Neil has some horror stories for us. Not suprising I suppose, when he deals with VAT and VAT problems all day long!

Sometimes when I write about the nation’s favourite tax, I highlight planning points that will hopefully save some VAT for a business, or at least help its cash flow. On other occasions, I highlight compliance issues that will help a business to stay in the headmaster’s good books (the headmaster being a visiting officer from HMRC!).

However, in this article I am going to illustrate three horror stories relating to legal entity situations, the message being that VAT should never be ignored when a change in the legal entity or structure of a business is being considered.

Beware the flat rate scheme

A case referred to me recently was a management consultant who traded as a limited company but a decision was taken to disincorporate the business and he became a sole trader.

As far as VAT is concerned, this looked straightforward. The limited company was deregistered and he re-registered as a sole trader in his own name. Both entities adopted the flat rate scheme, which means that VAT is accounted for by applying a specific flat rate percentage to the VAT inclusive turnover of a business, rather than accounting for VAT based on the traditional method of output tax less input tax.

But here comes the sting in the tail. When someone is VAT registered as a sole trader, the registration includes all supplies made by the individual in question, and the consultant also received income from buying and selling books on an internet site (not VAT registered). A rule of the flat rate scheme is that the flat rate percentage needs to be applied to all sales made by a legal entity, including any zero-rated and exempt income that is earned.

The end result of this story was a rapid exit from the flat rate scheme and a retrospective VAT adjustment on the book sales.

Property pitfall

Imagine the following situation: a very generous father who owns a commercial property on which an option to tax election is in place (he is therefore VAT registered) decides to gift half of the property to his daughter as an inheritance tax planning move. The property in question is being rented out to a tenant on a long lease.

In the above situation, the VAT reality is that the business activity is being transferred from a sole trader to a partnership i.e. a change in legal entity.

I won’t go into detail about what happened (there was more drama than in an Eastenders storyline) but here’s what should have happened:

• Assuming they do not retain the same VAT registration number (VAT68 procedures), the partnership will register for VAT in its own right and is effectively taking over a property rental business from the father. This qualifies as a transfer of a going concern situation i.e. there is no output tax due on the supply of the property to the partnership (outside the scope of VAT). However, a requirement to make this acceptable is that the partnership must make an option to tax election with HMRC before the transfer takes place. It must also confirm that it will not seek to disapply this option.




• The end result is that the new entity has taken over the option to tax responsibilities of the old business – and HMRC will continue to get output tax on the rent charged to the tenant

Private tuition

It is usually fair to state that the VAT treatment of a supply is not affected by the legal entity operated by the supplier. So it makes no difference to the VAT liability of services provided by a hairdresser if he cuts hair as John Smith T/A Trim and Strim or if he becomes a director of his own company and trades as Trim and Strim Ltd.

However, there is an exception to this rule. The supply of private tuition is exempt from VAT if provided by a sole trader or partner in a business – but not by a director of his own company. In the latter situation he is now an employee providing tuition – not a business owner. The service is therefore standard rated!

The above principle was confirmed in the tribunal case of Empowerment Enterprises Ltd.

So here’s my final horror story:

• Steve trades as a sole trader providing football-coaching services to individual groups of children (£30,000 per year). This income is exempt from VAT as private tuition




• Steve also buys and sells sportswear to private individuals with annual sales of £60,000.




• Steve is not VAT registered because his annual taxable sales of £60,000 are less than the current registration limit of £67,000.




• Steve’s accountant recommends that he incorporates his business and trades as Steve Sports Ltd.




• The taxable sales of Steve Sports Ltd are £90,000 per year (coaching income is no longer exempt)– there is now a VAT registration issue to deal with!

Note – private tuition applies if a subject is normally taught in a school or university and includes coaching or tuition in sporting or recreational activities. It is irrelevant whether instruction is given on an individual basis or in a group.

Conclusion

To quote the famous line from the film Jaws 2…….just as you thought it was safe to go back into the water! VAT is often the forgotten tax – so make sure its shark-like tendency to bite you when you least expect it does not cause you a big problem. Any decision concerning the structure or organisation of a business should give VAT a thought……if only for a few minutes!