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HMRC Challenging VAT Flat Rate %

HMRC Challenging VAT Flat Rate %

My client has been challenged on the trade sector chosen for VAT FRS, from application to the scheme in Sep 2013.

Letter received dated 29th January 2016 titled 'Check of VAT Returns'. No specific mention of percentage or trade sector, just that they are 'checking that you are operating the VAT Flat Rate Scheme correctly'.

HMRC asked for:

  • A full description of the main business activity and the trade sector chosen
  • The flat rate percentage used to calculate the amount of VAT due
  • Monthly t/o for each period they are checking
  • Amount of VAT charged for each quarter
  • A breakdown of how the VAT declared has been calculated
  • Provide invoice dates and payment dates

All to be sent by 19th Feb.

I'm not a rocket scientist, just an Accountant but it didn't take long to work out that the clients 'Other Business Services' at 12% was being questioned. They are a husband & wife Limited Company, circa £100k turnover for last five years with CT of around £8k each year, filed and paid 6 months early and no late or missed VAT returns. The squeakiest clean of my pretty tidy client portfolio.

I duly sent all information off to HMRC on 2nd Feb.

Letter received 6th March from HMRC 'further items needed':-

  • Send us a detailed breakdown of what your business actually does so we can ensure you are using the correct trade class

The company is a web / graphic designer. My hunch is that HMRC are looking to re-classify them as IT Consultant at 14.5%, something my client insists they are not (which I agree).

Any others have experience of this? What would you do next if they respond insisting on IT Consultant and ask for the VAT shortfall (Approx £8k, though then less an adjustment for CT as therefore less profit.....interesting side discussion....).

A 2014 case discussed here https://www.accountingweb.co.uk/article/engineering-business-wins-vat-tr... looks to be very similar and focuses on the legality of the guidance to choosing the category. Any update since then?

Replies

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08th Mar 2016 09:10

Whilst your client is not a IT consultancy, you have to pick which best fits – there isn’t a % for every trade or profession. I would say a web designer is a close match to “Computer and IT consultancy or data processing” and that is the % I would have chosen.

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By RedFive
08th Mar 2016 09:32

Not that simple

cheekychappy wrote:
Whilst your client is not a IT consultancy, you have to pick which best fits – there isn’t a % for every trade or profession. I would say a web designer is a close match to “Computer and IT consultancy or data processing” and that is the % I would have chosen.

Of course. It's not that simple Cheeky, hence the question. Did you read the Engineer tribunal case? The result was that it is 'guidance', not encased in law.

The HMRC manual which gives fuller descriptions than the overview list Computer and IT Consultancy as "Data processing and database activities, Hardware and software consultants or software publishing"

My client does none of these things. In fact they would be more closely related to the Advertising sector which carries a 11% rating.

Anyway, I have always felt it prudent to let the client peruse the list and choose their own sector - they know their business better than I do. Otherwise if this all goes pear shaped and HMRC come looking for 35% penalties as in the quoted case then I would be sitting between a very hard cart and a mountainous sized rock.

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08th Mar 2016 09:36

I tend to agree that advertising is a closer fit than IT consultancy. I don't understand why people consistently argue that people who work almost exclusively on a computer are IT, they are not. The computer is just a tool.

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08th Mar 2016 09:19

The web designer clients I have are down as IT consultancy, which covers a range of computer-related topics. I would disagree with you and your client that they are not an IT consultant.

EDIT - please let us know the outcome - I have a few clients who would benefit from being re-classified.

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08th Mar 2016 09:22

.

If you run that through a new registration for VAT where it picks the category for you based as trade sectors  (as opposed to the old system when you picked it) you get.............IT Consultancy if you pick anything much which has "software design" in the title. 

I would go for damage limitation and try to agree to use it ongoing. Probably a verbal on the phone is the best bet but the VAT bods are none too sharp who do this work so its a bit hit and miss. 

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08th Mar 2016 09:24

What are their inputs?

The high percentage for IT consultants is because the nature of their business is they have low inputs. If you want to challenge HMRC's expected assertions, demonstrating that the business activity better fits the rate you have chosen would be the way to do it. If a calculation on standard VAT accounting shows your client is significantly ahead using FRS then you have your answer.

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08th Mar 2016 09:46

If you have documentary evidence that shows the original decision was reasonable, HMRC don’t usually seek to change things retrospectively.

I agree with the engineering decision. The taxpayer in that case was an engineer that specialised in motor and machinery engineering. HMRC tried pursuing the taxpayer based on the % of “architects, civil and structural engineers” and also the fact that the taxpayers original choice was deliberate (though later changed to careless). The most surprising part of this case was the fact that HMRC originally considered that it was deliberate.

