Common VAT Errors
What’s a gingerbread man with chocolate trousers got than a plain one hasn’t?
Now if you may think this is a silly question, especially when this blog is about VAT well think again. This is a real question that you need to consider if you sell gingerbread men. The answer is 20% VAT, that’s right the plain gingerbread man isn’t considered a luxury item so is zero rated whereas his more exotic cousin with chocolate trousers is vatable.
With the complexity of the VAT laws, it’s understandable that businesses make mistakes on their VAT returns. However, these mistakes can be very costly both in terms of paying the wrong amount of VAT and triggering a VAT investigation.
VAT was meant to be such a simple and straightforward tax!
When VAT was first introduced in the UK way back in 1973, it was hailed as a simple tax. A VAT registered business supplying Vatable products and services, simply must charge its customers 20% VAT, the business then deducts from that figure any VAT they’ve paid to their suppliers and pay the difference over to HMRC. What could be more straightforward than that? Turns out it isn’t quite so simple after all. So, what are the most common mistakes small businesses make on VAT Returns?
The 3 most used VAT Schemes
Before we get into the common mistakes lets look at the three common VAT schemes businesses use to calculate their VAT liability:
The VAT Standard or Normal accounting scheme. Here you pay VAT on your sales regardless of whether your customers have paid you for the outstanding invoices. You then reclaim VAT from your suppliers’ invoices, whether or not you have paid the bill.
The VAT Cash Accounting Scheme. You only pay and reclaim VAT based on the money you’ve received and paid, so you are not paying the VAT on sales invoices until you have received the money into your bank account.
The VAT Flat Rate Scheme. You raise your invoices and charge your customers at the appropriate rate of VAT (e.g. 20%) but you simply pay over a reduced percentage (the percentage depends on your industry sector) to HMRC. Importantly with the flat rate scheme you’re unable to reclaim any VAT on your expenses except on some capital equipment.
Now, we have looked at the three most common VAT schemes lets now have a look at some of the most common mistakes people make, the first of which is not comparing VAT schemes and which one is best suited to their business circumstances.
On the face of it, the Flat Rate scheme delivers cashflow savings to small businesses and it does simplify your accounting to some extent.
However, a costly mistake some businesses can make is not comparing this scheme to, say, the Cash Accounting VAT Scheme. Where a business has a fair chunk of expenses it pays VAT on, it might not be tax efficient to join the Flat Rate Scheme.
And where a business has some exempt income (rental income), extra care needs to be taken when joining the Flat Rate Scheme because you end up having to pay VAT on income that is normally exempt from VAT.
Some of the mistakes people make with the flat rate scheme.
Using the wrong flat rate percentage
This is an area where HMRC is beginning to raise VAT enquiries and is also an area where small businesses can easily be caught out because of the “limited cost trader” VAT rule. This rule will essentially increase the Flat Rate percentage for most service-based businesses. So please do take extra care and ensure that your Flat Rate percentage is reviewed to avoid triggering a VAT enquiry and having to pay back-dated VAT.
Under-stating the Flat Rate turnover
Normally when an income is exempt from VAT, it means just that. Exempt. You do not include it on your return. But here is one of the quirks of the Flat Rate Scheme. The gross income you enter in Box 6 of the VAT return should include the value of all exempt supplies as well as the VAT-inclusive value of all standard-rated, reduced-rated and zero-rated supplies. So, in some cases, you may end up paying more VAT under the Flat Rate Scheme.
Using the 1% reduction beyond its expiration date
Sticking with the flat rate scheme, when you first join this scheme, you get a 1% reduction off your industry percentage for the first year only. The reduction expires on the anniversary of your VAT registration and NOT the anniversary of you joining the scheme.
Depending on what bookkeeping software you use, this may get flagged up. If not, take extra care as recent VAT enquiries are picking up on this common mistake resulting in HMRC for payment of backdated VAT.
Common Mistakes on VAT returns
No satisfactory evidence for VAT reclaims
When it comes to claiming back VAT, the general rule is simple if you don’t have a VAT receipt, you cannot reclaim the VAT and even where you have a VAT receipt, make sure the item you bought does carry VAT. Whilst there are few exceptions to this rule, why take the risk? And to avoid losing money, I recommend that my clients use Dext that allows you to take a quick snap of your receipts on the go. The receipts are then automatically stored in Dext for 7 years (the number of years required for HMRC compliance) and also within the transaction in your bookkeeping system.
Claiming back VAT on non-business use expenses
Where you’ve incurred expenses which is partly business and partly personal, for example your mobile phone bill, some people forget that VAT can only be claimed on business part of the expense and not the full amount, meaning no VAT can be claimed on the personal element. So a manual adjustment will be required here.
