HMRC have published some very detailed guidance for businesses explaining the implications of the reduction in the VAT rate. It is on their website here http://www.hmrc.gov.uk/pbr2008/vat-guide-det.pdf.
The issues have clearly been thought out in detail and there are 2 particularly helpful documents. The first is the Questions and Answers for Businesses, which is a very helpful, short and readable summary, the second being the detailed Technical Guide for Businesses.
The Technical Guide runs to 44 pages and covers all of the main issues concerning the change in rate and how it will affect all sorts of different types of business transactions. I’m not going to repeat or even list them here, the Technical Guide itself is well written and well laid out so you should be able to find information on anything that you need easily enough.
But it is important that people understand the concept of the “time of supply” or the tax point, as it is more known in the VAT world. A lot of the guidance given by HMRC refers to the time of supply so you have to understand these rules in order to fully comprehend a lot of the information contained in the Guide.
Special rule for supplies spanning a VAT rate change
One specific point that should be mentioned is a special rule dealing with VAT rate changes and supplies “spanning” a VAT rate change. You need to understand this as it could save you and your customers some money. Many of you will not have dealt with a VAT rate change before and this particular rule only applies when there is a VAT rate change, so the last time most of us even thought about it was 1991.
This article is not about the VAT rate change as such, but a reminder about the basic rules concerning the time of supply. Believe me, even as a VAT consultant, I need to be reminded about these rules from time to time because it is easy to get confused!
NB: Please see my previous forum article “PBR VAT rate cut” where I have explained the arithmetic involved when calculating VAT on gross prices and the difference between VAT at 17.5% (7/47) and VAT at 15% (3/23). The difference in fractal terms is 1/47th. This is the fraction that should be used to calculate the reduced VAT amount on sales where the time of supply is on or after 1 December.
Time of supply
Now everybody knows that when you are completing a VAT return for any period, you include on that return the output tax on sales made and input tax on purchases and expenses incurred in that period. So if the return is for the period 1 October 2008 to 31 December 2008, you include your output tax and input tax for supplies made and received during that period. It also, of course, covers the period of the change of rate, but more about that later.
The time of supply is based on normal commercial factors of payment, delivery and even when the VAT invoice is issued. This isn’t a problem when all 3 of these events happen on the same day, or even in the same VAT period. But what happens if you receive payment in one period and deliver the goods or services in the next period? What happens if you issue a VAT invoice before receiving payment or delivering the good or services?
How to establish the time of supply
To deal with these situations, the law contains a set of rules that must be followed to establish the correct time of supply, or date or tax point. There are 2 steps to determine: first, the basic time of supply and second, the actual time of supply.
First, the “basic” time of supply occurs when the goods are delivered or made available; or the services are supplied. For example, when a new car is delivered to or collected by a customer; or when a garage repairs a car.
The second step is that the basic time of supply is over-ridden in the following situations:
• In the case of pre-payments or if a VAT invoice is issued before the basic tax point. This becomes the “actual” time of supply. The supplier must account for VAT on the earlier of the date on which the payment is received, to the extent that the payment is received or on the date on which the invoice is issued.
So if, for example, you receive £2000 deposit for the sale of a new car (which is priced at £10,000 with 17.5% VAT included) in the VAT period to 30 September, but don’t deliver the car until 1 December or issue a VAT invoice until delivery, then you must include VAT on the £2000 deposit in the September return and the remainder when in the following return.
• In either case, if a VAT invoice is issued within 14 days after the basic tax point, the date on which the invoice is issued becomes the time of supply. The exception to this is if payment is received in advance of the basic tax point, in which case the date of payment becomes remains the actual tax point to the extent of that payment.
So in the case of the car mentioned above, if the VAT invoice was issued on 10 December (ie within 14 days of delivery) this would qualify under the 14 day rule and create the actual tax point for the £8000 balance. The actual tax point for the deposit would remain as the date of payment in September.
In the case of our car above example, you would account for the following amounts of VAT:
i. On the £2000 deposit, the amount would be £297.87 in the September period return.
ii. On the remainder of the sales price, £1191.49 in the December period return.
In each case, the VAT is calculated as 7/47ths of the VAT inclusive price.
These rules apply to most business transactions. However there are several special rules for dealing with situations that don’t fit into this scenario. These include instalment payments, sale or return goods supplies, continuous supplies of goods (ie fuel and power) or services (eg hire of goods). They are explained in the VAT Guide, Notice 700.
Change of rate rules
So how does all of this fit with the special change of rate rule? We know that if the supply takes place before 1 December, the VAT rate is 17.5%, if on or after 1 December, the VAT rate is 15%.
Now in the case of our car, under the original scenario, we had 2 separate tax points which were established when the deposit was paid and when the VAT invoice was issued. So under the normal tax point rules, the deposit would be liable to VAT at 17.5%, while the remainder would be liable to VAT at 15%.
This means that the VAT included in the £8,000 can be reduced to 15% by issuing a credit note to the customer for 1/47th of the £8,000, ie £170.21.
What the special rule does is to allow the supplier to opt to treat the whole of the supply by reference to the basic tax point even if payment has been made in advance or if a VAT invoice is issued in advance. Remember that the basic tax point is always the date on which the goods are made available (delivery or collection) or the services performed. So this is useful for those who are buying or selling goods or services where you have received deposits or invoiced before 1 December but the goods are delivered or services performed on or after 1 December.
This means that the car dealer could elect to treat the deposit as liable to VAT at the new rate or 15% because the car is delivered on 1 December. The dealer must issue a credit note for 1/47th of the £2,000 deposit, ie £42.55 and refund this amount to the customer. The customer will have benefitted by a total saving of £212.76 as a result of the VAT reduction.
If however the car is delivered one day earlier, ie 30 November, the basic tax point would be before 1 December. This would mean that the time of supply would be the date of delivery in November and the whole supply would be liable to VAT at 17.5%.
In this example, I have focused on a VAT inclusive price of £10,000 and a potential VAT refund of 1/47th. Of course, if the £10,000 is VAT exclusive and VAT is chargeable at 17.5%, then the difference is 2.5% of £10,000, ie £250.
If you wish to take advantage of this change of rate rule, you must issue a credit note for the reduced VAT and refund the difference to the customer.
Pay attention to the detail
As you can see from this one example, this whole issue could become very messy depending on your business practices and how these fit into the time of supply rules. HMRC have also included in their guidance a short (ie 3 page) document explaining the rule about supplies spanning the change, which is useful. But it is only helpful if you understand the basics about the time of supply and how the rules apply to your business.
And as our example above shows, the difference in VAT rates is only really worth while if the value of the supply is significant. In spite of HMRC’s very well intentioned and well written guidance, I can’t help thinking that many people will be frustrated at the amount of time and energy they have to spend working out relatively small adjustments.