Given the increased interest in tax activities in the legal sector, Martin Ramsey, Partner at MHA MacIntyre Hudson, believes firms must review their VAT affairs now, rather than bury their heads in the sand and wait for inspectors to come knocking.
HMRC’s spotlight on the legal sector has resulted in several high profile legislative changes, including new rules on the use of corporates (mixed partnerships) and alterations to transfer pricing rules applied to service companies. Professional practices remain firmly in HMRC’s sights, with VAT on the hit list following the 2017 Brabners Solicitors case, where the firm faced a £68,000 bill after a tribunal ruled electronic property search fees shouldn’t be treated as expenses.
Firms can’t bury their heads in the sand – they must review their VAT affairs. Proactive reviews of compliance in several key areas of VAT legislation will put firms in a better position should HMRC chose to visit. A VAT inspection can be stressful and time consuming. Preparing in advance not only increases the likelihood that an inspector will find a firm compliant, it also reduces the impact on the finance team, and the chances of an unexpected cash outflow.
Target VAT areas include:
VAT on search fees
It’s common practice for search fees to be treated as a disbursement. HMRC contends that, as lawyers utilise this information and include it in their advice, the cost should be included within the supply of services and subject to VAT.
As HMRC visit firms, it’s quantifying the amount of under-declared VAT and demanding firms pay up. However, it’s noting that if the appeal against the Brabners decision is successful, the amounts will be refunded. Firms subject to such assessments will need to protect their position by formally appealing.
Firms should undertake a historic review to identify the scale of this potential issue. Although this may involve an arduous interrogation of thousands of lines of data, this could be trickier to undertake ‘on the hoof’ during an inspection. To avoid penalties, a carefully worded disclosure should be made to HMRC which protects their position in the event that Brabners successfully overturn HMRC’s assessment on appeal.
VAT recovered on bad debts
HMRC is examining the process adopted by firms closely. The key principle of the current rules (as set out in VAT notice 700/18) is that a firm must wait at least six months from the later of when payment was due and payable or the date of supply, before reclaiming any VAT. HMRC conditions stipulate that before a reclaim is made, debts must have been written off from the firm’s day to day VAT accounts and transferred to a separate bad debt account. There’s often still confusion around the bad debt rules as they have changed many times. A hygiene check may prove valuable.
VAT on older unpaid creditors
The rules for unpaid purchase invoices (post 1997) require firms to repay the input tax that it has claimed if it does not pay for the supplies within six months of the relevant date. The relevant date is defined as the date of the supply, or if later, the due date for payment. If the amounts in question are subsequently paid then the input VAT can be accounted for again at that point.
While most professional practices don’t have significant purchase ledgers, it’s not unusual to have a number of older ‘in dispute’ invoices.
VAT on personal tax return fees
This is another commonly overlooked area. Partners’ personal tax return fees are not a business expense and VAT should not be reclaimed. Accountants must separately identify the costs relating to personal taxation from those relating to the business both from a VAT perspective and, more importantly, it’s a corporate criminal offence to ‘hide’ personal taxation fees within those of a business to gain a tax advantage.
VAT on gifts
Where business gifts are provided in the normal course of business and are less than £50 in value (in aggregate over a 12 month period to each individual), then no output VAT is normally due and the related input VAT may be reclaimed. Where a gift (or gifts) exceeds the £50 limit then the output VAT must be accounted for on the value of the gifts in question.
Act sooner rather than later
While some of these areas may not appear significant individually, the value of a VAT demand arising from an inspection can quickly accumulate if there are a number of failures. This is especially important due to the stringent penalties of up to 30% which HMRC can impose on ‘careless errors’. Being well prepared for a VAT visit, highly likely in the legal sector in 2018, is much better than being caught off guard when the day arrives.