I disagree with the other contributors that advertising is a more close fit. Advertising is what the end user might use the website for, but it isn’t what your client is producing.

I would say that web design is more akin to software design, again, fitting in with the IT category.

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By RedFive
08th Mar 2016 10:06

Advertising

SteLacca, thanks. I'm going to use that line when up against the Judge "the computer is just a tool". It would make everyone from Accountants to HMRC civil servants IT consultants if that was the basis of classification.

Good follow up points by Cheeky, though I don't agree. That is I concur with your findings in the engineer case 100% and also can not understand how they went for deliberate in the first place. But I don't agree that web design is more akin to software design. My guy uses computer software to display an advert for his clients business. he sits with a paper and pencil and creates logos and banners.........or an iPad....or a PC.......then puts them into a website....sometimes. He does not consult on hardware or software with anyone, he does not publish software and doesn't just 'process data' (I do that, and I bet my HMRC man does too).

But that is the crux of this problem, if we as esteemed professionals can not agree, then what chance does the man in the street have?

Thanks to all for very useful and constructive comments so far. I will update on response, though keep your thoughts coming as I can feel in my water that they aren't going to go away quietly.

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08th Mar 2016 10:18

Is it just publishing a site?

Or do they advise clients on HTML or Java?
Do they advise on changes to make the site mobile friendly?
Do they advise on changes so that the site is compatible across a range of browsers?
Do they advise on integrating payment solutions?
Do they advise on integrating the site with an app?
Do they advise on administration of the sites?
Do they advise on SEO optimisation?
Do they advise on hosting and servers?

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By RedFive
08th Mar 2016 10:40

Most of that I think

Ha, leading questions Mr Cheeky - I know what you are trying to do! ;-)

Not wishing to play tennis and argue the toss, I am genuinely looking for the best outcome for my client and do not have the answer....hence my question.

Here is a redacted version of the letter prepared by my client in response.

......................are a website / graphic design company specialising in web design and online advertising. We mainly work for businesses located in the ............. of England allowing them to showcase their company and advertise their own products and services.

Businesses approach us with requirements for a mixture of web / graphical design and advertising work and we take their information and present these in the best way online.

The web design and graphical work is a mixture of websites, newsletters, logo, banner adverts and infographics. Clients approach us with their requirements and we produce suitable material to match their brand and help achieve their goals.

We also use web development to create our own in house Content Management System (CMS).  The CMS allows our clients to manage their own websites, create new pages, blog posts and events in order to advertise their products, services and company as a whole.

In addition to web design and graphical work we also do online advertising for our clients.  This is mainly in the form of Search Engine Marketing (SEO) and Social Media Marketing (SMM). For SEO we create campaigns that boost our clients’ website up the search engines (eg Google) so their prospective customers can find them more easily.  For SMM we help with promoting websites on social media platforms such as Facebook and Twitter.

When determining the Flat Rate percentage to use there was no clear category for web / graphic design, and therefore the best match was “Any other activity not listed elsewhere (12%)” or “Business services not listed elsewhere (12%)” and therefore the latter was chosen.

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08th Mar 2016 14:20

@red5

maybe if you were to use terms  in your communications with HMRC aka - as creative writing / multi media publishing / design and print[did they not create letterheads/image/logo / business cards for corporate branding alongside the website ? - if it was these activities provided &  all away from the generic 'IT' and more into media / publishing or as you state other business services

hope though they do not host the client websites ?

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08th Mar 2016 10:59

To RedFive - we received the exact same letter for a web designer client of ours a few years ago and they had also chosen other business services many years before that before they were our client incidentially. No need for a lengthy response. We literally wrote a couple of sentences: that they are web designers and builders and therefore they chose any other activity sector. To make the decision, they followed the steps in VAT Notice 733 section 4.1. As they reached Step 4 of this HMRC guidance, they spoke to the VAT National Helpline and it was concluded that their business falls into the "Any other Activity...". That is literally it, they replied with no further questions.

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By RedFive
08th Mar 2016 11:05

very useful

Gary Stevens wrote:

To RedFive - we received the exact same letter for a web designer client of ours a few years ago and they had also chosen other business services many years before that before they were our client incidentially. No need for a lengthy response. We literally wrote a couple of sentences: that they are web designers and builders and therefore they chose any other activity sector. To make the decision, they followed the steps in VAT Notice 733 section 4.1. As they reached Step 4 of this HMRC guidance, they spoke to the VAT National Helpline and it was concluded that their business falls into the "Any other Activity...". That is literally it, they replied with no further questions.

Brilliant, thanks for your help, very useful.

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08th Mar 2016 11:03

To RedFive - I am sure you know this, but please don't over explain yourself to HMRC at the initial stage, there's probably no need to do it. I personally think a response similar to the one we gave you is sufficient - it works. The response you or your client prepared is way over the top and will start the little grey cells in the HMRC officer's head start to think too much. Give them a short one or two sentence response and wait if they want more information.

