Neil Warren explains why a company couldn’t leave the flat rate scheme retrospectively, having been caught out by a quirk in the capital expenditure rules.
I felt a great deal of sympathy for the taxpayer in the case of Apex Vehicle Management Ltd (TC06911). The company was caught out by a little-known quirk of the flat rate scheme (FRS), and once the directors realised this, they frantically tried to backpedal at a furious pace by asking HMRC to withdraw the company from the scheme retrospectively. Let me explain.
Here are two statements about the FRS and capital expenditure. Answer true or false to each of them based on what you think:
- A scheme user can claim input tax on all capital expenditure goods it buys, as long as the cost exceeds £2,000 including VAT. The exception is the purchase of a new car that is available for private use.
- If an asset has some private or exempt use, then an appropriate amount of input tax should be reduced to reflect this use.
The answer to both questions is false.
Input tax cannot be claimed on capital goods being leased, let or hired out. This is an exception to claiming input tax on ‘all capital expenditure goods’ costing more than £2,000 (VAT Notice 733, para 15.7).
Somewhat bizarrely, there is no need to adjust any claim for input VAT in respect of exempt or private use; you can claim 100% (VAT Notice 733, para 15.8).
This gives a bizarre disadvantage to some business models. Say the business rents out courtesy cars to customers following an accident (this was the main activity of Apex), it cannot claim any input tax on the vehicle purchases if it uses the FRS, even if the cars have 100% business use.
On the other hand, a builder on the FRS that buys equipment costing over £2000, which is used 50% for business and 50% private, can reclaim the whole of the input tax charged on that equipment.
Apex claimed input tax of £40,625 on 12 vehicle purchases on its June 2015 VAT return which HMRC rightly disallowed because the assets were being rented out. The company then said it should not have been allowed to join the FRS in the first place (on 1 March 2013), because its taxable sales were always expected to exceed the annual joining threshold of £150,000. It sought retrospective withdrawal back to this date and HMRC refused.
The case took on a farcical twist when the accountant produced 228 invoices supposedly issued between 2012 and 2014, with total sales in excess of £1.3m – ie well over the FRS joining threshold.
However, 152 of these invoices were unpaid, without any explanation for this situation. As the company used the cash basis of accounting for VAT, only the payments received, rather than the total value of the invoices raised, were relevant to the turnover test threshold of £150,000.
The total value of cash received was comfortably within the scheme parameters.
HMRC’s policy on retrospective withdrawal from the FRS is to only allow it if there are exceptional circumstances, usually linked to compassionate reasons or if the survival of the business is at stake.
It rejected Apex’s request for retrospective withdrawal from the FRS, only allowing it to withdraw from a current date.
Despite the confusion with the sales invoices, the taxpayer had a partial success but it is only likely to be short-term.
The tribunal was critical of HMRC for not asking more questions to check whether the taxpayer had been eligible to join in 2013.
The onus is back on the directors to clearly explain to HMRC why the company should not have joined back in 2013, and why so many of its sales invoices were unpaid. It will be difficult to do this but there is at least a window of opportunity.
The key lesson here is that the FRS cannot be underestimated. It is supposed to simplify VAT accounting but has various quirks that can prove costly if they are not fully understood.
You might think the FRS is a harmless domestic cat but at times it can frighten you like a Bengal tiger. Beware!
About Neil Warren
Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.