How to avoid the pitfalls of VAT deregistration

It is a reality of the current economic climate that many UK businesses will either cease to trade or suffer reduced long-term turnover in the coming months and years. As far as VAT is concerned, this means that advisers need to be aware of the rules concerning deregistration, and some of the pitfalls involved with this process. There are a couple of hidden traps in the legislation that are often forgotten.

Voluntary deregistration

A business can deregister at any time if it expects its taxable sales in the next 12 months will be less than £83,000. The deregistration threshold has traditionally been £2,000 less than the registration threshold, which is currently £85,000. A request for deregistration based on an expectation of reduced turnover can only be made from a current or future date. You are a member of the VAT club until the date when you decide to leave and there is no scope to deregister retrospectively if you are still trading.

The £83,000 threshold includes zero-rated and reduced-rated income but excludes exempt sales or those that are outside the scope of VAT. This means that a business selling overseas services will exclude these sales in most cases, but not for the export of goods, which are zero-rated.

Stock and assets 

A request to deregister can be made online by completing form VAT7 – it is very straightforward. However, a business must first consider whether deregistration from VAT might produce a costly output tax liability on any stock and assets still owned at the time of deregistration. Any VAT due under these rules must be declared on the final VAT return.

There is potential good news:

• A business can ignore any stock or assets where input tax was not claimed when it was purchased (for example, a computer bought from a private individual).
• Output tax is calculated according to the market value of the item on the date of deregistration. As most items depreciate, this will be a lower figure than the original cost price. Stock valuations will take account of obsolescence, physical damage and a reduced value if an item it is out of date, etc.
• No output tax is payable on zero-rated or exempt items (for example, some food stock for a grocer).
• If the total VAT payable after all of the above exclusions is less than £1,000, then no output tax is due – it is de minimis.

Property pitfalls

The biggest pitfall with deregistration is to forget about a property owned by a business seeking to deregister – and specifically property where an option-to-tax election has been made with HMRC. There have been many horror stories relating to this issue.

Example

Marie trades as a florist. She purchased the freehold of her shop 15 years ago for £200,000 plus VAT and claimed input tax. She opted to tax the property with HMRC because she rented out the first floor to a tenant and wanted to charge VAT on the rent to avoid a partial exemption problem. Her turnover has reduced following the coronavirus crisis and now she wants to deregister.

However, output tax will be payable on the market value of the property on the date of deregistration because of her option-to-tax election. If the property value has increased by, say, 50% since she purchased it, the output tax liability would be £60,000. It will therefore be costly for Marie to deregister while she still owns the property.

Note: in five years’ time, Marie could revoke her option-to-tax election before she deregisters by submitting form VAT1614J to HMRC under the 20-year revocation rule (see VAT Notice 742A, para 8.3). The property will then be an exempt asset when she deregisters. 

Capital Goods Scheme

Here is my second horror story. Imagine that a sole trader accountant purchased a property five years ago costing £500,000 plus VAT. She didn’t opt to tax her interest in the building because it was only used for business purposes (ie, no renting activities were involved). She wants to deregister because her turnover in the next 12 months is expected to be less than £83,000.

There will be no output tax liability on her final VAT return with the stock and assets rule I considered above. This is because the absence of an option-to-tax election means that the property is classed as an exempt asset. However, because the property cost more than £250,000 excluding VAT, her original input tax claim of £100,000 is subject to a 10-year adjustment period under the Capital Goods Scheme (see HMRC VAT Notice 706/2).

These adjustments would have been nil in the first five years of ownership because the property was wholly used for taxable accountancy services. But deregistration will mean that 50% of the input tax will need to be repaid on her final VAT return because the asset is exempt from VAT under the stock and assets rule. Years six to 10 are therefore linked to exempt rather than taxable use. She might be wise to remain VAT registered for another five years until the scheme adjustments end.

Deregistration opportunity: B2C services post-Brexit

If you act for clients who sell business-to-consumer (B2C) services to EU customers, there might be a potential opportunity to deregister in certain situations. The process is as follows:

• The starting point with the place-of-supply rules is that the VAT charge depends on where a supplier is based as far as B2C services are concerned (ie, UK).
• There is a list of professional services in the legislation where no VAT is charged if the customer is based ‘outside the UK’ – the place of supply is the customer’s country in such cases. Until 31 December 2020, this legislation only applied if the customer was ‘outside the EU’.
• For a list of services where this rule applies, see HMRC VAT Notice 741A, section 12. It has been updated to reflect the end of the UK’s transitional deal with the EU on 31 December 2020.
• The subtle change from ‘outside the EU’ to ‘outside the UK’ since 1 January 2021 means that many services are no longer subject to UK VAT. Does this create opportunities for deregistration?

Example

Jenny is a sole trader solicitor who specialises in inheritance tax issues and writing wills. Her annual sales are £120,000 excluding VAT and half of her turnover is earned from customers who live in Spain. From 1 January 2021, she will no longer charge UK VAT on fees charged to Spanish clients (B2C) because legal services are within the list of services in VAT Notice 741A, section 12. Her expected UK sales are now £60,000 (ie, less than £83,000). She can deregister from UK VAT if she wants.

Note: Jenny is not obliged to register for Spanish VAT as Spain does not apply a ‘use and enjoyment’ clause for legal services. Each EU country can choose the services to which it applies the clause.

Ceasing to trade

This article has considered voluntary deregistration based on reduced UK turnover. A common question is whether a business that has completely ceased to trade should deregister from the date of cessation or can ‘hang on’ to its VAT number to claim input tax on final expenses. The cessation date should be the deregistration date, and any belated input tax is claimed from HMRC by submitting form VAT427 (VAT Notice 700/11, section 9).

About the author

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