Neil Warren warns that the VAT annual accounting scheme has many potential pitfalls, as clearly is illustrated by the case of Curtises Ltd.
To understand the background to this case (TC06460), a timeline of events is useful.
The business uses the VAT annual accounting scheme and its year ends on 31 December. It was required to submit its December 2016 return by 28 February 2017. Note that the annual VAT scheme users get an extra month to complete a return compared to a business submitting monthly or quarterly returns (VAT Notice 732, para 1.4).
The company failed to submit the VAT return by the due date, so HMRC estimated the liability and issued a central assessment for £35,578 on 17 March 2017. The company had already paid £32,499 on account during the year (payments on account are a condition of the annual scheme), but it made an additional payment of £46,131 on 5 April 2017 as well.
HMRC wrote to the company on 18 May asking for the VAT return to be submitted, which eventually happened on 7 June. But the amount owed on the return was actually £215,233.43. HMRC had greatly underestimated the liability for the period when it raised its estimated assessment for £35,578.
If a business accepts a central assessment which is too low, then it is subject to a potential penalty (FA 2007, Sch 24, para 2). The business owner has 30 days from the receipt of the assessment to “take reasonable steps” to notify HMRC that there is a problem. The penalty is based on the ‘potential lost revenue (PLR)’, which is the difference between the assessed amount and the true liability for the period. In this situation, HMRC correctly treated the situation as a ‘prompted disclosure’ and issued a penalty for 15% of the PLR, which is the minimum penalty which can be applied:
£215,233 - £35,578 = £179,655 x 15% = £26,948.25.
After reading the above facts, you may conclude that the taxpayer had no chance of overturning the penalty, and you would be right!
HMRC applied the penalty rules correctly. The penalty system is there to act as a disincentive to a company that accepts a low assessment when it has a higher liability for a period.
The taxpayer’s argument was weak: the director highlighted the company’s general good compliance for its tax matters and the fact that the outstanding VAT liability was fully paid when the return was submitted. He agreed that the company was “struggling to cope with the growth in its business.” The judge agreed that “a penalty of this magnitude for what is ultimately a fairly minor mistake does appear a little harsh” but the law had to be applied, and the appeal was dismissed.
Annual accounting pitfalls
I have never been a big fan of the annual accounting scheme and I haven’t recommended it to any of my private clients. I like the discipline of a client completing quarterly (or monthly) returns to ensure that his record keeping is up to date. Quarterly payments also mean that his cash flow is easier because he is paying his actual dues on a regular basis.
I can see how the Curtises problem arose: the company’s annual turnover increased from £700k in 2015 to £2.75m in 2016, so the final VAT liability on its 2016 annual VAT return was always likely to be higher than both the directors and HMRC were expecting.
This is another potential pitfall of the scheme, namely that the payments on account during the course of the year will often be too low for a growing business, leaving a big balancing payment when the return is submitted.
The message is simple: beware of the annual accounting scheme!
About Neil Warren
Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.