Incorrectly claiming for VAT on motor vehicles and fuel
A common error is to claim VAT on a motor vehicle which is available for private use. The VAT can only be claimed back where the vehicle is to be used exclusively for business purposes and will not be available for anyone’s private use, and this is very rare indeed as in the case of most company vehicles these are used for the commute. Another classic mistake is claiming the full costs of fuel where the car is available for private use without restriction. In this case fuel scale charge should be used.
Claiming back VAT on business entertainment
Although entertaining clients is justifiable to win contracts, VAT on these expenses is normally blocked and cannot be claimed back. HMRC will have this on their check list when doing a VAT inspection as this is an easy win for them. There is a simple solution to avoid mistakes in this area, when setting up your bookkeeping software have a separate category for business entertainment with nil VAT and ensure your bookkeeper knows when any receipts should be allocated to this nominal code.
Not claiming VAT on staff entertainment
Here’s one exception to the rule that VAT cannot be claimed on entertainment. Where you entertain staff, including directors of their own company, do ensure you claim back the VAT on the expenditure, assuming the type of entertainment or expense carries VAT. Just one of the many quirks in the VAT rules a bit like the gingerbread man scenario.
Not adding the human element to the automation
All modern bookkeeping software has an element of automation and technology that saves loads of time on the data entry, which is great, however, it is always my recommendation that before you file your return you look through the detailed summary to ensure everything is correct. Having used cloud software since 2014, I must dismiss the myth that the computer will do it all for you. There are many TV adverts that claim to have a VAT checker build into the software the danger is companies rely too heavily on this software and fail to carry out basic checks on the VAT return before filing. Errors such as automatically coding expenses to wrong accounts, the entertainment expenses example above being a case in point and duplicated bank transactions are all too common and they lead to costly VAT enquiries.
One of the most common mistakes I have come across here occurs when the actual invoices as well as the statements or pro-forma invoices are uploaded to the software and the VAT is then claimed twice, the software will not recognize this as a duplicate as the pro-forma will, in most cases have a different number to the actual invoice.
Do carry out a review of the input VAT and pay particular attention to VAT amounts that are the same. Most cloud software options will allow you to export to an excel spreadsheet you can then simply sort the items for a quick review.
Bookkeeping is a skilled and often undervalued job so many small businesses try to go it alone instead of paying for a qualified bookkeeper. This can cause a number of classic errors the most common ones I have come across are:
Business entertainment been classified as marketing and VAT claimed.
VAT been claimed on expenses which do not carry VAT (such as stamps, train tickets, milk for the office coffees etc
Input tax claimed on costs incurred outside the UK (for example /business trips hotels and meals.
Not accounting for VAT on services received from overseas suppliers
The Reverse Charge, in simple terms means where a UK business buys services from an overseas supplier in the EU, the UK business is required to account for VAT on those services on their VAT return, as if they were the supplier. Under the reverse charge rules output VAT, which is the VAT on income, must be declared in Box 1 of the VAT Return. This VAT, subject to the normal rules, is also recovered as input VAT, which is VAT on expenses, in Box 4. The overall effect is NIL, if you’re thinking what is the point in that you are not alone, but rules are rules!
Ignoring VAT demands and notices
Ignoring HMRC’s demands and notices is never a good idea and can prove to be very costly. Don’t bury your head in the sand, running a business and staying on top of cashflow can be hard enough without adding additional stress and extra costs. One example of this is when HMRC send out an estimate assessment and the business fail to send in the correct VAT return in good time, if the estimate turns out to be higher than the actual return, HMRC is not obliged to change the figures on their estimate meaning you could pay more VAT that you need to.
Failing to repay VAT on supplier invoices
When using accrual scheme for your VAT returns and VAT has been recovered on purchases from a supplier, if you do not pay this supplier within six months, you are required to repay any VAT recovered to HMRC. Similarly, where a customer has not paid you for over six months and you’ve already paid VAT on that invoice to HMRC, you can claim that VAT back. This is something to watch out when reviewing your return before filing, again I have not come across any software yet that checks this for you.
This oh so simple and straightforward tax can be anything but so if you are unsure seek the advice of accountant or a bookkeeper to help with your VAT. For any major or complex VAT issues related to land, property, imports, and the other high-risk areas seek the advice of a VAT specialist. If, however your business is straight forward and your VAT is simple and you're happy to keep on top of changes in the rules then there is no reason you cannot complete your own returns. My advice is to take extra care, use a checklist, don’t assume the software will always get it right and lastly don’t leave it to the last minute.