Most people associate VAT registration with an obligation rather than as something that could give an advantage. But there are two ways in which applying for VAT registration could be regarded as giving some kind of advantage:
- reducing risk; and
- obtaining a better fiscal outcome.
Risk mitigation
Nature of the risks
VAT registration rules set specific deadlines by which to apply, failing which there is a risk of penalties. In general, however, it is possible to apply for VAT registration sooner rather than later. Accordingly, being registered on what may appear to be the early side of what is required constitutes a risk mitigation strategy.
VAT Registration
It is often forgotten that the normal time limitation on HMRC for assessment (generally four years) only applies to an entity which is already registered for VAT. By contrast, where an entity is not registered for VAT, the time limitation extends to twenty years (VATA 1994, s. 77(4)). This, in turn, gives rise to the following risks:
The amount of the VAT applicable to supplies made over the full 20-year period (or even a substantial proportion of it) would be a figure that could easily bankrupt a business, and is particularly dangerous where the business format does not give rise to limited liability for the people who have operated the business (such as with sole proprietorships and traditional partnerships).
Over such a long period it is unlikely that it will be possible to amass sufficient evidence of VAT-bearing expenditure to offset a sufficient amount of input tax recovery against the sales made, such as to reduce the liability to what it would have been had the business been registered at the right time. (It should be noted, however, that HMRC have powers to estimate a more realistic input tax deduction, but it seems at least probable that that would undershoot what might have been available.)
A person may have decided to run the business on the basis that it was making a profit without having considered that, if accounting for VAT on that business, it would not have been making a profit. Had the business been registered for VAT at the right time, this might have led to a change of business model, to a decision to shut the business, or to diversification in order to create profit. What this means is that the business was prolonged beyond its useful life, or run in an unsatisfactory manner, under the illusion of making a profit. It is particularly unfortunate in a case where a person had decided to be an entrepreneur rather than an employee but could have made considerably more money as an employee without the attendant VAT risks.
There may have been some opportunity within the business model to charge VAT to parties that could reclaim it, but this would have been missed entirely unless either the records were exceptionally good, and thus former customers can be traced, and any of those customers have the ability to claim the VAT charged to them. In addition, given that there is a four-year cap on rectifying errors of claiming VAT, it is an interesting point as to whether the VAT charged on a supply that was more than four years old, by a belatedly VAT registered business, would be regarded by HMRC as recoverable by the customer business under the four-year rule.
A sad example
The saddest example of this happening relates to the first-tier tribunal decision in the case of Susan Evans.
Mrs Evans had operated a retail unit which was of marginal profitability, even leaving aside her failure to register for VAT. While some of her products were zero-rated, a number were standard rated. Neither she nor her accountant had spotted the possibility that she needed to register for VAT. At a very late stage (some ten years in) HMRC cross-referred to her self-assessment returns and made an enquiry. She was found to be registerable for a number of years. The liability was finally settled at around £10,000. For her, this was an enormous sum.
The case came forward on the basis of whether she should suffer a penalty on top of this, but clearly the tax alone was a crippling figure for a lady who was at that time in her seventies, and had almost nothing to live on by way of a pension, having had a less than lucrative commercial career. Whilst the tribunal decision could not, of course, go into the question of “what might have been” had she registered for VAT on time, there seems little doubt that she would have noticed that her small profits were in reality losses, and would have shut the business before she had accrued more liabilities. She might have sought employment, or a different business model, elsewhere. As it happened, however, it was not possible to rewrite history, and thus she owed the VAT (though thankfully the tribunal decided to strike out the penalties).
Furthermore, it was simply not possible for the tribunal to apply any concept of “reasonable excuse”, or compassionate grounds, to reduce the actual tax liability itself, despite the fact that the taxpayer may well not have incurred that level of tax had she been aware of the position at an early date.
This extremely sad case is a salutary lesson concerning the perils of not being registered for VAT.
There are three basic sources of fiscal advantage which ought to be considered when weighing up the pros and cons of VAT registration:
- That the customer, if it is a business which is making taxable supplies, can reclaim all or the majority of the VAT which may be added to the price, thus leaving the business in a position to reclaim input tax without a corresponding erosion of its revenue stream (all of which has to be checked with each customer).
- All or the majority of the supplies made by the business may be zero-rated (such as sales of printed material, certain kinds of food, new housing etc.) which will allow VAT to be claimed from HMRC, but with no corresponding output tax. This could even apply where the supplies are reduced-rated and thus the input tax is greater than the output tax for that reason.
- The business is structurally loss-making (such as is not uncommon with a charity) so that the VAT-bearing costs are higher than the VAT bearing income.
Clearly, these benefits have to be weighed up carefully, since not all businesses can reclaim VAT, and supplies that are zero-rated might revert to being subject to a positive rate of VAT in the future, or the business may change its products. However, given that this cannot really be avoided because, in most cases, the registration will be compulsory, this is not of itself a particular concern. Where registration is voluntary it may be possible to de-register from VAT voluntarily if the position becomes adverse.
It is also conceivable that an advantage will arise from the deployment of the partial exemption de minimis limits which will allow full VAT recovery even though a certain amount of exempt activity is undertaken.
General commercial advantages
Although deciding to register for VAT on a voluntary basis is not normally based on a purely commercial advantage, it is obvious that the fact that a business making taxable supplies on a certain scale must, by law, be registered for VAT, gives rise to a perception that a VAT registered a business has such scale. A customer will not know, for instance, that the business is voluntarily registered for VAT at an embryonic stage if it receives a VAT invoice. This, therefore, gives the impression of a more established business. It also wards off fears that the business has deliberately failed to account for VAT which is due, and even though this may well not be the case, that concern is allayed by actually charging VAT. It is not impossible that certain Potential customers would be unable to enter into a contract with a non-VAT registered company on the basis that it does not pass this rough and ready compliance test. It is likely that this kind of self-policed compliance approach will become more marked over time, thus giving small businesses an incentive for registering for VAT.
The obvious disadvantage
Obviously, there is a disadvantage to registering for VAT when one might not have to have done so. This is generally that VAT will be Imposed on an income stream without the ability of the customer to reclaim it (particularly in B2C sales, or where the business contracts heavily with exempt service providers such as those in finance, housing, education, and care). In that case, the input tax will generally be a lower value than the output tax, so a net loss has to be accepted by the business, or its charges become effectively uncompetitive.
Summary
Prom the standpoint of the professional adviser, registering clients promptly for VAT removes another item from the “to-do list” which could otherwise be overlooked with disastrous consequences.
Please contact our experts to discuss your situation and receive help and take the right decision.