Neil Warren considers what VAT checks accountants should carry out when producing annual accounts for clients
First, the VAT creditor or debtor figure in the accounting records should always be reconciled to the VAT liability in box 5 on the VAT return which coincides with the end of the business’s financial year. This should be quite easy because most businesses have VAT periods that coincide with their accounting period year-end.
The next important check is to reconcile the turnover figure on the annual accounts to the outputs (and output tax) declared on monthly or quarterly VAT returns. Any differences should be discussed with clients to correct errors, see below why differences may occur.
This turnover check wasn’t done by the accountant of Wholesale Clearance UK Ltd (tax case TC5027), but it was subsequently carried out some years later by an HMRC compliance officer. The years concerned were those ending 31 July 2009 to 31 July 2011. A VAT assessment was raised for £27,768 because more sales were recorded in those accounts than on the VAT returns.
The VAT bill was subsequently reduced to £17,614 because only the final quarter of 2009 was within time under the four year assessment rule. The only time HMRC can assess VAT beyond four years is in cases of fraud, where the time limit increases to 20 years.
The accountant was not available to explain the differences to HMRC or the tribunal because of a ‘personal tragedy’. This shows that it is usually better to deal with differences when they arise rather than back pedalling many years later.
HMRC has the power to assess tax on unexplained turnover differences, under VATA 1994 s73(1). HMRC officers can take action to “assess the amount of VAT due…to the best of their judgment.”
What HMRC did
The HMRC officer did everything which was expected of him to produce a fair VAT assessment, which included:
- Recognising company had zero-rated sales, so no output tax was due on part of the difference.
- Giving the company the opportunity to explain the differences.
- Noticed that some VAT periods were out of time under the four-year assessment rule.
The VAT officer even considered whether the 2009 accounts had been made available to the officer on the previous compliance visit. If they had, this would have restricted his VAT assessment because an officer must assess tax no later than “two years after the end of the prescribed accounting period; or one year after evidence of facts, sufficient in the opinion of the Commissioners to justify the making of the assessment, comes to their knowledge” (VATA1994, s73(6)(b)).
If there are differences between the turnover reported in the annual accounts and that reported on the VAT returns - check for these circumstances.
Many small businesses with annual sales of £1.35m or less will complete VAT returns using the cash accounting scheme. This means that reconciliations between turnover and outputs will need to adjust for debtors (VAT Notice 731, para 2.1).
Work in progress
This will be included in the accounts, but not on VAT returns until a tax point is created, usually at the conclusion of a job.
It is possible that a business might receive a large advance payment from a customer (non-refundable) which will be an output on the VAT returns (tax point) but will not be included as turnover in the accounts until the work is carried out. So an excess of outputs in one year compared to accounts turnover could produce an outputs shortfall in the following year.