Understanding VAT: Exemptions and Partial Exemption
Disputes can arise between a taxpayer and HMRC in relation to how much Value Added Tax (‘VAT’) needs to be paid to HMRC or reclaimed from HMRC. The disputes can become more complex where the supply of goods or services involves a mixture of ‘standard rate’, ‘exempt’ or ‘partially exempt’ supplies for the purposes of VAT.
What is VAT: a brief overview
VAT is the tax that is added on the sale of goods and services. It follows the general principle that businesses pay VAT when purchasing items and then pass this cost on to customers when selling those items.
Businesses making annual taxable sales above the VAT registration limit, currently £85,000, are required to register for VAT. Those businesses not exceeding that threshold may opt to register voluntarily, although such option is not available to those which are entirely exempt.
A VAT registered business, when reporting to HMRC, will compare the value of tax paid to suppliers, known as input tax, with the tax collected from customers, known as output tax. If the input tax is greater than the output tax, the business can claim the difference from HMRC. Conversely, if the output tax exceeds the input tax, the business must pay the difference to HMRC.
Effectively, VAT registered businesses collect VAT on behalf of the Government and make payment according to an agreed payment schedule. The intent is that a business either pays as much as it collects, or claims the difference through its VAT Return, with the result that it breaks even.
Whilst, at first blush, accounting to HMRC would seem to be a straightforward mathematical exercise, in reality, the administration, calculation and statutory governance of VAT renders the entire process extremely technical, complicated and expensive to all parties.
The system is also open to potential abuse by those seeking to illegally minimise or totally avoid liability for payment of VAT.
Many items are exempt from or are considered out of scope of taxation with the result that businesses trading in both categories are treated as being partially exempt from VAT.
In view of the many complications and technicalities, numerous potential pitfalls await the unprepared. It is essential that both those already participating in business of any description and those intending to commence any form of trading, ensure that they are guided by professionals who fully understand the complexities of the VAT system.
Hamraj Kang of KANGS comments upon the nature of exempt and partial exemption to VAT.
VAT Exempt Businesses
A business which only sells or provides exempt or out of scope goods and services is a VAT exempt business and, accordingly, is not taxable.
Such a business cannot register for VAT given that no taxable items are sold to customers. However, VAT must still be paid on taxable items purchased and no VAT credit can be claimed for the amount paid.
Exempt or out of scope items include:
- insurance, finance and credit,
- postage stamps or services,
- health services provided by health professionals,
- education and training,
- items forming part of a hobby, such as coin collection,
- fundraising events by charities,
- subscriptions to membership organisations.
When accounting to HMRC, it is not necessary to include sales exempt or out of scope goods or services when calculating taxable turnover for VAT purposes.
Exempt or out of scope items are not the same as those which are reduced or zero-rated items which remain to be considered as subject to VAT and need to be included as taxable sales.
Reduced rate products include:
- heating,
- energy,
- children’s car seats,
- maternity products,
- donated goods sold by charity shops,
- mobility aids.
Zero rated goods
Such goods are not the same as exempt items and have a ‘zero rate’ of tax applied. On such items, VAT is not paid on a purchase from another business but credit can be reclaimed on the input tax for that zero rated supply.
Partial Exemption
A partially exempt business is one which sells both:
- non-taxable goods and services (which are VAT exempt and out of scope) and
- those which are subject to tax (whether standard, reduced or zero-rated), known as taxable supplies.
Taxable supplies include:
- sales of goods and services,
- sales of assets,
- the loan of goods,
- acquisition of goods for business use,
- commissions earned,
- goods and services used for personal use.
Eligibility for VAT registration is dependent on the nature of sales, with the description of purchases being irrelevant.
A partially exempt business must register for VAT when sales exceed the £85,000 threshold.
However, a partially exempt business may, should it so elect, register for VAT voluntarily even when it is anticipated that the £85,000 threshold will not be met. This will enable VAT which is paid upon the purchase of goods to be passed on its customers, thereby gaining a potentially substantial financial advantage.
Voluntary Registration | General Considerations
Whilst voluntarily registration for VAT by a business with partial exemption may appear attractive in that it potentially carries the financial advantage referred to above, the process involves the following, which can be daunting, especially to a new business with limited resources:
- maintaining the substantial paperwork which will ensue,
- compliance with the strict statutory rules and guidelines,
- meeting deadlines which will be imposed,
- strict separation of exempt supplies from non-exempt purchases is absolutely essential,
- filing VAT Returns may affect cash flow if there is a delay in recovering VAT back from HMRC or there arises a liability to pay HMRC.
However, VAT registration conveys the immediate impression that the value of trade of a business exceeds the threshold of £85,000, thereby enhancing its trade creditability. Indeed, some businesses refuse to trade with those which are not VAT registered, not only because of this potential lack of creditability but dealing with non-registered businesses can complicate the required paperwork.
How Can We Assist?
The Team at KANGS has for many years been assisting clients involved in disputes with HMRC, developing the enviable national and international reputation now enjoyed.
Disputes with HMRC can arise from various issues, such as disagreements over liability for payment of VAT and the amount requested for payment by HMRC.
We are able to advise clients who wish to challenge a VAT Assessment and we can provide expert guidance through the Tax Tribunal appeal process.
KANGS is well-known for defending clients against HMRC prosecutions for alleged VAT offences and has been involved in many significant MTIC prosecutions.
If we can be of assistance, please reach out to us using the contact details below:
Tel: 0333 370 4333
Email: info@kangssolicitors.co.uk
We provide initial no obligation discussion at our three offices in London, Birmingham, and Manchester. Alternatively, discussions can be held through live conferencing or telephone.
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