A bit of an odd one.
I registered a client for VAT and FRS with an activity that attracted a rate of 12%.
Unknown to me, the client made a unilateral decision that his activity had a rate of 14.5% and prepared his VAT Returns accordingly.
This has come to light in preparing his year-end accounts. The client maintains that 14.5% is correct. For my part, 12% seemed appropriate based on the information I was given.
What do we need to do? There is no loss to the public purse but, although I do not expect HMRC to even notice the discrepancy, I am uncomfortable with returns being filed at a different rate to that registered.
Thanks in advance.
Replies (19)
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What penalty would arise?
Using a rate other than the declared one is wrong. However, aren't VAT penalties based on the tax lost? No tax lost, as they have used a higher rate, so no penalty. Maybe HMRC will give your client a reverse penalty for the tax overpaid if they find out. :-)
I would be more worried about continuing to work with a client that changed the rate without telling me, and then argued that they were correct. That's just a fundamental lack of respect. They are paying you for your expertise but clearly have no faith on it. I'd say you have a candidate for sacking there.
Possible sequence of events
Client signs FRS registration prepared by you. Signs without reading fully, as many clients do.
Client prepares first return. Forgets intended rate and looks it up on HMRC website.
So they did not ask you about the £2,000 difference because they didn't know there was a £2,000 difference. They have just looked up the rates, picked the one they think is correct and assumed that was what went on the form. It just never occurred to them that another rate could have been used, so they never thought to check what had been used.
My "respect" concern more arose from the client's insistence contrary to your advice once the difference had been spotted. If you agree that, with further information from them, the amended rate is correct then it is just a communication issue.
Normally lower rate
Blimey!
We normally get the clients looking to obtain a lower rate than we advise!!
swings and roundabouts
Would it not be the case that if you tried to reclaim the £2,000.00 VAT, then this would mean that the net profit of the business will have increased and there will be a liability to pay additional self/assessment or corporation tax?
It would
Would it not be the case that if you tried to reclaim the £2,000.00 VAT, then this would mean that the net profit of the business will have increased and there will be a liability to pay additional self/assessment or corporation tax?
It would - but not the whole £2000.
Can't change retrospectively
If the client chose 14.5% reasonably then HMRC will not accept a retrospective refund claim. All you can do is convince the client to change to 12% going forwards, assuming this is a better reflection of what (s)he does.
As somebody who runs a training and consultancy business which used to use FRS, I had no problem in choosing the 'none of the above' as at the time our turnover from training exceeded our turnover from consultancy which is the key test.
This is likely to result in an enquiry (probably by telephone) as the VAT returns will show a different ratio of VAT liability to turnover compared the that expected by HMRC.
Has the client filed correct returns i.e. showing the turnover gross of VAT, and not showing input VAT and purchases figures (subject to claiming pre-registration input VAT and capital goods on the same invoice with a VAT-inclusive value of over £2,000)?
Malcolm
Malcolm Greenbaum
Director, Greenbaum Training and Consultancy Limited.
IFRS, UK GAAP, US GAAP, UK tax and VAT
Initial registration won't necessarily set a rate
With FRS, the taxpayer decides the most appropriate category and applies it. It is then up to HMRC to challenge it if they believe it to be incorrect.
I did not get the impression from the OP that business had been registered for FRS with a 12% flat rate, just that there was a disagreement over the rate. If it was registered as a 12% business and the client has been applying 14.5% then I would have thought HMRC would have enquired into the VAT returns as I would think a flag would be set against the return for using an unexpected rate.
Might be worth a phone call to HMRC to explain that the client has been using the wrong rate, but only if it was registered as a 12% business.
As for the appropriate rate, this should be initially based on expectation, but if it turns out that a different service predominates (i.e. accounts for more than 50% of the total supplies) the rate should be adjusted as appropriate. It is very rare for HMRC to backdate any increase required unless the taxpayer was unreasonable in making their initial selection.
There is an annual review
HMRC's own guidance says keep applying the initial percentage until the anniversary of the scheme.
Para 4.7 of Notice 733 in full:
4.7 What if the balance between parts of my business changes?
If the balance changes but you continue to do all the same activities, carry on using the percentage that was appropriate at the start of the year until the anniversary of you joining the scheme. Review the balance between the parts of the business each year. Make this review for the first day of the VAT period in which the anniversary of you joining the scheme falls. If on that date the balance has changed, or you expect it to change over the year ahead, switch to the trade sector for the larger portion of your expected business.
This may also mean that your flat rate changes. If this occurs use the new flat rate from the start of the VAT period in which your anniversary falls, not just from the anniversary to the end of the period
So if you applied on the basis the business would be mainly training and submitted an FRS application showing 12% (minus the 1% discount for the first year) then VAT should have been calculated using 12%.
You would need to make a voluntary disclosure of the error and seek a repayment of the overpaid amount.
If at the anniversary of joining the scheme, the consultancy is the major part of the business, then it would be proper to increase the rate to 14% from that point.
Hope this helps.
Malcolm
Retrospectively ?
12% was chosen - does that mean that 14½% can't be used ?
I'm just wondering how HMRC would have viewed that if 14½% was originally chosen but the client used 12%. These reverse situations often give rise to different HMRC views.