As plans and objectives for 2022 are made, we can reflect on some of the common value-added tax (VAT) errors made by U.K. businesses in 2021. Some of these challenges were new; however, others have been long-standing and remain areas to which the U.K. tax authority, HM Revenue & Customs (HMRC), pays particular attention as part of its investigations.
Making Tax Digital Phase 2
Many tax professionals will have noted a trend in recent years for there to be a greater emphasis on the processes and controls in place to ensure good tax governance. Further Making Tax Digital for VAT (MTD) requirements took effect from April 1, 2021. In addition to filing VAT returns digitally, phase 2 compliance required and continues to require automated digital links between any software program, product or application used in the process of preparing a VAT return.
Copying and pasting data and any manual entry of data other than the original creation of records are not considered to be digital links for MTD purposes, and this is an area where businesses are typically lacking in their MTD compliance.
It’s likely that HMRC will start to include MTD in its VAT reviews in 2022 and therefore, if they have not done so already, businesses are recommended to undertake a review of their VAT compliance processes with a focus on MTD to ensure they are compliant.
In early 2021, HMRC gave businesses the option to extend the period to repay VAT postponed under the Covid VAT deferral scheme.
If an organization deferred VAT between March 20, 2020 and June 30, 2020 and still had payments to make, instead of paying the full amount by the end of March 2021, businesses could choose to repay the VAT with up to 11 equal monthly installments.
The extended repayment period will conclude at the end of January 2022, and therefore businesses should ensure that all repayments have been made before this time.
With Brexit came changes to the process for bringing goods to the U.K. and the resulting requirements for customs declarations and paying and reclaiming import VAT.
On Jan. 1, 2021, HMRC introduced Postponed Import VAT Accounting (PIVA), which allowed importers to clear their goods through customs without payment of import VAT at the border. Instead, the import VAT is paid and reclaimed at the same time on the VAT return, resulting in cash flow benefits.
However, the “old” system of paying import VAT at the time of entry and recovering it on the VAT return when a C79 certificate is issued by HMRC still remains. The two different methods remaining side by side has caused businesses some confusion as to how to account for import VAT, and in a number of situations the business has missed out on VAT recovery.
If import VAT is not shown on the PIVA statement, which is downloadable from the Customs Declaration Service, then it is likely that the import VAT has been paid at the border and should be recovered on the VAT return using the C79 certificate as evidence.
Domestic Reverse Charge for Construction Services
Following a number of delays, the domestic reverse charge for construction services (DRC) was introduced on March 1, 2021 and applied to supplies of standard rated and reduced rated VAT services made by a contractor to a subcontractor where both the contractor and subcontractor are registered for U.K. VAT, and the supply of services falls within the Construction Industry Scheme.
Where the DRC applies, the responsibility for accounting for the VAT moves from the supplier to the customer, except where the customer is an end user or an intermediary. A supplier is an end user if it is a consumer or a final customer (i.e. the supplier does not make an onward supply of a construction service supplied to them). An intermediary supplier is connected to or linked to an end user.
Understanding whether or not a customer is an end user has caused organizations some confusion when it comes to invoicing for their construction services and related building materials. Where VAT is incorrectly charged to customers, it is incorrect for them to recover this VAT as input tax.
Although it is early days and we are yet to see it happen, HMRC can assess for errors, and penalties may be considered if HMRC believes that a business is deliberately not accounting for the DRC correctly.
End users should look to provide contractors with a certificate confirming that it is an end user for the purposes of Section 55A of the VAT Act 1994 reverse charge for building and construction services and therefore should be charged VAT under the “normal” VAT rules and not the DRC.
Missing Reverse Charges of Foreign Services
We often see businesses fail to correctly account for the reverse charge on services provided by suppliers located outside the U.K. The reverse charge applies to almost all business-to-business supplies of services except exempt supplies and those where the place of supply is elsewhere, e.g. charges relating to land located overseas.
Under the reverse charge procedure, the U.K. customer acts as both the supplier and the recipient of the services by self-accounting for VAT on the services as well as subsequently recovering the VAT in the VAT return.
For fully taxable businesses this is a VAT-neutral exercise; however, for businesses that make exempt supplies (or are not U.K. VAT-registered and need to take the reverse charge into account when assessing their obligation to VAT-register), the amount of VAT recoverable will be dependent on the partial exemption recovery rate, and the self-assessed VAT is likely to represent at least a partial, if not complete, cost to the business.
HMRC often use the application of the reverse charge to measure the strength of an organization’s VAT compliance procedures. A failure to carry out the reverse charge may cause HMRC to question what other VAT compliance errors may be taking place.
VAT Recovery for Holding Companies
The ability of holding companies to recover VAT on costs incurred continues to be scrutinized by HMRC.
Where a holding company just passively holds shares and receives dividend income, it cannot register for VAT as it is engaged wholly in non-business investment activity.
In order to register for VAT and recover VAT on costs, a holding company would need to be carrying on a taxable business activity for VAT purposes. A holding company could become “active” for VAT purposes where it provides management services to its subsidiaries.
Case law has shown that there needs to be substance to the services activity. For example, services need to be genuinely carried out, and ideally should be documented in a service agreement with an appropriate charging mechanism, as well as invoices for the services being issued and payment made by the recipient. There continues to be case law resulting from HMRC challenges where some or all of these elements are missing.
As such, organizations must plan in a careful and timely manner to protect their VAT recovery regarding refinancing, restructuring, deal transactions, and ongoing operating costs.
Call to Action
As VAT is a transactional tax, it is difficult in an article such as this to cover everything and there were plenty of sector-specific changes and challenges that impacted those affected.
Organizations now operate in a world where tax can be front-page news and, as we move into 2022, many boardrooms will be focused on ensuring that they do not face negative publicity from their tax affairs. Ensuring that their teams have put in place robust processes and controls to manage the common VAT errors listed above, and those specific to the organization, is recommended.
VAT is a tax which continues to evolve and we can fully expect more developments in 2022.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Robert Marchant is VAT & Customs Partner at national audit, tax, advisory and risk firm Crowe.
The author may be contacted at: email@example.com