Feb 192017

At the start of 21st century it dawned on the then generous Commissioners (HMRC) that VAT was a subject too complicated for small businesses (with turnover up to £150,000) to be spending their business time on. So, they inserted a new Part VIIA into the Value Added Tax Regulations1995 introducing what is now known as the ‘flat rate scheme’ (FRS). Simply put, normal VAT accounting would mean paying to HMRC the difference between the output tax collected on sales less input taxes paid on purchases made during a VAT period. But then simplicity has never had anything to do with VAT anyway. Accounting for VAT for each item of sales and purchases and other inputs, as a matter of fact, ate up considerable time each quarter. FRS, on the other hand, promising instant simplicity, would disregard input taxes altogether and, subject to some exceptions, the VAT due from a person operating it for any VAT period would be the appropriate percentage of his gross turnover (including VAT) for that period. The percentages varied from 4% to 14.50% depending on which sector the business operated in. So, if you were an accountant in practice, and for a VAT period if the turnover was £100,000 + 20% VAT, you would pay 14.5% of £120,000= £17,400 over to HMRC and keep the change of £2,600 (£20,000-£17,400). Simple?  Not really.

Firstly, there was this constant tug of war between HMRC and the business as to what percentage should apply. HMRC would obviously look for a classification with a higher percentage rate and the business would argue otherwise. The Chilly Wizard Ice Cream Co Ltd successfully argued that its ice cream kiosk with two plastic chairs kept outside for customers to sit and relax was a business “retailing food, confectionery, tobacco, newspapers or children’s clothing” attracting 4% FRS VAT as opposed to “catering services including restaurants and takeaways” attracting 12% VAT as HMRC argued. Calibre Tas Ltd was into “business services that are not listed elsewhere” applying 12% instead of HMRC’s choice of “management consultancy” that attracted a 14% charge. Then there was this mechanical engineering business (Idess Ltd) successfully arguing that its was “any other activity not listed elsewhere” as opposed to HMRC classification of “architects, civil and structural engineers or surveyors” with 2.5% VAT advantage.

Then there were other complications; businesses seeking to apply FRS retrospectively, changing an appropriate percentage rate already chosen and applying a new percentage, and so on. However, HMRC appeared more concerned about businesses voluntarily registering (those below the registration threshold) for VAT with a view to pocketing the FRS bonus!

Enough: HMRC decided in the 2016 autumn statement that it wished no more to be generous with the small businesses as there has been an ‘aggressive abuse’ of the scheme. So, to be introduced in to the list of business sectors effective 01 April 2017 is a new category called Limited Cost Trader effectively killing the scheme for most of the small businesses. A limited cost trader will be defined as one whose VAT inclusive expenditure on goods for a VAT accounting period is either less than 2% of their gross turnover; or more than 2% but less than £1,000 (or £250 for a quarterly return).Those hit by ‘limited cost trader’ definition will be responsible for using the new 16.5% rate or the trade-related rate as appropriate. A 16.5% on the gross turnover (including 20% VAT) will effectively mean paying 20% of the output tax collected, and thus writing the obituary of the scheme for many out there.

Now for those enterprising businessmen and women, goods, for this purpose excludes a) items of capital expenditure, b) food or drink for consumption by the business or its employees, and c) vehicles, vehicle parts and fuel (except where the business is one that carries out transport services – for example a taxi business – and uses its own or a leased vehicle to carry out those services). So, don’t just rush to buy a laptop every quarter thinking that would keep you out of being a limited cost trader! However, all is still not lost – you could still buy items of stationery, ink cartridges, software etc for example, and still stay out of this new category!

So back to the twentieth century for quite a few out there when it comes to preparing and filing their quarterly VAT returns!

Tax Partners

Feb 172013

Basically an anti-avoidance provision, this rule is aimed at preventing avoidance of VAT by the maintenance or creation of any ‘artificial’ separation of business activities carried on by two or more persons. Schedule 1 to Value Added Tax Act 1994 (VATA 1994) deals with disaggregation of businesses as follows:

Para 1A(1): Paragraph 2 below is for the purpose of preventing the maintenance or creation of any artificial separation of business activities carried on by two or more persons from resulting in an avoidance of VAT.

Para 1A(2): In determining for the purposes of sub-paragraph (1) above whether any separation of business activities is artificial, regard shall be had to the extent to which the different persons carrying on those activities are closely bound to one another by financial, economic and organisational links.

Para 2 specifies the impact upon the constituent members of the businesses caught by these rules as follows:

a) The taxable person carrying on the specified business is registrable in such name as the persons named in the direction jointly nominate in writing within 14 days of the direction. Otherwise the taxable person is registrable in such name as may be specified in the direction.

(b) Any supply of goods or services by or to one of the constituent members in the course of the specified business is treated as a supply by or to the taxable person.

(c) Any acquisition of goods from another EU country by one of the constituent members in the course of the specified business is treated as an acquisition by the taxable person.

(d) Each of the constituent members is jointly and severally liable for any VAT due from the taxable person.

(e) Without prejudice to (d) above, any failure by a taxable person to comply with any VAT requirement is treated as a failure by each of the constituent members severally.

(f) Subject to (a)–(e) above, the constituent members are treated as a partnership carrying on the specified business and any question as to the scope of that business at any time is determined accordingly.

That brings us to the question as to what exactly is ‘artificial separation of business’? Well, artificial separation arises where the entities, closely bound to one another by financial, economic and organisational links, disaggregate businesses with a view to avoiding VAT. In order to prove artificial separation generally at least one link needs to be established under each head:

  • Financial Links include providing financial support to one entity by the other, common financial interest in the proceeds of the business or the mere fact that one entity wouldn’t be financially viable without financial support from the other.
  • Economic Links arise where the same economic objective is pursued by the constituent business entities, where the activities of one part benefit the other or where both supply the same circle of customers.
  • Organisational Links could be established by having a common management or common employees

HMRC’s view on what constitutes disaggregation of businesses to avoid VAT is contained in VAT notice 700/1. Generally, HMRC would look at striking at least one link each under financial, organizational and economic heads before proceeding to issue a direction. That said HMRC, as a general rule, would view the following to be a single taxable entity:

  • Two businesses owned by same persons where one VAT-registered entity sells only to VAT-registered customers, and the other entity, not registered for VAT, sells only to customers not registered for VAT.
  • The premises and/or equipment are shared; something common with businesses such as launderettes and takeaway food supplies
  • Splitting up a single supply for e.g. bed and breakfast business where one supplies the bed and another the breakfast.
  • A number of businesses owned by the same person making the same type of supplies.

Here are some examples, where the businesses were held to be artificially separated with a view to avoiding VAT:

  1. Husband and wife acting as tax consultants, operating from the same office (Osman v C & E Commissioners 1989)
  2. A company operating a fitness club and a director and his wife operating a beauty salon in partnership from the same premises (West End Health and Fitness Club)
  3. A company operating a service station and a director’s son running a video club at the same premises (Old Farm Service Station Ltd & L Williams)
  4. Married couple providing computer programming services via a partnership and supplying computer hardware via a limited company (A & S Essex (t/a Essex Associates)).
  5. Bed & Breakfast business carried on by one who is also partner in farm with onther  – Self-catering accommodation part of farm business (Patric and Patric V HMRC [2011] UKFTT 865 (TC)

What this brief discussion aims to convey is that businesses are unlikely to be caught by these rules where employees, premises, equipment are NOT common and where the business and customers are different. It must, however, be noted that the INTENTION where apparent also plays a crucial role in determining whether the disaggregation is artificial or not.

Tax Partners

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