How to treat "Out of time" VAT in accounts...

How to treat "Out of time" VAT in accounts...

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I am looking for opinions on the best way to treat an output VAT liability that is “out of time”. I have a new client, a partnership, who has made some genuine mistakes on their VAT return. They use the VAT Cash Accounting Scheme.

The short story….

The liability has been included in the VAT control account/balance sheet but it has not been paid over to HMRC. My options seem to be:

1. Reduce the liability and post to the P&L, so that tax is paid on this “income”.

2. Reduce the liability and offset against drawings.

With option 1: The client has received some income that has not been taxed, but is it “out of time” in terms of income tax too? Is the relevant date the period of the initial transaction or the date that the error was discovered?

With option 2: The partners are effectively self-employed, so they have been “let off” a personal liability and income tax does not really come into it at all?

Now, being accountants, we never have enough information, so…

The long story…..

The client has been using a very old accounting system that supposedly produces VAT returns. The client “hits a button”, writes a cheque and that’s the VAT return done. The client has no concept of what the VAT control account is and the need to keep it reconciled.

The accounting systems VAT return: does not include journals, posts adjustments in previous VAT return periods and handles “matching” of cash on account items poorly. Add the fact that the client is using Cash Accounting and it is inevitable that a discrepancy has occurred.

Where were the accountants in all of this you ask? Well, it seems that when the client had his accounts produced by his previous accountants, they just analysed the “movement” for the period to produce accounts and the tax return. They did not seem to feel the need to reconcile any of the balance sheet accounts. Thank you!

Replies (24)

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By johngroganjga
02nd Oct 2013 08:35

Surely - put it on the next VAT return and pay it.

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Replying to harestock:
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By catlady
02nd Oct 2013 08:55

Not quite that simple.... I mean VAT that is 5 to 12 years late, and therefore "out of time" and no longer "assessable" by HMRC (provided that it is a genuine error). It would also cause great hardship to the client to find the funds after all of this time, so taking the "Voluntary" payment route is not really an option.

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By Peter Kilvington
02nd Oct 2013 08:55

Time limit

Does this time limit not come into play.

http://www.hmrc.gov.uk/vat/managing/problems/corrections/correct-mistakes.htm#5

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By catlady
02nd Oct 2013 08:58

Following on.... I feel fairly comfortable on the VAT implications of this, just querying the correct accounting treatment! Thanks

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By johngroganjga
02nd Oct 2013 09:03

There is no correct accounting treatment for evaded VAT. 

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By catlady
02nd Oct 2013 09:12

Hardly "evaded" johngroganjga

Hardly "evaded" johngroganjga - it is an event that the HMRC recognises, has procedures for and is fair. I am sure that other, more experienced, accountants have come across this issue before and I am interested in how they treated it their accounts -  that is all! :)

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By johngroganjga
02nd Oct 2013 09:25

It's been sitting in their records for 5 to 12 years as a VAT liability owing to HMRC.  For reasons best known to themselves they have been submitting VAT returns that declare a lesser liability than their own records show as due.  Looks like evasion to me. 

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By Mouse007
02nd Oct 2013 09:29

If it is ot of time for VAT

If it is out of time for VAT

tis it not also out of time for Income?

 

Much as it goes against the grain I think so.

 

In which case the "correct" accounting treatment would be to adjust the capital brought forward (because it is neither drawings nor income of the current period).

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By Mouse007
02nd Oct 2013 09:30

Lack of intent John

Can it be "evasion" when there is no intent?

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By johngroganjga
02nd Oct 2013 09:40

No doubt, but we don't know, the original error was an innocent mistake but for several years after there was knowledge that the error had been made yet they did nothing to correct it.

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By catlady
02nd Oct 2013 09:49

Mouse007 - thank you for your comments, they are very helpful! That was the one of the two options that seemed most suitable.

John - if my client was an accountant, I would agree with you - in fact, I would say string him up from the nearest tree!

But.... he is not an accountant; he was sold the "lie" that his accounts system would "do the VAT return for him". He believed that if he was doing anything wrong, his accountants would sort it out or at least inform him so that he could correct it. Most people do not understand accounts (I asked this client something about his balance sheet, he responded "what's a balance sheet?" Did he reconcile his VAT return to VAT control - "What's that?)

He is excellent at providing his service but he is not an accountant. He has been let down, the HMRC recognises that and will not penalise him as he made mistakes that were not intentional.

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By catlady
02nd Oct 2013 09:55

johnrogranjgha said "No doubt

johnrogranjgha said "No doubt, but we don't know, the original error was an innocent mistake but for several years after there was knowledge that the error had been made yet they did nothing to correct it."

The mistake was discovered THIS WEEK by me, the new accountant. The client is horrified and frightened and definitely innocent. As to the previous accountants - who knows - they certainly did not inform the client.

Phew...I may have to duck away from this discussion now, I feel an ulcer coming on!

 

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Replying to Mr_awol:
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By glenbogle
02nd Oct 2013 12:22

Have you....

Contacted the former accountants and sought their comments.

If they did know about it they ought by rights to have advised you when sought professional clearnce.

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Replying to andy.partridge:
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By catlady
02nd Oct 2013 12:37

I am still

glenbogle wrote:

Contacted the former accountants and sought their comments.

If they did know about it they ought by rights to have advised you when sought professional clearnce.

I am still awaiting their response to an email that I sent earlier this week.

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Replying to slipknot08:
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By glenbogle
02nd Oct 2013 14:01

This is not funny

because either they or their former.clients have put you in a potentially compromised situation.

