Value Added Tax is a tax on the supply of goods or services. The responsibility for its administration and collection lies with HM Customs and Excise.
VAT is chargeable on goods or services supplied by a business and is ultimately payable by the consumer. Where supplies are made to another business, that business can offset the tax it is charged against the tax it must charge to its customer in the supply chain.
If a business pays more VAT to its suppliers than it charges to its customers it can recover the difference from Customs.
Supplies made by businesses may be subject to VAT at a positive rate, the zero rate or may be exempt or outside the scope. Although no VAT is charged on zero-rated, exempt or outside-the-scope supplies, the distinction is crucial. Exempt supplies, in nearly all cases, do not allow input tax incurred by the business to be claimed, whereas zero-rated and (most) outside-the-scope supplies do.
The first obligation faced by most businesses is the need to register for VAT. In the UK there is a relatively high registration threshold - £60,000 in taxable turnover per year from April 2005 - and businesses that supply goods or services below this level are not obliged to register for VAT.
Once registered for VAT, a business must collect VAT from its customers and pass this on to Customs and Excise.
There are two tests a business must consider to determine when it has to register for VAT. The first is the historic test, which says a business must register for VAT when its taxable turnover has exceeded the VAT registration threshold in the previous 12 months.
This is a rolling 12-month period and the test must be applied at the end of each month. If the limit has been exceeded, the business is obliged to notify Customs and will be registered at the latest from the end of the month following the month in which the limit was exceeded.
The second test is a forward-looking test, which says a business is liable to be registered, if at any time there are reasonable grounds for believing its taxable turnover in the next 30 days will exceed the registration threshold.
Where a business is taken over, the buyer must take account of the seller's turnover in establishing if or when VAT registration is required.
If a business can show that its taxable turnover in the ensuing 12 months will fall below the deregistration limit, currently £58,000, it can apply to cancel its VAT registration or can ask Customs to waive registration if it has exceeded the registration threshold, but is not yet registered.
Businesses can apply for voluntary VAT registration if their taxable turnover is below the registration or if they make supplies outside the UK that would be taxable if made in the UK.
Returns and payment of tax
A business that is registered for VAT is obliged to pay the output tax it has collected on its supplies to Customs after deducting any input tax it is allowed to offset. This is done by submitting a VAT return showing the appropriate information and making the required payment.
Returns are normally made on a quarterly basis, although monthly returns are available for businesses that usually receive refunds from Customs - or can be imposed by Customs if it considers tax is at risk.
For small businesses with a turnover of up to £660,000, annual VAT returns can be submitted, but monthly or quarterly interim payments are required with a balancing payment at the year end.
Records And Inspections
A business that is registered for VAT, or is required to be registered, must keep sufficient business records to identify the tax that is due and the supplies it has made.
Customs do not prescribe the records that must be kept, except that all businesses must keep a VAT account, copies of all invoices, credit and debit notes received or issued, and documentation relating to imports or exports, both for EU and non-EU transactions.
Special requirements are imposed for certain businesses, for example retailers, second hand dealers, and businesses that use self-billing.
Records must be kept for six years, although certain documents may be destroyed earlier if agreement is reached with Customs.
Customs has the right to inspect business records and business premises at a reasonable time. A business must allow this and produce any documents relating to the supplies made by the business. Businesses must also allow Customs to remove records, take samples or make copies of records if this is required.
A business is not obliged to allow Customs to search premises unless they have obtained a search warrant.
Adjustments and assessments
If a business discovers that it has made an error, which has resulted in an underpayment of its VAT, it is obliged to notify this to Customs and make the necessary payment.
If the amount is less than £2,000 the adjustment can be made on the next VAT return; if it exceeds this amount a separate Voluntary Disclosure to Customs is required.
If a business has received an assessment from Customs and has reason to believe that the assessment is too low it must notify Customs of the correct amount of tax that is due.
Disclosure of tax avoidance schemes
For VAT return periods beginning after 1 August 2004 a business, which has a turnover in excess of £600,000, must notify Customs if it is using a listed tax avoidance scheme.
Steve James is an associate director with WJB Chilter