The party’s over

KEY POINTS

• Normal tax points will apply.
   
• Billing work that crosses over into 2010.
   
• Date of the supply of services or goods is key.
   
• Anti-forestalling rules are likely to be limited in effect.

How quickly a year flies by – or 13 months to be exact! It only seems like yesterday that we were all getting very excited about the temporary reduction in the standard rate of VAT from 17.5% to 15% on 1 December 2008.

But to misquote the 1966 words of the late football commentator Kenneth Wolstenholme: you think it’s all over, and it will be on 1 January 2010 when we’re back to 17.5% again!

In this article, I will consider some of the practical challenges of dealing with the rate increase, and highlight some potential cash flow benefits, which could be more worthwhile to a business than any VAT savings.

Tax points

A priority for any business in a time of economic difficulty is to get cash in from customers as quickly as possible. The change in the VAT rate can help this process by encouraging customers to pay their dues before 31 December, and enjoy a 15% VAT charge, even if this is in advance of them receiving goods or services.

However, the reality is that the tax savings involved are actually quite small. For example, £25 saved on a £1,000 spend will just about pay for a couple of meals at my local Indian restaurant (but only if I don’t have a starter or any nan bread) and the main advantages to be gained for a business could be linked to cash flow.

The key point with the rate change is that the normal tax point rules for VAT will apply in most cases:

• VAT is due when a customer receives goods or services (known as the ‘basic’ tax point).
   
• However, the basic tax point is superseded if an actual tax point is created by either receipt of money or raising a sales invoice, as long as this happens within 14 days of the goods or services being supplied. The actual tax point also applies for advance invoices raised or payments received before goods or services are supplied.
   
• In the case of an increase in the rate of VAT, the VAT charge can be based on the basic tax point date. So invoices raised in January for goods delivered to a customer in December can still benefit from a 15% rate of VAT.
   
• To avoid any jiggery-pokery when the VAT rate increases, there is anti-forestalling legislation in place, mainly relevant to prepaid transactions exceeding £100,000, and which I will cover later in this article.

Advance invoices and payments

Let’s get straight down to the telephone query I received from a practitioner two days ago, see Tax point creation below.

The key outcome from this example is that because the club members are not able to reclaim input tax on their fees, this is a real VAT saving. In addition, the club will definitely benefit from the early cash windfall.

Let’s move this example forward and think of a deal involving the sale of goods. This practical situation arose as I was standing at the counter of a furniture shop buying a new bed for the eighth bedroom of my mansion. See Boosting cash flow below.

The key point with both examples is that the advance receipt of money is probably worth a lot more to the business than the potential to improve slightly its profit margin with a reduced VAT liability.

I would not be surprised if the government is actually quite keen for this type of deal to take place in November and December because it will boost the economic activity figures for the final quarter of 2009.

Do not feel guilty about taking advantage of the advance payment or advance invoice mechanism I have described above. It works both ways, and many of us paid 17.5% VAT on goods and services we bought before 1 December 2008, but consumed after this date. This is now payback time.

Continuous supply of services

Another very common situation is where accountants and other professionals do regular work for clients (continuous supply of services) and raise an invoice on a periodic basis.

A tax point is created when an invoice is raised or payment received, whichever happens first. If we are raising an invoice for work carried out in the three months to 31 January 2010, we can just charge 17.5% VAT on the full amount based on the invoice date.

This keeps things simple. Suppose, however, that the client cannot reclaim input tax and is keen to minimise his exposure to non-recoverable VAT.

In this situation, a concession within VATA 1994, s 88 allows the measured work carried out up to 31 December to be charged at 15% VAT and all work after this date at 17.5%.

This is fair because an invoice raised on 31 December rather than 31 January would produce a 15% VAT charge for the December work, so the outcome is consistent.

Overlap of services

What happens if a painter and decorator starts a big job for a customer on 15 December but does not finish it until 15 January? In such cases, my advice to the decorator will be to encourage his customer to pay for the job in full before 31 December (to create a tax point that means the entire job will be due at 15% VAT).

Failing that, the decorator can raise an advance sales invoice up to 31 December, again creating a 15% VAT liability (and improving his profit margin if he quoted the customer for a job figure including VAT).

Even if he does not do this and only raises an invoice or receives payment when he has finished the job, there is still scope to produce a partial VAT gain. This is because he can charge 15% VAT on measured work completed up to 31 December, and 17.5% thereafter.

However, be aware that HMRC will be a bit suspicious if this is done on a simple date-apportioned basis because not many decorators work in the last week of December.

