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Sister company support causes VAT problem

Unpaid invoices raised between connected companies caused HMRC to challenge the VAT deductions, but the taxpayer won the argument.  

3rd Jul 2020
Independent VAT Consultant
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Invoice past due
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It is better to not have a VAT problem in the first place rather than create a problem which then needs sorting out later. That was my conclusion about the FTT case of The Premspec Group Ltd (TC07653) – despite the taxpayer’s win, there seemed to be a simpler way of doing things.

The issue was whether purchase invoices received from two sister companies were more than six months overdue for payment and input tax, therefore, needed to be reduced on Premspec’s VAT returns.

Six-month rule

Most businesses are aware that if they suffer a bad debt in respect of sales invoices which are more than six months overdue for payment, and they are written off in the sales ledger, then any output tax declared on an earlier VAT return can be reclaimed from HMRC as bad debt relief. But to ensure HMRC is not out of pocket, the customer must reduce input tax claimed on purchase invoices once they are six months overdue for payment, (VAT Notice 700/18: Relief from bad debts).

Example

John raised a sales invoice to Steve on 31 March 2020 on 30-day payment terms for £10,000 plus £2,000 VAT. Steve does not use the cash accounting scheme, so claimed input tax of £2,000 on his March VAT return. If Steve has not paid the invoice by 30 October 2020, he must reduce his input tax on the VAT return that includes this date, ie the quarter to 31 December 2020. He can reclaim it again if he pays John in the future.

If there is no payment date shown on the invoice, the invoice date becomes relevant as far as the six-month clock is concerned.

Trading facts

Premspec was formed in 2012 to distribute electrical goods to wholesalers. There were two other companies under the same ownership, which had a long trading history and therefore better cashflow. The issue was whether Premspec had to reduce its original input tax claim on purchase invoices received from the sister companies after July 2013, because they remained unpaid after six months.

The invoices were for various supplies of goods and services. The taxpayer argued that the invoices were payable within 10 years of the date when Premspec started trading, as agreed by all parties, ie payable by July 2023. This was the date for the six-month bad debt clock to start ticking.

Bad debt relief not claimed

The taxpayer emphasised that the sister companies had accounted for output tax on the sales in question and had not claimed bad debt relief, so HMRC was not out of pocket. HMRC’s view was that the ten-year agreement “never emerged in Premspec’s correspondence with HMRC” and the terms were “somewhat imprecise.” It decided that the ‘relevant date’ was the invoice date rather than any later date. The fact that the sister companies had not claimed bad debt relief was irrelevant.

FTT decision

Despite the lack of evidence concerning the supposed ten-year payment period, the tribunal allowed the appeal. The judge was satisfied that the ‘relevant date’ was “no later than around July 2023 – but that, of course, is not a precise date – and it could be sooner if Premspec so choose.”

Different approach?

The strategy of a new business being financially supported by longer-established associated companies is not new. I wonder why the sister companies did not just lend funds to Premspec to help its cashflow in the early days of trading. This would have provided Premspec with the necessary working capital to pay the supplier invoices straight away and VAT would not have been a problem. This seems an easier option to me.

Top tip

Trading or credit agreements between connected companies should always be properly documented in writing. The judge accepted the oral evidence of the directors but the agreement to postpone payment for ten-years seemed to be very vague.  

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