VAT: have you been overcharged?

HMRC categorisation leading to VAT overcharges

The Association of Taxation Technicians (ATT) has accused HMRC of overcharging small business consultants using the VAT flat rate scheme (FRS) and has called upon the department to review its guidance and current procedures, following rulings laid down by a number of tax tribunal cases.

Although First-tier Tribunal judgements are not legally binding the ATT believes that the Revenue should pay due regard to these and revisit VAT assessments of users of the FRS.

What is the FRS?

Normally a VAT registered business pays over to HMRC the net difference between what it charges to its customers and what it incurs on eligible expenses. Under the FRS a business, whilst still charging 20% VAT on its sales, only pays a fixed rate of VAT to HMRC and keeps the difference. The business cannot however reclaim the VAT on its purchases, with the exception of certain capital assets over £2K.

To be eligible to join the FRS a business must have reasonable grounds for believing that its VAT exclusive turnover will not exceed £150K.

There are a number of circumstances that prevent a business using the scheme, e.g where the business left the scheme or committed a VAT offence in the last 12 months.

The amount of VAT paid

The VAT flat rate is calculated as a percentage of the VAT inclusive turnover. The percentage rate is that which corresponds to the category of trade that is closest to the businesses activities.

Example:

An IT consultant’s VAT flat rate is 14.5%. The business raises an invoice for £1,000 + VAT, giving a total of £1,200. The actual amount of VAT to be paid over to HMRC is £174, i.e. £1,200 x 14.5%.

Businesses in their first year as VAT-registered are able to reduce the flat rate by 1% until the day before their registration anniversary.

Business sectors

There are 51 categories of business but the problem is that not all trades/professions are covered, in particular consultants. In these cases, consultants have, quite understandably, selected the sweep up category of ‘business services not listed elsewhere’, which carries a 12% rate.  HMRC however take a different view based on a statement in its published guidance, VAT Notice 733, para 4.4, “If you act as a consultant and you do not fit into another specific sector, you should choose management consultancy. This sector is not restricted to businesses that fit the traditional idea of management consultancy.”

Uncoincidentally, the VAT flat rate is 14%, so HMRC are press-ganging businesses into parting with an extra 2% of VAT and they expect the likes of health and safety, advertising or employment law consultants to adopt the category of management consultant to squeeze more VAT out of them.

Despite recent case law confirming that a mechanical engineer provides services linked to plant and machinery which does fall under the sweep-up rate of 12%, HMRC are still maintaining that such businesses should be categorised as ‘architect, civil and structural engineer or surveyor’ which carries a rate of 14.5%. This is outrageous and nothing short of day-light robbery.

VAT expert, Neil Warren, said, “Recent court cases have clearly confirmed that a business owner should use ordinary everyday words in choosing their category. So an advertising consultant would never describe himself as a management consultant and a mechanical engineer would never describe himself as a civil engineer. In continuing to go against the courts views, HMRC’s thought process is flawed.”

HMRC Notice 733 states that it will not change a choice of sector retrospectively as long as the original choice was reasonable. Yet, HMRC have been doing exactly that and issuing retrospective tax assessments, flagrantly ignoring the views of the Tribunal.

President of the ATT, Michael Steed, said, “We feel it is the right time for HMRC to amend its guidance to accept that honest small business owners have adopted the correct category as intended by the legislation and to ensure people are not paying too much tax. Furthermore, HMRC must provide clarity and certainty to scheme users that they will not be faced with the threat of receiving unexpected assessments or penalties for back-dated VAT that, according to the letter of the law, should not be due.”