A fall in the VAT rate last occurred in July 1974, which means that the relating issues have not been recently rehearsed. The principles at stake relate to tax points which determine when a supply takes place. Although these normally have a cash flow consequence; this is usually inconsequential and as a result both taxpayers and HMRC tend to over look whether the rules are correctly applied. With a rate change they become fundamental as they will determine what rate of VAT applies. It is therefore important you consider the tax point rules and whether you apply them correctly.
The VAT rate fall is only intended to be temporary which means you should start to consider the consequences of the planned rise in 2010 and whether you can take advantage of the lower rate. We discuss some of these options below.
Duration of the VAT rate fall
The standard rate of VAT will fall to 15% from Monday December 1st 2008. It will last for 13 months until 1st January 2010 when it is planned to rise back to 17.5%. There has been recent speculation that it will rise above this to 18.5% or even 20%.
The VAT rate fall will apply to all standard rated supplies. These are all supplies that are not otherwise relieved by a zero rate, a reduced 5% rate or a VAT exemption. The change does not alter the VAT treatment of any supplies with these VAT liabilities.
Tax Points
Tax points determine when a supply has been made and what rate of VAT will apply.
There are two types of tax points. A basic tax point occurs when a supply is made. In the case of goods this will be when the goods are made available. In the case of services it will usually be when you finish performing the service.
You normally account for VAT at the time of the actual tax point. This occurs when an invoice is issued or payment received. This can be before the basic tax point (i.e. if you obtain payment or issue an invoice in advance). Alternatively providing an invoice is issued within 14 days it can occur after the basic tax point. In some cases HMRC allow extensions to this 14 day rule. If you do not issue an invoice within the designated time then you must account for VAT at the time of the basic tax point. Regardless, all businesses have an obligation to issue an invoice within 30 days of the basic tax point.
Examples:
1) You made a supply of goods on or before 18th November and issue an invoice on 1 December. You can account for VAT at 17.5%.
2) You made a supply of goods on 18th November and issued an invoice at the time. You have yet to be paid. Here you must account for VAT at 17.5% as the issuing of an invoice created a tax point.
There is a concessionary treatment that allows you to opt to account for VAT at the time of the basic tax point in the event of a VAT rate change. When the VAT rate falls this will only be useful if you have pre invoiced or obtained a pre payment or deposit (i.e. created an actual tax point) before making a supply. In this case you must issue a special VAT credit note – see below.
When the VAT rises back to 17.5% next year you will have the chance to account for VAT at 15% providing the supply takes place prior to the change – unless the rules change.
Continuous Supplies of Services
The exception to the above occurs when there is a continuous supply of services. This occurs when you supply services on a continuous basis and receive payments from time to time. In this case VAT will be accounted for when payment is received or a tax invoice issued, whichever is earlier.
Businesses which have an ongoing engagement with their clients tend to operate under the continuous supply of services rules. For example: solicitors, consultants, accountants and tax advisors.
As the VAT rate has fallen you only need to account for VAT at the lower rate if you invoice for your services (or receive a payment before issuing an invoice) after 1 Dec 2008. It does not matter when the work you are invoicing took place.
Example:
3) A firm of solicitors undertakes work for a client throughout the year with the bulk of the time being spent in October 2008. They wish to invoice the work. If they invoice on 30 November 2008 VAT will be charged at 17.5. If they invoice on 1 December 2008 then VAT will be charged at 15%.
Professional firms that make supplies to private individuals or commercial clients who cannot recover VAT may wish to consider delaying the issue of an invoice until after 1 December.
Firms that make continuous supplies and have received a payment or issued an invoice before undertaking a piece of work, are able to account for VAT at the lower rate if the work takes place after 1 December 2008 they must issue a special VAT credit note.
When the VAT rate rises next year, it will make sense to take advantage of the rules that allow you to charge VAT at the rate applicable when the work was done. In such circumstances you can apportion your fee, charging VAT on work undertaken between 1 December 2008 and 1 Jan 2010 at 15%. If you are likely to wish to do this it would be as well to ensure that your fees software can cope with multiple VAT and fee apportionment. Alternatively ensure that all work in progress is billed on 31 December 2009.