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08th Mar 2016 12:16

Never understood it

The stated purpose of the Flat Rate Scheme is a book-keeping simplification. I have encountered few businesses that use it as such but have many client who use the scheme and make considerable savings in doing so.

HMRC could not possibly have intended this to be the result and must be losing substantial amounts of money on it but have made no move to plug the obvious gaps - any one making labour only supplies will always "Win".

The guidance at FRS7300 seems to have more entries to explain sectors that are unlikely to be available to the FRS (how many quarries or banks have low enough turnover to qualify?) than more common businesses - project mangers, tree surgeons, car washes being some I have encountered.

 

 

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By cbp99
09th Mar 2016 12:14

Similar letter recently

We had a similar letter recently for a web designer client.

We replied to HMRC, copying the contents of an email to the client when we registered the client for FRS, as follows:

 

You have described your work as "Website and SaaS creation, management and maintenance"

I have considered the following sectors from HMRCs list to see which is most appropriate:Computer and lT cansultancy and data processing. Comment - although your work uses computers, it is not a computer consultancy business per se. Advertising. Comment - although there is an advertising element and outcome, it is not what is commonly understood by "advertising". Publishing. Comment - there is a publishing element, but again, not what is commonly understood as publishing  Therefore, in the absence of any specific category which fits the bill, I suggest reverting to "Any other activity not listed elsewhere" and have completed the form accordingly.                                                                                                                                                                                                                                    HMRC closed the enquiry without further comment.

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08th Mar 2016 12:50

Interesting that they are keen to reclassify businesses and to get tax out of it but when it can be proved that the client used a rate which was favourable to HMRC, the balance is irrecoverable.

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09th Mar 2016 12:16

Irrecoverable

bendybod wrote:

Interesting that they are keen to reclassify businesses and to get tax out of it but when it can be proved that the client used a rate which was favourable to HMRC, the balance is irrecoverable.

In my experience it has always cut both ways, where a percentage change has been agreed I have never had HMRC try and back-date it, as it was a reasonable choice at the time, regardless of whether they owe or are owed money.

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By RedFive
09th Mar 2016 12:32

not always

Constantly Confused wrote:

bendybod wrote:

Interesting that they are keen to reclassify businesses and to get tax out of it but when it can be proved that the client used a rate which was favourable to HMRC, the balance is irrecoverable.

In my experience it has always cut both ways, where a percentage change has been agreed I have never had HMRC try and back-date it, as it was a reasonable choice at the time, regardless of whether they owe or are owed money.

If you read the excellent article (which is exactly relevant to my case, thank you michaelblake), then it list cases where they have gone for retrospective tax and penalties, including the Engineer case I quoted originally. 

The fact being HMRC eventually lost all the cases wouldn't help an unrepresented taxpayer who didn't have this sort of knowledge gained from our esteemed members of this parish and would probably cave when issued with the summons.

My clients are happy if proven wrong to go with IT going forward (I'm less so on principal, but not my choice) but would not accept a £10k bill with penalties. The help on here solidifies my original stance, so thanks again. Will keep you all updated.

Food for thought for others who just blindly pick a category though, no???!!!!

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08th Mar 2016 13:42

The moral of this story...

...is that the FRS is a mess. I agree with Roland that I know no clients who use this because it makes their bookkeeping easier but several because they make a profit out of it.

I don't know about others but I find it vaguely distasteful that a business using the FRS is making a profit out of tax which Joe Public are paying in the belief they are contributing to the NHS, nuclear weapons, free school dinners or whatever but not to lining Mr Entrepreneur's back pocket.

I also dislike having arguments with clients who want to use the any other category when they clearly, in my opinion, fall into a higher rate one. That said, I actually agree with the OP that IT consultancy doesn't seem the right category to me either. Which also makes the point that guidance which isn't definitive isn't worth the paper it's written on. If Customs want to make a case that the wrong category was chosen, the onus is on them to show that there was clear guidance out there at the time the decision was made which the client overlooked / chose to ignore. Otherwise, as an earlier poster has mentioned, the worst case scenario ought to be a change from this point forward only.

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09th Mar 2016 11:27

Clearly you see things differently but

adam.arca wrote:

...is that the FRS is a mess. I agree with Roland that I know no clients who use this because it makes their bookkeeping easier but several because they make a profit out of it.

I don't know about others but I find it vaguely distasteful that a business using the FRS is making a profit out of tax which Joe Public are paying in the belief they are contributing to the NHS, nuclear weapons, free school dinners or whatever but not to lining Mr Entrepreneur's back pocket.

