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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Time limit
Does this time limit not come into play.
http://www.hmrc.gov.uk/vat/managing/problems/corrections/correct-mistakes.htm#5
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.
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).
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.
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.
This is not funny
because either they or their former.clients have put you in a potentially compromised situation.
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.
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.
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.
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.
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.