Slow invoicing

So far we have considered advance invoicing and payments, but what about our client called Joe Slow, who sells goods and services but does not get round to raising invoices for his December sales until January?

There is good news here: he can either charge 17.5% VAT based on the invoice date in January or the lower rate of 15% on the basis that the goods were supplied or work was performed before the rate of VAT increased.

It is up to Joe which option he takes, probably depending again on the amounts involved and whether his customers can reclaim input tax.

Flat rate scheme

As many readers will know, I cannot resist a little mention for the flat rate scheme in my articles, and it is very relevant as far as the VAT rate change is concerned.

The flat rate percentages will be revised to coincide with the rate increase on 1 January and my message here is that you should not assume that the rates will be the same as they were back in 2008.

It is possible that HMRC could tickle the revised rates upwards compared to 2008 rates (they could surprise us all and tickle them downwards as well, but if they do, I’ll become a Manchester City supporter!).

We will be watching very closely to make sure the tickle is not too great. If it is excessive, then I shall launch a call to arms on YouTube. The challenge for scheme users will be to make two flat rate calculations if a VAT period overlaps 1 January, e.g. quarter’s end on 31 January or 28 February, but this will not be a problem for a business on calendar VAT quarters.

Other issues

Here is a common question I expect to receive over the next couple of months:

‘I have a client who uses the cash accounting scheme. If he raises a sales invoice in December but doesn’t get paid until January or later, which is when we will include the sale on our VAT return, should we account for 15% or 17.5% VAT?’

The key point with the cash accounting scheme is that it does not change the tax point as far as VAT is concerned, but only the time when VAT charged on a sale is entered on a VAT return; i.e. usually from the earlier invoice date to the later date of payment. So the answer to the question is that VAT is only due at 15% on pre-December invoices paid in 2010.

Then there are credit notes. If my new bed collapses in late December, is it worth me not telling the retailer about it until January, so that I get issued with a credit note when it is returned based on a 17.5% VAT rate rather than 15%?

The answer is ‘no’ because a credit note must be based on the same rate of VAT as the original sale. This is reasonable, otherwise there would be some unfair VAT windfalls being enjoyed after 1 January.

Finally, if a business (mainly retailers) is seeking to pass on the VAT rate increase to its customers after 1 January, then the mathematical formula is to multiply the current VAT inclusive price by 47/46. See Calculating the increase below.

Anti-forestalling legislation

I have saved this topic until last, mainly because the number of transactions that will be affected by the legislation should be very limited in practice. The relevant legislation here is contained in FA 2009, Sch 3.

The starting point is to consider whether an advance invoice is being raised or advance payment received before 1 January, but where goods or services are supplied after this date.

If so, the next question to consider is whether the customer can reclaim all of the VAT charged as input tax on his own returns. Answer ‘yes’ to this question and there is again no problem.

However, if you still have a problem, then a ‘yes’ answer to one or more of the following questions means the sale will be subject in most cases to an extra 2.5% supplementary VAT charge on 1 January:

• Is the value of the sale (and any related sales) more than £100,000 (excluding VAT)?
   
• Are the customer and supplier connected to each other (husband, wife, son, daughter etc. as defined in TA 1988, s 839)?
   
• In the case of an advance invoice (but not an advance payment), is payment due more than six months after the invoice is issued?
   
• In the case of a prepayment arrangement, is the supplier, or anyone connected to the supplier, financing the prepayment?

As a final observation, even if your transaction fails one or more of the anti-forestalling tests above, then all is not lost.

For example, if your sale involves the letting, hiring or rental of assets and the advance invoice or payment is ‘normal commercial practice’ for the supply in question, then you will not have a problem.

Was it worthwhile?

The reduction in the rate of VAT was intended to produce a fiscal stimulus to boost business activity at a time of economic slowdown. Did it achieve that aim? The jury is out on this question but, to be honest, it definitely boosted my own business.

In fact, I was so busy dealing with VAT queries last December that I didn’t get round to having my Christmas dinner until 5 January.

However, on a serious note, I think the main outcome of the ‘rate change experience’ is that it has shown that businesses across the country have adapted very well to the related administrative and IT challenges.

This makes one think that more rate changes could be in the pipeline and that we should all be getting ready for a 20% rate of VAT on 1 July next year. A VAT rate that is the same as the basic rate of income tax – what a lovely thought!

Neil Warren was the Taxation Tax Writer of the Year in 2008 and is an independent VAT consultant, lecturer and author. He can be contacted by e-mail on neil@nwas.freeserve.co.uk.
 

Issue: 4227 / Categories: Comment & Analysis , VAT