Reviewing your VAT affairs
The 2017 case Brabners LPP v HMRC and in particular the VAT treatment of online search fees, has been well documented. We have seen evidence of HMRC’s targeted approach from visiting firms to follow up on this issue.
It certainly appears that professional practices remain firmly in the spotlight for HMRC. The sector has been targeted for many years now, resulting in several high profile legislative changes. For example, the new rules relating to the use of corporates (“mixed partnerships”), alterations to the transfer pricing rules as applied to service companies and the revised interpretation of the self-employment criteria for fixed share partners. It appears that VAT is the latest item on HMRC’s hit-list for the sector.
We recommend that firms undertake a review of their VAT affairs now, rather than waiting for an inspection from HMRC. If a firm proactively reviews its compliance within several key areas of VAT legislation, it will be much better positioned in the event of a visit from HMRC. In our experience, a VAT inspection can be stressful and hugely time consuming. Time spent in advance not only reduces the impact on the finance team, it also makes it less likely to lead to unexpected cash outflow. In addition, the inspector is more likely to determine that the firm has a high level of compliance and understanding of the rules.
Recent experience has shown that VAT inspectors have attended specific training sessions in relation to professional practices and are arriving for their visits well briefed and with a list of sector specific hot topics to target.
The following are a few areas our team have seen in practice:
VAT on Search Fees
As mentioned above, this matter came to light following a HMRC disagreement regarding the VAT treatment of search fees with Brabners Solicitors and the matter is now being pursued by the Law Society.
In summary, the issue is that it is common practice in the sector for search fees to be treated as a disbursement. Therefore, if the cost incurred is free from VAT then the amount billed on to the client is also treated as VAT-free. This is on the basis that the cost is simply being passed through to the client. HMRC are contending that the lawyers actually utilise this information and include it in their advice. Therefore the cost should be included as part of the supply of services and subject to VAT. In the Brabners’ case, HMRC took the view that their agreement with the Law Society about the treatment of postal search fees did not extend to electronic searches.
It appears that as HMRC visit firms, they are quantifying the amount of under-declared VAT and are demanding that firms pay the related VAT to HMRC. They are noting that if the appeal against the Brabners decision is successful, then the amounts will be refunded. Firms subject to such assessments will need to protect their position by formally appealing.
Therefore, the action point for firms is to undertake a historic review in order to assess the potential issue. This may well involve interrogating thousands of lines of data which will not be a straightforward exercise, but it may be more difficult to undertake ‘on the hoof’ during an inspection. In order to avoid penalties, a carefully worded disclosure should be made to HMRC which protects the position in the event that Brabners successfully overturn HMRC’s assessment on appeal. Going forward, we do recommend that VAT should be charged on electronic search fees.
VAT Recovered on Bad Debts
This may seem a simple issue, but HMRC are looking at the process adopted by firms closely. As a reminder, the key principle of the current rules (as set out in VAT notice 700/18) is that a firm must wait at least six months from the later of when payment was due and payable or the date of supply, before reclaiming any VAT. HMRC sets out certain conditions that must be met before a reclaim may be made. This includes writing off the debts from the firm’s day to day VAT accounts and transferred to a separate bad debt account.
There is often still confusion in relation to the bad debt rules as they have changed many times over the years. Therefore a hygiene check may be appropriate.
VAT on Older Unpaid Creditors
In our experience, this area is commonly overlooked. The rules for unpaid purchase invoices (post 1997) are that a firm is required to repay the input tax that it has claimed if it does not pay for the supplies within six months of the relevant date. The relevant date is defined as the date of the supply, or if later, the due date for payment. Should the amounts in question be subsequently paid, then the input VAT can be accounted for again at that point.
Whilst most professional practices do not have significant purchase ledgers, it is not unusual to have a number of older ‘in dispute’ invoices on a ledger.
VAT on Personal Tax Return Fees
Again, this is commonly overlooked. Partners’ personal tax return fees are not a business expense and therefore the VAT should not be reclaimed. It is important that accountants separately identify the costs relating to personal taxation from those relating to the business. It is a Corporate Criminal Offence to ‘hide’ personal taxation fees within those of a business in order to gain a tax advantage.
VAT on Gifts
Where business gifts are provided in the normal course of business and are less than £50 in value (in aggregate over a 12 month period to each individual) then no output VAT is normally due and indeed the related input VAT may be reclaimed. Where a gift (or gifts) exceeds the £50 limit, then the output VAT must be accounted for on the value of the gifts in question.
HMRC’s definition of business gifts is quite wide and VAT Notice 700/7 explains that this term includes “a wide range of items from brochures, posters and advertising matter to expensive goods of the kind given as ‘executive presents’”. They go on to explain that this category also includes long service awards and retirement gifts and indeed gifts to clients.
HMRC’s view is that the majority of supplies by a solicitor are single supplies, albeit the supply may involve work undertaken over an extended period of time. This is important because it means that VAT becomes due at the end of each discrete service. This is only overridden if payment is received prior to the end of the service, or a VAT invoice is issued within 3 months of completion. If a firm decides not to issue a proper VAT invoice within 3 months (for example on legal aid work), VAT reverts to being due at the time the work was completed.
In conclusion, many of the above matters may not individually appear to be significant, but in our experience the value of a VAT demand arising from a VAT inspection can quickly accumulate if there are a number of failures. This is especially important due to the stringent penalties of up to 30%, which HMRC can impose on ‘careless errors’.
We recommend that being well prepared for a VAT visit, which is highly likely in the legal sector in 2018, is much better than being reactive when the day arrives.