Clearly you see things differently but when I have my consumer hat on rather than my accountant's hat I'm not interested in where the VAT element of my purchase goes or even if their is VAT on it. The price is what I pay for the item and if the whole lot goes to the shop or whoever or if 5, 10 or 16.67% of it goes to HMRC I honestly couldn't care less. If anything I'd rather as much as possible of what I'm handing over goes to the person I'm trading with.

There's enough taxes disproportionately hitting small businesses, let them have their £2k FRS saving.

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09th Mar 2016 12:05

Neil Warren's Article in Taxation Magazine 3 March 2016

There was a very useful article on the subject by Neil Warren's in Taxation Magazine on 3 March 2016

 

http://www.taxation.co.uk/taxation/Articles/2016/03/01/334425/enough-enough

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09th Mar 2016 12:34

FRS + CT

Hi,

Very interesting discussion.

When I had a similar issue I contacted the VAT helpline and their response was: "We cannot recommend or give guidance on the Trade Sector, you have to decide based on the Trade Sector tables and your main business activity"

As for making a profit from FRS, it is my understanding is that if you do make any profit from FRS then this has to be accounted for in your accounts for CT.

 

Regards

SteveB

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09th Mar 2016 12:38

Advertising

I have a client who undertakes a very similar business to RedFive's client.  My client discussed their activities with the VAT helpline and it was agreed that they could use the 11% Advertising trade sector.

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By RedFive
09th Mar 2016 12:44

Crazy system

The Naked Accountant wrote:

I have a client who undertakes a very similar business to RedFive's client.  My client discussed their activities with the VAT helpline and it was agreed that they could use the 11% Advertising trade sector.

As already mentioned, the way of deciding your percentage is crazy and needs to change - also inferred by that Taxation article. Or HMRC need to stop chasing for retrospective tax when businesses get it wrong. 

So all those web / graphic design clients realise they could have been on 11% instead of 14.5% and decide to sue their Accountants who advised them accordingly.....to quote another of this parish.........how do you like them apples Cheeky and Tim?

 

 

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By ShayaG
09th Mar 2016 13:36

FRS is begging for creative interpretations

And you'd be borderline negligent not to advise clients on the lowest reasonably argued band. That's me with my accountant's hat on.

With my taxpayer's hat on, it seems arbitrary and asking for abuse. I see benefits in terms of reduced computation for businesses, which I'd look to retain. IMO we should have a single band priced at the upper end of the current spectrum (say 15%). If the business owner think s/he should pay less, prove it:  put in the legwork and fill in a VAT return the normal way. And I'd reduce the threshold to £50k. If you can turn over more then that you are probably bright enough to fill in a VAT return.

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09th Mar 2016 13:57

KDT Tribunal case.
The IT Sector is inappropriate in the OP's case.

One can validly use [i] the Advertising or [ii] the "Other" Sector [the correct choice between those two Sectors [i] and [ii] IMHO depends upon the precise nature of the design work - the point does not really warrant excessive debate as the rates are similar, at 11% and 12% respectively].

For those members who have clients in website/graphic design, where the IT Sector has been previously used [I reaffirm incorrectly so, as previous posters have cogently explained] for FRS purposes, I recommend reading the recent KDT case.

http://www.bailii.org/uk/cases/UKFTT/TC/2015/TC04808.html.

The "Advertising" element of the case is in fact coincidental - the essence of the Tribunal decision is that if one can establish that the decision as to which Sector to use was unreasonable, then one can indeed claim for the over-declarations. This recourse might of course create a slight dilemma where the accountant has himself advised the client to use the IT Sector, ie his now recommending the client to claim the over-declaration could be construed as the accountant's having acted negligently in the first instance - but, tactfully dealt with, it should not normally be a problem.

Basil.

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By RedFive
09th Mar 2016 15:01

Diamond
Mr Basil you are a Man amongst men.

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By thomas
01st Apr 2016 12:54

RedFive -  have you had a

RedFive -  have you had a reply from HMRC re this case?  It would seem they have a particular interest in this area at the moment. 

 

 

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By RedFive
01st Apr 2016 13:14

nothing yet

No response from HMRC yet.

It could just be a coincidence but your case looks very similar to mine, so they could be on a hunt for perceived easy pickings.

I will update here when I have news.

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By thomas
02nd Apr 2016 13:37

Thank you, I have sent my response today so will update as well.

 

 

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By RedFive
11th Apr 2016 09:02

***Update***

Received from HMRC:-

..........

"We have now completed the check of your VAT returns for the periods 09/13 to 12/15.Thank you for your help during our check.

Conclusion

Our Check shows that there is no additional tax for you to pay, and no tax due back to you, for these periods.Our check is now complete..."

............

Thanks to all who contributed to this discussion and I hope it helps others in a similar situation.

 

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