VAT: Exempt is not the same as zero

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Neil Warren considers a case where the taxpayer wrongly thought his sales were exempt from VAT, and as a result was late registering for VAT. The purchase invoices should have provided the required information.

Background

Nathaniel Hendrickson (TC6005) was a retailer of motorbike clothing and helmets, who did not register for VAT because he wrongly thought his sales were exempt from VAT.

Motorbike helmets are zero-rated for VAT purposes as protective equipment, and rightly so. But jackets, trousers and other adult clothing items for motorcyclists are standard rated. They are not listed within VATA1994, Sch 8, Group 16 (Clothing and Footwear) as items that qualify for zero-rating.

The taxpayer’s turnover exceeded the VAT registration threshold on 30 September 2012 but he failed to register from 1 November 2012 on the basis that; “he had been assured by several people that motorcycle protective clothing was not subject to VAT”.

HMRC registered him for VAT for the period from 1 November 2012 to 30 September 2014, and issued him with a tax bill of £23,962, plus a 20% late registration penalty of £4,792. The latter is the minimum penalty for a prompted disclosure where the late registration period is more than 12 months.

Zero-rated versus exempt

To add confusion, the taxpayer referred (in his letters to HMRC and before the tribunal) to his sales as being ‘exempt’ from VAT rather than potentially ‘zero-rated’. This is an important point: exempt sales are ignored as far as the VAT registration threshold is concerned, but zero-rated sales are still classed as “taxable”. In effect, VAT is being charged on a zero-rated sale, but at a rate of 0%.

Even if motorbike clothing was zero-rated (which it is not), the taxpayer would still have been required to register for VAT on 1 November 2012, but he could have asked HMRC for an exemption.

Example

Marie is a sole trader who only sells children’s clothing (ie zero-rated for VAT purposes). She exceeded the VAT registration threshold on 31 March 2017 so is liable to register on 1 May 2017.

However, her business has very few expenses where input tax could be claimed so she has asked HMRC for an exemption from registering on the basis that all of her VAT returns will show repayments due, and therefore no VAT will be payable to HMRC.

Her request is likely to be granted, but she must review the position regularly. For example, if she suddenly started trading in adult clothing or other standard-rated items, the VAT repayment outcome might change and the exemption would no longer apply (HMRC Notice 700/1, para 3.11).

Purchase invoices

One confusing issue around the Hendrickson case was why he did not review his purchase invoices from suppliers to see if they were charging him VAT on his stock. The answer would have almost certainly been “yes”, and this would have alerted him to a potential VAT registration problem.

He should have realised that the onward sales of these goods would also be standard-rated rather than exempt or zero-rated. But according to the tribunal report, he “only took informal advice from a supplier and business acquaintance.”

However, it is not wise to only rely on supplier invoices for information about the correct VAT rate to charge. What happens if the supplier has misunderstood the VAT liability rules?

Each business is responsible for determining the VAT liability of its sales and this responsibility can’t be delegated by relying on information or advice from another person. But purchase invoices from well-established suppliers would certainly be a good starting point to check the position.

Learning points

There are a number of important lessons from this case:

  • Ignorance of the law is not a reasonable excuse for getting VAT wrong.
  • Reliance on another person for advice and information is also flawed, even though the person in question might be knowledgeable about the subject in question.
  • When it comes to late VAT registration, HMRC has the power to go back up to 20 years and correct the registration. If the lateness exceeds 12 months, then it will almost certainly be subject to a penalty based on the tax payable for the late period.

About Neil Warren

Neil Warren

Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.

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07th Aug 2017 10:23

You can't rely on purchase invoices as a source of whether you should be VAT Registered. It is wholly based on total taxable sales exceeding the threshold. Taxable sales include standard rated and zero rated sales, but not exempt sales. There are numerous examples of exempt purchases being subject to VAT when included as part of an onward sale.

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