The standard rate of VAT will increase on 4 January 2011, from 17.5% to 20%. This will be the third adjustment in the standard VAT rate in the last two years.
This rate change presents a number of challenges to clients, particularly as it occurs part way through the month. Here are some of the key issues:
The VAT fraction is used to calculate the VAT element of a price inclusive of VAT. For a 20% rate of tax, the relevant fraction is 1/6. So if you fill up your car with petrol costing £50, the amount of VAT you have paid after 3 January 2011 is £8.33, i.e. £50 x 1/6. The VAT fraction for the 17.5% rate is 7/47.
For clients who need to increase the price they charge for goods or services sold on a VAT-inclusive basis, the key fraction is 120/117.5 of the current selling price. So if an item sold before 4 January 2011 is priced at £11.75, the new price to ensure the VAT saving is fully passed on to customers is £11.75 x 120/117.5, i.e. £12.00.
It is important to remember that the price of zero-rated, reduced rate (5% VAT) or exempt items is unaffected by this VAT rise (e.g. food, books, newspapers). Only the price of standard rated items needs to be changed.
Deposits paid or invoices raised in advance
If a business wants to help its customers avoid the VAT rise it can raise invoices or ask for payment from customers before 4 January 2011, for goods or services supplied on or after that date. VAT on those invoices and prepayments should be correctly accounted for at 17.5%.
This is fine – but there are anti-avoidance rules to prevent clients using advance invoicing or prepayment where the customer cannot recover all the VAT charged, and any of the following apply:
Where the client is caught by this anti-avoidance rule, they will have to pay the additional 2.5% VAT on 4 January 2011.
Goods delivered early
Another way to help customers avoid the VAT rise is for clients to arrange for goods to be delivered to customers before 4 January 2011. Even if the invoice is raised on or after 4 January, and the payment received after that date, the correct rate of VAT to charge is 17.5%.
Work overlapping 4 January 2011
There is good news for customers of clients providing services (e.g. a builder) where the work is started before 4 January and finished after this date. In such cases, the client has a choice. They can keep life simple and charge VAT at the new rate of 20% when an invoice is raised or payment received at the end of the job. Alternatively, the client can split the invoice to apportion the work done on a time basis between, for example, December and January work. The work performed before 4 January 2011 will attract VAT at 17.5%, and the rest of the work will have VAT applied at 20%.
Credit notes raised on or after 4 January 2011
In cases where an invoice was raised before 4 January 2011 (charging 17.5% VAT) then any credit note subsequently raised against the invoice (e.g. to correct a pricing error or if some of the goods are returned) will be based on the percentage of VAT charged on the original invoice. So the credit note will refund VAT based on 17.5% even though it is being raised on or after 4 January. This may cause some software problems for clients using computerised systems – a manual credit note may be the best option.
Flat rate scheme
Many businesses with annual taxable sales of £150,000 or less adopt the flat rate scheme, i.e. where VAT is paid by applying a specific flat rate percentage to the gross sales made by the business. It important to apply the new flat rate relevant for the business sector to sales made on and after 4 January 2011. The positive news is that although the flat rates have been increased from 4 January to reflect the higher rate of VAT, there are no big adjustments for particular business sectors.
A full list of revised rates can be found on the HMRC website at www.hmrc.gov.uk/budget2010/bn45.pdf or by telephoning the VAT National Advice Service helpline on 0845-010-9000 (open Monday to Friday from 8am).
Road fuel scale charges
Many businesses reclaim input tax on the road fuel they purchase for cars and account for output tax using scale charges published by HMRC to reflect private use. New scale charge rates apply from 4 January 2011 – details are available in Appendix C of the VAT technical guide on the HMRC website at www.hmrc.gov.uk/vat/forms-rates/rates/rate-rise-guidance.pdf or from the National Advice Service helpline.
Fee bills and invoices
Many professional businesses will have raised ‘request for payment’ notes to clients in November or December 2010 in relation to work carried out on an ongoing basis. These documents are not tax invoices. For VAT purposes, this is known as a ‘continuous supply of services’ arrangement and VAT is payable according to the date when any tax invoice is raised or payment received from the customer, whichever happens first.
In the case of ‘request for payments’ notes raised in November or December 2010, these will have requested VAT to be paid at 17.5%. If these requests are paid on or after 4 January 2011, then VAT is actually due at 20%. To avoid this difficulty, the professional firm should raise a tax invoice before 4 January 2011 to fix the VAT charged on their services at 17.5%. Even if this invoice is paid later, the VAT is due at 17.5% not 20%, although the client should be aware of the anti-avoidance rules discussed above.
We would be pleased to provide help and advice on any issues your business is facing ahead of the VAT rate change.
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