VAT savings tips for SMEs

VAT is a simple tax made complicated by the exceptions, concessions and adjustments in the legislation. I remember a past editor of a magazine I write for saying those words to me – and they are very true. But the existence of these concessions and exceptions can sometimes produce legitimate tax savings for our clients, which they need to be aware of and enjoy, ideally before they begin a contract or new venture. I’ll consider some practical examples in this article.

Partial exemption de minimis test

Imagine the following situation: a husband and wife are VAT registered as a partnership – let’s say as a florist. They have decided to buy a house in joint names as an investment to rent out on a long-term basis. The house needs a lot of work because it is in a state of disrepair.

Note: a property purchased in joint names is always classed as a partnership – see VAT Notice 742A, para 7.3.

Some advisers might think that the income and expenditure of the property will not be relevant to the partnership’s VAT registration, despite being purchased in joint names, because it is an ‘investment’ rather than a ‘business’. This is incorrect. The exploitation of land or buildings for an income or profit is always classed as a business.

The rental income and sales proceeds from the property will be exempt from VAT, so input tax is blocked as a starting point with the rules of partial exemption. But the good news is that input tax can be claimed on costs relevant to exempt activities if the numbers are kind and the total input tax comes within the partial exemption de minimis tests. There are three different tests – see VAT Notice 706, section 11.

Example

Jack and Jill have purchased a house in Leeds for £100,000 and need to spend £30,000 plus VAT on building work before renting it out to tenants. Jack and Jill are VAT registered as a partnership, trading as a florist.

If all the building work is incurred in one VAT quarter, it will be blocked because £6,000 exceeds the quarterly de minimis test (ie, exempt input tax is more than £1,875). However, all quarterly calculations are superseded by an annual adjustment. The main test with the annual calculation is that exempt input tax must be less than £7,500 and less than 50% of the total input tax for the business. A partial exemption tax year ends on 31 March, 30 April or 31 May, depending on the VAT periods of the business (it is 31 March for a business on monthly returns). So, hopefully Jack and Jill will fully claim input tax on the building work when they carry out their annual adjustment calculation.

Note: don’t forget that exempt input tax also includes a proportion of input tax on general overheads after applying the standard method of calculation. Hopefully, this figure will be less than £1,500 for Jack and Jill, so not a problem  – see VAT Notice 706, section 4.

Brexit and B2C services

The general business-to-consumer (B2C) rule for services is that the place of supply depends on where a supplier’s business is based. This outcome was unchanged on 1 January 2021 when our EU transitional deal ended, just as the place of supply for business-to-business (B2B) services has continued to be where the customer is based. However, the rules for B2C services will be changing from 1 July 2021 – to find out more, see the TAXguide on this topic.

There is a list of services in the legislation where no VAT has ever been charged for a B2C sale if a customer is resident outside the EU (para 16, Sch 4A, Value Added Tax Act 1994). These services are also listed in VAT Notice 741A, section 12. The list is very extensive and includes, for example, accountancy, consultancy and legal services.

But the good news is that the list of exceptions extended to B2C sales of these services to EU customers from 1 January. In other words, they are outside the scope of VAT instead of standard rated. This provides many businesses with a great opportunity to perhaps increase fees and share VAT savings with EU customers. There will be no need to register for VAT in the customer’s country unless that country applies a ‘use and enjoyment’ rule for the service in question. These extensions are quite limited.

Example

Jane is a VAT-registered lawyer in London and regularly carries out inheritance tax planning work for a family in Spain. Her fees were standard rated until 31 December 2020 under the general B2C rule but are now outside the scope of VAT from 1 January – the place of supply is Spain rather than UK. There is no ‘use and enjoyment’ override in Spain for legal services.

Backdated VAT registration

Imagine that you have taken on two new clients. The first is a computer consultant, who only works for businesses in Canada. His annual fees are £120,000. The other client is a small bakery that sells take-away sandwiches and cakes. Neither is VAT registered because their annual taxable supplies are less than the registration threshold of £85,000.

The reason why the computer consultant does not need to register for VAT is because his work is outside the scope of VAT (although he may be liable to register and account for Canadian GST). Under the general place of supply rule for B2B services, the place of supply is Canada. You might think he cannot register for VAT anyway because he has no taxable UK sales but there is good news on three counts:

• A UK business can still register for VAT and claim input tax if the services they provide for overseas customers would be VATable if supplied to UK customers, (ie, subject to VAT at 0%, 5% or 20%);
• The VAT registration will be voluntary, and the legislation allows it to be backdated by up to four years if requested by a taxpayer (ie, back to December 2016 as I write this article). This produces a ‘win win’ for our consultant (ie, no output tax on past income but a four-year input tax windfall on his UK expenses, subject to normal rules).
• On the first long-period VAT return, he can take advantage of another concession and also claim input tax on some pre-registration expenses incurred before December 2016 (ie, assets bought by his business in the previous four years and still owned in December 2016, and a six-month window for services). So, for example, if he bought a laptop for his business costing £2,000 plus VAT in November 2013, which he still owns in December 2016, he can claim input tax of £400 on his first return.

The income of our imaginary bakery is zero-rated as cold takeaway food and a backdated registration will also produce an input tax windfall on past expenses.

One for the road

As a final example, don’t forget that there is another useful ‘exception’ in the legislation that means a client will not need to register for VAT if he has exceeded the £85,000 annual threshold because of a temporary increase in turnover – perhaps a builder having a one-off big job that included a lot of materials. The key challenge is to explain in writing to HMRC why taxable sales in the next 12 months will be less than the deregistration threshold (ie, £83,000). HMRC usually grants an exception if the explanations are supported by relevant evidence of future trading plans – see VAT Notice 700/1, para 3.7.

Conclusion

In this article, I have considered one adjustment, two exceptions and two concessions – a ‘fab five’ of VAT tips, so to speak. 

Many readers might think that the ending of some of these concessions, exceptions and adjustments would make VAT both simpler to operate and also increase the government’s tax yield in these difficult fiscal times. I agree – but let’s enjoy them while they last.

About the author

Neil Warren CTA (Fellow), ATT is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997