From 4 January 2011, VAT will increase from 17.5% to 20%. It will be an unpopular measure but businesses should be preparing NOW for the increase. In particular, businesses should be looking at the implications of the VAT increase on their pricing and on their cost control.
So what should all businesses be doing to prepare for the increase in the VAT Rate. They should be looking at the following matters:-
ANTI – FORSTALLING LEGISLATION
Businesses should be looking for opportunities for pre-invoicing and payment at the lower VAT rate of 17.5%. However, businesses should ensure that they are complying with allowable legislation.
The Government has introduced Anti-Forstalling Legislation to prevent arrangements which will be set up to apply the 17.5% rate of VAT to goods or services to be delivered on or after 4 January 2011. In some circumstances, a supplementary charge to VAT of 2.5% where the 17.5% rate has been declared.
This measure will affect business which either:-
• receive a prepayment or issue an advance VAT invoice before 4 January 2011 for a supply of goods to be delivered or services to be performed on or after that date; or
• make supplies of rights or options to receive goods or services before 4 January 2011, where the goods or services are supplied free or at discount and will be delivered or performed on or after that date.
The supplementary charge will apply where the customer cannot recover all of the VAT and one of the following conditions is met:
• the supplier and the customer are connected;
• the value of the supply exceeds £100,000, unless prepayment or the issue of an advance VAT invoice is normal commercial practice;
• the supplier or someone connected to the supplier funds a prepayment for the goods or services; or
• an advance VAT invoice is issued where payment is not due in full within six months.
If the supplementary charge is levied, it will not become due until 4 January 2011 and will be chargeable in addition to standard rate VAT on the supply at 17.5 per cent.
It is vital that the business gets this right because fines levied by HMRC have never been harsher.
TAX POINT RULES
Following on from the Anti-Forstalling Legislation, it is vital that businesses learn, if they don’t already know, the tax point rules.
The tax point is the date when a transaction takes place for VAT purposes. This date is not necessarily the date when the supply physically took place. You must pay or reclaim VAT in the VAT period (usually quarterly) in which the time of supply occurs, and use the correct rate of VAT in force on that date. This means you'll need to know the time of supply for every transaction, so you can put it on the right VAT Return.
The date of the supply is called the ‘basic tax point.’ This is overridden when an invoice is issued if that is within 14 days of the basic tax point, or if a payment is received before the supply is made. However, some industries have special rules governing the tax point. It is vital that the business knows the tax point rules.
Example
In the letting industry it is normal commercial practice for rentals to be demanded (invoiced) in advance.
So if a rental invoice was sent out on the 1 December 2010 to cover the period 1 December 2010 to 28 February 2010, what rate of VAT would be used, 17.5% or 20%?
In this example, VAT charged on this supply can be at the rate of 17.5% because it is normal commercial practice for rents to be paid in advance although the period covered by the invoice cannot exceed one year.
BOOKKEEPING AND ACCOUNTING RECORDS
The business should ensure that its accounting records are correct and that it does not fall foul of any bookkeeping errors.
In particular, the business should be looking to ensure that where credit or debit notes are issued, businesses should know that any VAT credit or debit is applied at the correct rate (i.e the rate which is applied as the same as for the original supply).
It is vital that the business accounting records are accurate. It is believed that HMRC will be less lenient with accounting errors arising as a result of the VAT rate increase because of the similar increase of VAT from 15% to 17.5% in January earlier this year.
SALES PRICINGS, COSTS OF GOODS AND PROMOTIONS
It is vital that businesses look at their margins. The business should be trying to reduce the cost prices for their goods and increase their selling prices to compensate for the lower margins that they will achieve.
Retailers, for example, may wish to consider boosting their pre-Christmas sales by advertising the lower VAT rate currently in place. Post-January, "no VAT rise" pricing can be compensated for by boosting margins on other lines to compensate.
Similarly, businesses should be wary of promotions, from their suppliers, which advertise the lower VAT rate. Remember, the business will only incur an additional VAT charge of £2.50 for every £100 spent. Unless cash flow is very tight or the VAT is irrecoverable, for whatever reason, then the business should not be spending too much on pre rate rise promotions.
Businesses, especially retailers, need to ensure that the resources are in place in January to manage the changeover to the new higher rate. January, with the Christmas period just ended and the New Year sales underway will be a very busy time.
