The VAT man cometh

The UK penalty regime for VAT is now blessed with a more stringent approach to errors, with penalties amounting from 30% to 100% of the tax in error.

Therefore, it is key to ensure that your house is in order before any inspector arrives on your doorstep. This is especially true for financial services firms due to the complexity of the VAT rules relating to the sector.

It is advisable to identify any issues that could require disclosure to avoid any suggestion that a penalty is applicable for a failure to make such a disclosure.

The three areas to focus on:

VAT liabilities of supplies

Supplies of financial services in many cases attract VAT exemption. There is therefore a need to look at the method of VAT recovery (partial exemption). Additionally, getting the right VAT treatment can affect so much of the VAT recovery. So the identity and the location of your customer in a particular transaction will be crucial to getting the actual VAT treatment correct.

Whilst many types of financial transactions will be VAT exempt, many will be liable to VAT at the standard rate. More importantly, where a customer in a transaction is located outside the EU, then such transactions, whilst still in many cases are exempt, they will still allow the business to claim VAT on the related expenditure. The term exempt with credit is used.

An inspector carrying out a VAT audit will be charged with ensuring the customer in a transaction is identified correctly and ensuring the taxable, exempt and exempt with credit transactions are correct.

Partial exemption

Notoriously those financial services businesses with VAT expenditure restricted, because of the exempt income they receive, will often come under the spotlight to make sure that the level of VAT recovery is based on a methodology acceptable to HMRC. The use of a turnover method for VAT recovery is a standard methodology, but many businesses will have special models which should have been agreed with HMRC in the past. These may well be ripe for review as business methods and trading patterns do vary.

We would therefore caution that if you do have an impending VAT visit and do allocate and apportion your VAT on expenditure, it is worth ensuring that the methodology used is fair, reasonable and appropriate for your business.

Imported services

For many businesses in the financial services sector, the impact of having to self account for VAT on imported services has been a much forgotten aspect. This is the so called ‘reverse charge’ which compels any business to record and self account for VAT on imported services. Normally this has no effect for a business but it will impact those businesses who are partly exempt and is an area a VAT inspector will inevitably focus his attention.

Related news articles - for FSA regulated firms.