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By DMGbus
02nd Oct 2013 11:07

Fraud

Several decades ago I came across the case of a client who, although informed about a VAT error liability declined to settle it (from memory it was around £30k).

Presumably the current question is a similar situation.

In the case that I experienced HMC+E (as it then was) approach was as follows:

If client is aware of liability and fails to settle the liability it is a fraud / evasion of tax on the part of the taxpayer (client)There would be issues if an advisor continued to act and carried the creditor forward each year (something to do with agreements between accounting bodies and HMC+E with issues such as this)

Since that time things have moved on and forward with Money Laundering Regulations.

Writing off a certain liability (*) looks like fraud to me and I'd expect a MLR report to be made.

(*) It was a fraud in past years anyway not to settle a certain liability.

I regard it as an acknowledged = certain liability by carrying it as a creditor, unless it was a "provision" for a potential VAT liability which was uncertain due to being a "grey area" of VAT law interpretation where published cases either don't quite match the transactions / alleged VAT liability or reporting contradictory judgments.

Going back to the question [ignoring ethics, MLR obligations and fraud] the accounting treatment I would see as being: credit P&L and debit creditor (or provision) for VAT.   Tax relief will undoubtedly have been claimed for this VAT creditor, so logically the credit in writing it off is liable to taxation.   Maybe logic doesn't apply here.  Maybe trying to get the credit tax-free is a further fraud.  

Maybe assisting the client with a fraud is a serious legal and/or ethical issue.

Decades ago the advisor would resign from such a client, then in the "clearance" letter reply to the new advisor mention "professional reasons" why a new advisor should not act for said client.   Things no doubt have moved on, and maybe I'm very out of date on these matters.

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Replying to DJKL:
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By catlady
02nd Oct 2013 11:47

Several decades...

DMGbus wrote:

Several decades ago I came across the case of a client who, although informed about a VAT error liability declined to settle it (from memory it was around £30k).

Presumably the current question is a similar situation.

In the case that I experienced HMC+E (as it then was) approach was as follows:

If client is aware of liability and fails to settle the liability it is a fraud / evasion of tax on the part of the taxpayer (client)

My client was not aware until this week. There were liabilities shown in his accounts, but he had no comprehension of what it all meant. His previous accountants should have kept an eye on things at the very least.

Not sure what the rules were decades ago, but now the HMRC will not demand that VAT unpaid due to an error over 4 years ago has to be repaid if it is a genuine error and not the result of fraud (They have 20 years for fraud). THIS IS FACT! By the same rule, if you found an invoice that you forgot to claim from 2005, the HMRC will not refund the input tax to you... it is "out of time"!

 

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By Mouse007
02nd Oct 2013 11:26

How?

"Tax relief will undoubtedly have been claimed for this VAT creditor" ?

That defies fundamental double entry accounting.

 

Decades ago things were different, we now have a four year cut off (except for fraud and dishonest conduct). Accepting the OP's assertion that this was unintentional then the balances brought forward need correction.

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By johngroganjga
02nd Oct 2013 12:00

Client's accountant was clearly aware.  Are you taking client's word that accountant never told them (they would say that wouldn't they)?  if so you should get previous accountant's version of events in writing so you can advise client properly.  If client was told to correct but didn't that is dishonest conduct, however innocent the error may have been in the first place.

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By Alfie Bet
02nd Oct 2013 12:18

I agree with John Grows Ganja

Put the client on a ducking stool; if they drown they're innocent; if they survive they're clearly a witch and you have a duty to burn them without delay.

I understand though that the modern lily-livered accounting approach is to take people at their word (reporting only suspicions to SOCA) and advise them based on their explanations of the position.

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By DMGbus
02nd Oct 2013 13:57

Dishonest clients

A dishonest client changes accountants if existing accountant insists that things be done right.

A dishonest client will deny knowledge of historic alleged tax underpayments when seeing a new accountant.

Until the former advisors explanation of the VAT creditor is received (and then asked if they advised the client to settle it) the client's truthfulness is uncertain on this matter.  I suppose "innocent until proven guilty" is a fair comment here.   

The suggestion that the VAT error was because of a computer system or software failure and was many years ago suggests that someone has knowledge that's not been properly explained in this matter.   

 

 

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Replying to mrme89:
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By glenbogle
02nd Oct 2013 14:02

agree your last para.....
 

agree your last para.....

 

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Replying to mrme89:
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By catlady
02nd Oct 2013 14:26

The suggestion that....

DMGbus wrote:

The suggestion that the VAT error was because of a computer system or software failure and was many years ago suggests that someone has knowledge that's not been properly explained in this matter.   

It is no suggestion... I have proved it:

I have access to the clients accounting file from his system. I have rerun all of the VAT100 reports; once on a cash basis and once on an accruals basis. I  then downloaded all of the transactions into Excel, matched and sorted them and found the items that have never been picked up by the VAT100.  The client did not have reason to believe that the VAT100 from the computer system was not accurate.

Extreme I know, but I hate to take things at face value, so it had to be done. That is how I know that the client is not telling porkies.

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By catlady
02nd Oct 2013 14:38

Many thanks for your comments everyone!

Just to finish up here, once I have heard back from the old accountants, I intend to write to the VAT errors people at HMRC, just to get confirmation from them that they will not take the matter further.

My original message never was to debate the rights and wrongs of the VAT situation; the correct thing will be done, rest assured. I merely came here for some input on the DR & CR involved in the accounting!

I think that hanging, drawing and quartering my client is a little extreme. No one has even asked the amounts involved!

I really am going to try and get away now.........

 

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