VAT errors and adjustments, the new way to solve

Did you know that you can now complete and submit an online form to HMRC in relation to VAT errors and adjustments?

Firstly, it is worth noting the difference between a VAT error and a VAT adjustment. Adjustments are NOT classed as errors.

Underpayments and overpayments of VAT are adjustments and can be adjusted for on the next VAT return. Adjustments are NOT classed as errors because they are made in accordance to legislation. An example of this would be partial exemption and bad debts when on the accrual scheme.

VAT adjustments and bad debt relief

Given that the world is bordering an economic recession, bad debt relief will be of interest to HMRC. It is therefore important that business’ make adjustments to VAT in relation to bad debts correctly.

So what are the rules?

Cash Scheme:

Bad debt relief is automatically applied because VAT is accounted for when payment is made, not the invoice date.

Accrual scheme:

Bad debt relief is NOT automatic as VAT is accounted for at the invoice date.

A bad debt must be older than 6 months for it to be adjusted for and reclaimed. To make this adjustment, a business should adjust for the bad debt on the next VAT return.

What happens if I incorrectly state VAT errors?

When you report a VAT underpayment error to HMRC, they will charge interest. Interest will be calculated from when the VAT should have been paid over to HMRC.

What about VAT adjustments?

As adjustments are within the legislation, HMRC does not charge interest on these.

Therefore, mistaking a VAT adjustment for a VAT error could be a costly mistake!

When must I report VAT errors?

Normally, when the net amount of VAT owed is more than £10,000 it cannot be adjusted for on the next VAT return and the online form should be used to report the error. Anything less than £10,000 can be adjusted for on the next VAT return and not disclosed to HMRC separately.

There are some cases whereby HMRC will allow larger businesses to adjust errors up to £50,000 before they have to be separately disclosed.

The new online form has the advantage that you can attach supporting documentation to help HMRC verify that the claim is correct. This may also help HMRC determine the right level of interest and penalties to apply in each individual situation.

Payback and clawback adjustments

VAT is complex enough so what happens when your sale intention changes? Let’s look at this in more detail.

Initially, you decided that your business was going to build a new-build house with the intention to sell on completion. In this instance, the VAT on your purchases that helped build this house would have been reclaimable from HMRC. This means you would have received multiple refunds no doubt over the duration of the house build.

The sale of the house would have been a zero-rated sale and therefore it would have been correct to reclaim the input tax on these purchases.

However, the world is in the midst of a cost of living crisis and the house isn’t able to be sold. Instead, you decide that your business will rent the property out until the market is in a better place and you can get the right price for the property, sound familiar?

So what is wrong in this example?

The rental income the business will now receive instead is exempt income not zero-rated income as before. When you have exempt income you fall into the partial exemption rules which limits or fully removes your entitlement to reclaim any of the VAT on your purchases. Therefore, you have reclaimed VAT in excess of your entitlement and HMRC will want to claw this back.

This clawback is not classed as an error but an adjustment.

The key date is when the decision to rent out the property was made, not when you first start receiving rental income. Therefore at the decision date, the VAT treatment changes and HMRC is entitled to a repayment.

VAT notice 706 para 13.12. gives more details in situations whereby the intention to rent out is short term.

If in any doubt, speak to us first!

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