Many professional firms (including CVDFK) make use of a ‘request for payment’ (RFP) system. Here the firm does not issue a VAT invoice but a request that falls short of the invoice requirements. This means that a tax point is created only when payment has been received, at which point an invoice is sent. It should be noted that the recipients of an RFP cannot use it as evidence for VAT recovery but must await the VAT invoice.
Firms using an RFP system will account for VAT at 15% for all payments received after 1 December 2008; this will be regardless of what rate of VAT was on the RFP. If a client pays too much VAT then the firm will need to credit the overpayment.
In their recent guidance HMRC do not give the option of firms making continuous supplies of services charging the old rate for work undertaken before 1 December 2008 and invoiced afterwards. However, although this option would not be popular with clients, it should be possible and we can advise on this if necessary.
When the rate increases firms issuing RFP’s will be in a similar position to firms that initially issue VAT invoices – they will need to consider if they wish to apportion any fees issued after 1 January 2008 to reflect work undertaken whilst the 15% rate was in force.
The difficulty RFP users will have with the VAT rate increase is that any clients who pay late will have underpaid – paying only the 15% VAT identified on the RFP rather than the 17.5% due after 1 January 2008. You may wish to consider methods of dealing with this, possibly adding a warning to RFP’s issued towards the end of 2008 and reissuing RFP’s following 1 January 2010. Clients must realise that if they delay payment, they will pay more.
Credit Notes and Adjustments
Credit notes can be issued to reflect a genuine overcharge or mistake. They cannot be issued in an attempt to cancel a supply so as to re invoice it at a lower VAT rate.
Credit notes serve the purpose of altering the value of a supply, but not its tax point. It follows that where a credit note is issued after 1 December, in relation to an invoice issued prior to this date, the tax point will be the same as for the original supply, and VAT should be shown at 17.5%. Similar rules apply to debit notes.
Where a credit note is required to be issued as a result of the change in VAT rate, e.g. where invoices were issued prior to 1 December but in respect of work performed on or after 1 December, the credit note should reflect the difference between the VAT charged on the invoice at 17.5% and the VAT that is actually to be accounted for at 15%. These credit notes must be issued with 45 days of 1 December 2008 i.e. by January 14th 2009.
Example:
4) You sell goods in October 2008 and they are returned on 5th December. You agree to a credit note – issued at 17.5%.
Recovering VAT
If you receive a VAT invoice you can recover the VAT identified upon the invoice. This will be true even if the VAT rate changes. Over the next 18 months you are likely to have to post VAT invoices with different rates of VAT and you must ensure that you check the correct amount of VAT is posted. You cannot assume that all VAT invoices will be at 17.5% if received before 1 December or 15% afterwards and should not rely on any automation in your accounts package.
Retail Businesses
As you will be aware, the standard rate of VAT is to be reduced to 15%, with effect from 1 December 2008, meaning that the new VAT fraction is 3/23. The reduction will have effect for 13 months, with the rate reverting to 17.5% at the beginning of 2010. Retailers with electronic till systems that calculate VAT at the point of sale will need to ensure that their systems are adjusted, to take account of the new rate with effect from 1 December. You may need to consult the manufacturer or supplier of your particular system to find out how to make the necessary adjustments. The Government has reduced the rate of VAT in the hope that retailers will pass the reduction in tax on to their customers through lower prices. In practice the price at which items are sold is the decision of individual retailers, meaning there is no legal requirement to reduce the price at which goods and services are sold. It is however a legal requirement to charge VAT at the correct rate applicable to the supply. There is no effect on the VAT treatment of zero-rated sales, e.g. food and children's clothing.
How will the VAT rate fall affect Charities and membership organisations?
Charities suffer irrecoverable VAT. The VAT rate fall will obviously lessen this amount and is good news for the sector.
Membership organisations often charge a membership subscription that covers the next year. The tax point will usually be the invoice date, the day payment is received or the day that the membership year starts, whichever is first. In these circumstances you can apportion any VAT you charge on your subscription to reflect the lower rate for part of the year. This will obviously only be beneficial if your members cannot recover VAT.
