctly - Landlords Financial | Landlords Bookkeeping Accountants

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