HMRC will not likely accept any excuses if they were to find any errors on a VAT Inspection, so you must get it right!!
VAT EXEMPT BUSINESSES
The businesses to be worst hit by the increase in VAT will be those who are exempt (including charities) from VAT which are, therefore, unable to recover VAT on any purchase they make.
Such businesses will find that their budgets will stretch 2.5% less far in 2011 than 2010.
So if such a business was contemplating making a capital investment, they consider bringing the purchase forward to ensure that they benefit from the lower rate.
FLAT RATE SCHEME
Introduced in 2002, the flat rate scheme was introduced to simplify the calculation of VAT for small businesses.
In essence, instead of the business paying HMRC the total VAT charged on invoices minus any Input VAT you may reclaim, you instead charge a fixed percentage of your GROSS turnover and pay that amount over to HMRC.
The main benefits of the scheme are twofold:-
• Less administration required in preparing the VAT Returns because liability is calculated by reference to sales only;
• The calculation of VAT under the flat rate scheme may result in a lower VAT liability due to HMRC.
However, businesses that provide zero-rated or exempt supplies need to be particularly careful when considering the flat rate scheme.
Example
A vehicle repair shop is considering registering for the flat rate scheme. During the quarter ended 31st March 2010 its results were as follows:-
Sales income from standard rated supplies: £23,500 (including VAT of £3,500)
Sales income from exempt supplies (i.e. MOTs): £5,000
Total Gross Sales: £28,500
VAT incurred on expenses: £1,750
Under the normal rules, the VAT liability would be £1,750. However under the flat rate scheme the VAT would calculated upon a percentage (for a vehicle repair shop 7.5%) of gross sales (£28,500) leading to a liability of £2,317.50.
The above example shows that the business should consider all sources of income before it decides whether to join the scheme.
If the business decides to join the scheme then it should be aware of the following:
• Businesses in their first year of VAT registration can benefit from a 1 per cent reduction in the flat rate.
• You can apply if your annual taxable turnover (not including VAT) will be £150,000 or less; and your annual total turnover (including VAT) will be £187,500 or less.
• If you buy a single capital asset with an invoice value, including VAT, of £2,000 or more you can claim the input tax on your VAT return in the normal way.
• You continue to invoice clients at the normal VAT rate (currently 17.5%).
• You can voluntarily leave the flat rate scheme at any time.
• You can continue in the scheme unless your turnover breaches the £225,000 mark.
Smaller business which do not use the flat rate scheme presently should take this opportunity to review their position.
Businesses already using the scheme should also review their position because the various industry rates will be revised when the higher rate of VAT comes in on 4 January 2011 and there may be a chance to use a lower banding leading to an improvement in cash flow.
IMPORTERS
When a business imports goods into the UK a number of taxes which may have been levied included Import VAT, Customs Duty or Excise Duty. Many businesses set up a deferment account that allows them to ‘defer’ paying Import VAT and Customs Duty until the 15th of the month following for goods brought into the UK in the previous calendar month. There is a similar arrangement for Excise Duty, although the relevant dates are different, with payment required on the 29th of a month for goods imported in the preceding period of 15th of last month to 14th of the current month.
To protect itself against possible non-payment by a business HMRC require that the business sets up a guarantee against non payment via an approved bank or insurance company. The guarantee ensures that HMRC receives payment from the guarantor should the business default. The downside for a business is that the guarantor will charge them a fee for acting as guarantor.
However, Simplified Import VAT Accounting (SIVA), which was introduced on 1 December 2003, allows businesses to apply to HMRC to seek to reduce the financial guarantee required in connection with Import VAT but not for Customs Duty or Excise Duty. Any reduction in the level of guarantee will therefore reduce the charge levied on a business by the guarantor. Should the business incur Import VAT and have a deferment account set up then the business consider whether SIVA would be beneficial.
It should be noted that HMRC do not automatically allow the business to benefit from SIVA but a number of conditions must be satisfied before they enter any agreement with a business.
The increase in the VAT Rate from 17.5% to 20%, although unpopular, should give businesses opportunities to review their particular circumstances and seek a solution to any cash flow problems that the increase would bring. It is vital that the review is done now.
For any further information, please contact Trueman Brown http://www.truemanbrown.co.uk/
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