By Hannah Dobson, VAT Director at Smith & Williamson
On 4 January 2011, the standard rate of VAT will rise from 17.5% to 20%, the highest it has ever been in the UK. The Government will raise an estimated £13.5 billion in additional revenue. This marks the third change in VAT in two years, so for many businesses this is familiar territory, but the rules governing a change of rate still cause confusion. Here’s some helpful information and lessons learned from the last VAT changes, to help you plan for January.
Applying the new VAT rate
There are special rules for deposits received before 4 January, for “continuous supplies” and invoices covering one year. Don’t get caught out by anti-forestalling legislation, which is in place to prevent prolonged use of the 17.5% rate in respect of goods/services to be supplied on or after 4 January 2011.
Assuming the goods or services in question do not fall foul of the anti-forestalling legislation, the following rules can be applied for sales of goods or services that span the VAT rate change.
Rules for VAT on services
1. For services started before 4 January, but finished after this date the work up to 3 January can be invoiced at the 17.5% VAT rate. The work completed on or after 4 January should be invoiced at 20%. HMRC may require a business to demonstrate that the apportionment of services between the VAT rates is fair.
2. Services where the work is completed before 3 January but invoiced on or after 4 January can be billed at the 17.5% rate. HMRC may require evidence that the work was completed prior to 4 January.
3. If the services are to be completed on or after 4 January, but a VAT invoice is issued for the work prior to 4 January, the invoice can reflect the 17.5% VAT rate — but make sure you check that this is not caught by the anti-forestalling rules.
Rules for VAT on goods
1. Where goods are delivered before 4 January 2011 but invoiced and/or paid for on or after this date, the supplier can choose to use the 17.5% VAT rate. This is not compulsory, and the 20% rate can be used at the time of invoicing.
2. Where goods are invoiced or paid for before 4 January 2011, but delivered on or after this date, the supplier can chose to use the 17.5% rate.
3. Where goods are invoiced before 4 January 2011 but delivered and paid for on or after 4 January 2011, the supplier can chose to apply the 17.5% rate to the invoice.
Should businesses absorb the rise or pass it on to customers?
The general view in the marketplace is that this VAT rate rise will have to be passed on to consumers. Margins are already tight, and it will be hard for them to absorb any additional costs.
Many are considering slowly putting up prices towards the end of 2010, so there is not such a noticeable difference when the VAT rate rises. It is likely though, that for larger items (e.g. cars), the New Year may see offers such as 'we are holding the VAT rate down' to encourage people to buy in the January sales.
Will it increase the risk of customers delaying overdue payments? If so, how do I manage cashflow?
Given the recession, this is happening anyway, but adding additional VAT on to bills is likely to mean people will hold on to their cash for as long as possible. This has a compounding effect, as all payments are then delayed.
Businesses need to ensure that they collect and retain enough cash towards the end of 2010 to see them through any delays that occur in January due to the rate change - but again, this is difficult given the tough environment. Most businesses fail because they run out of cash, so this does need to be managed carefully.
What are the implications for the finance department?
Finance departments need to understand the rules and ensure that everyone in the organisation who issues invoices is aware of them too. For invoices received, if the VAT rate shown on them is wrong, correct invoices should be requested from suppliers. Only the VAT amount shown on an invoice can be reclaimed, even if the rate shown is wrong.
For invoices issued, businesses still need to declare the right amount of VAT on VAT returns, even if invoices have shown the incorrect VAT amount - so, if an invoice is issued for 17.5% VAT but 20% is due, the business will have to pay over 20% to HMRC and try to recover the additional 2.5% VAT from the customer. For finance departments in organisations that cannot recover VAT in full (e.g. banks, insurance companies, charities etc), it is essential that they ensure invoices show the correct amount of VAT, in order to maximise the VAT they can recover.
What can I do to minimise the impact?
If businesses can recover VAT in full, then depending on the value of their quarterly purchases, they may actually need to do nothing other than be aware of the new rules. For businesses that cannot recover VAT in full, or those trying to mitigate cashflow costs, they should seek advice and take full advantage of the special provisions allowed during a rate change that enable the 17.5% VAT rate to be used after 3 January 2011. If large purchases are expected in the run up to the rate change, consideration should be given to asking for invoices early (subject to rules relating to tax points and anti-forestalling provisions).
For help complying with or implementing the VAT rise or for any other VAT issue, speak to Hannah Dobson on 020 7131 8138 or email firstname.lastname@example.org
Watch a video of Guy Rigby, Head of Entrepreneurs at Smith & Williamson, giving advice on how to manage cash flow.
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