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VAT rate change to 20% - how "artificial" transactions are treated

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VAT expert, and Bytestart contributor, Les Howard, outlines the anti-forestalling legislation which will apply when the standard rate of VAT rises from 17.5% to 20% in January 2011.

The increase in the standard rate of VAT to 20% was fully expected in the weeks leading up to the Budget. This rate applies with effect from 4 Jan 2011, giving businesses plenty of time to prepare.

At the same time, the higher rate of IPT (Insurance Premium Tax) is increased form 17½% to 20%. This rate applies only to Travel Insurance (sold with holidays), and Warranty Insurance sold with motor vehicles and consumer goods (such as cookers and fridges). Expect companies selling these goods and services to run special promotions towards the end of this year. It may be a good time to buy!

The Budget includes special ‘anti-forestalling’ legislation, which targets transactions which are artificially structured to apply the 17½% rate of VAT where the 20% rate should apply. This is in addition to existing legislation that provides for supplies made around the time of the rate change. This new legislation applies a ‘supplemental charge’ of 2½% of the net value to those transactions caught by it.

There are essentially four tests, and the charge will apply if any one of the four is fulfilled;

1. the supplier and the customers are ‘connected parties’ at any time from the date the supply is made to the date of the VAT rate change;

2. the value of the supply exceeds £100,000; or, where there is a series of supplies, the aggregate value of those supplies exceeds £100,000;

3. the supplier, or a person ‘connected’ with him finances a prepayment by the customer;

4. the supplier issues a VAT invoice where payment is not due for 6 months from the invoice date.

The existing legislation is found at the VAT Act 1994, s88, and is explained in The VAT Guide (Notice 700), chapter 30. This legislation remains in force, and may prove helpful for some. Essentially, a business can opt to apply the ‘old rate’ on any supply where the ‘basic tax point’ precedes the rate change, but the VAT invoice is issued later.

Example

For example, a stationer sells a desk for £150 (VAT-incl) on 29 Dec 2010 (17½% rate applicable), but issues his VAT invoice on 7 Jan 2011 (20% rate applicable). The tax point rules would ordinarily deem that the supply is made at the 20% rate. However, he can opt to use the ‘old rate,’ and mark his invoice accordingly. Thus, his output tax is £22.34 instead of £25.00, a saving of £2.66.

Information provided by the Government indicates that the long ‘lead time’ is to bring forward business and consumer spending. Some ‘exempt’ businesses will want to consider bringing forward capital purchases. This is because they can recover only a proportion of the VAT charged, or cannot recover VAT at all. For example, health, education, financial services; also private sports clubs, professional associations, should consider accelerating certain purchases.

Two particular classes of businesses will be affected by the rate change:

  1. Users of the Flat Rate Scheme; which applies to smaller businesses. Budget Notice 45 includes details of the new, higher rates which will apply to such businesses. This gives these businesses time to decide whether to remain in the Scheme from Jan 2011.
  2. Users of the Payments on Account (POA) Scheme, which applies to larger businesses, where the annual VAT liability exceeds £2million. HMRC have indicated that the thresholds applying to the scheme will be revised later this year. One would expect that the thresholds will be raised, to reflect the higher VAT rate. HMRC have stated that they have no intention to widen the scope of the scheme, such that more businesses will be required to join.
Users of software packages will need to amend the default VAT rate to 20% on 4 Jan 2011. This will ensure that invoices issued form that date will apply the correct rate. For most B2B transactions, the effect will be minimal.

About the Author

Les Howard has more than 25 years experience in VAT, and works primarily with SMEs and charities. He is also a non-legal member of the Tribunal. He can be contacted on 0845 880 3667, or via email.

Posted July 22, 2010

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