If you do have members that cannot recover VAT then it is worth starting to think about how you will deal with the VAT increase. It may well be possible to obtain an advantage by bringing forward your membership renewals for the 2010 membership year to before 31 December 2009. If you wish to consider this then we recommend you take advice so as to ensure you fall outside any HMRC anti forestalling legislation.
If you apply the Lennartz method of recovering VAT incurred for business and non business purposes then the rate you use to calculate the VAT on the self supply will need to be adjusted.
Construction Industry - Retention Payments
In considering the tax point rules for retention payments, it is necessary to differentiate between the 'time of supply' rules for construction services that are supplied under contracts providing for stage or interim payments, and those that are supplied under single payment contracts.
Under single payment contracts, the retention element of the contract does not fall within the basic time of supply rules, which would establish the tax point of the main payment as being when the work has been completed. Instead, the tax point of the retention is the earlier of:
1. the time when a payment in respect of any part of the retention is received by the supplier; and
2. the date that the supplier issues a VAT invoice relating to the retention payment.
If the tax point falls on or after 1 December, VAT should be accounted for at 15%.
Contracts that provide for stage or interim payments have different tax point rules to single payment contracts, meaning that a tax point is created at the earliest of the following times:
1. each time a payment is received by the supplier; and
2. each time the supplier issues a VAT invoice.
Retention payments will also fall within these time of supply rules.
The consequence of this is that the creation of a tax point for retention payments is essentially the same for both stage / interim and single payment contracts. If the tax point falls on or after 1 December, VAT should be accounted for at 15%.
As you will be aware, the standard rate of VAT will revert to 17.5% on 1 January 2010. It would therefore be worth issuing VAT invoices for retention payments due at around this time prior to 1 January, in order to benefit from the 15% VAT rate.
Special schemes
If you use the flat rate scheme the flat rate you pay is likely to be adjusted to reflect the VAT rate. However, HMRC are taking the rate change as an opportunity to adjust the rates so you are advised to check that the new rate is still beneficial for your business.
HMRC are not automatically changing the interim payments already notified. If they are now too high you should notify them.
Fuel Scale Charges
These have now changed to reflect the rate change. The new rates can be found by clicking here
Preparing for Jan 1st 2010
The VAT rate will rise again on 1st Jan 2010. There will obviously be potential advantages for customers who can advance their 2010 purchases to 2009. So as to try and prevent abuse HMRC has published an outline of anti forestalling legislation that they intend to introduce in the April 2009 budget. The current position is that the legislation will prevent situations:
‘where the supplier receives a prepayment for the goods or services or issues a VAT invoice in advance of the rate increase. It will also apply where, in advance of the rate increase, the supplier grants the customer an option or a right to obtain goods or services at a discount or free of charge after the rate increase takes effect.
The circumstances are that the customer cannot recover VAT in full on the supply and that:
- the supplier and customer are connected parties; or
- the supplier receives a prepayment, or grants the customer an option or a right, and the prepayment, or the acquisition of the option or right, is wholly or partly funded (directly or indirectly) by the supplier; or
- a VAT invoice is issued by the supplier showing an amount any part of which is due more than 6 months after the date of the invoice’
The exact consequences of the proposed legislation are as yet unclear and we will be providing a further briefing next year.
Regardless of whether you decide to encourage prepayments, you will have to ensure that your systems can cope with the increase in VAT rate. As we explain above, this will have different consequences from the rate fall in that many businesses will wish to take advantage of the concession that allows them to charge VAT according to when the work is done. You must ensure that your accounts system can cope with this and the issuing of the special credit notes the rate change may entail.
For further information please contact Peter Ladanyi on 020 7509 9490 or pladanyi@cvdfk.com
This summary is for general information only and is not intended to be advice to any specific person. You are recommended to seek competent professional advice before taking or refraining from taking action on the basis of the contents of this summary.
Published in November 2008 by Chantrey Vellacott DFK LLP, Russell Square House, 10-12 Russell Square, London WC1B 5LF. © Chantrey Vellacott DFK LLP 2007. All rights reserved.
