Taxman isn't keen on all forms of retrospection

Advisors to contractors and other small company owners are right to recommend their clients consider the potential saving from using the VAT Flat Rate scheme. But as a recent judgement from a tax tribunal shows, the key word in the above is ‘potential,’ not least because there’s even the potential that ‘going flat’ will leave you, the contractor, worse off, writes Richard Bayliss, managing director of specialist contractor accountants the Low Tax Group.

VAT: Flat Rate Accounting – some background

The purpose of the VAT Flat Rate scheme (FRS) is to simplify the way a business accounts for VAT and, in doing so, reduces the administration costs of complying with VAT legislation.

However, businesses often make decisions based purely on cash flow considerations. Consequently, those that sign up for the Flat Rate Scheme do so in order to save money. The scheme is especially useful for businesses with minimal VAT on business expenses to reclaim.

The case

In court, Judge Kenneth Mure QC heard an appeal against the taxman’s decision not to allow a limited company owner to withdraw from the FRS from a date prior to the date of his withdrawal request. Going before the First-Tier Tribunal, the appellant - David Yeabsley, confirmed he joined the FRS with effect from June 1^st 2007.

Following receipt of a letter from HM Revenue & Customs in 2011, the taxpayer received an assessment for VAT underpaid. The accuracy of the underlying calculations was not disputed by Mr Yeabsley.

However the taxpayer applied in July 2011 to withdraw from the FRS retrospectively and if possible from the date he joined the scheme.

HMRC refused the taxpayer’s application to withdraw from the scheme retrospectively (even though HMRC was quite happy to allow Mr Yeabsley’s entry to the FRS retrospectively).

Problematically for the limited company owner, HMRC’s stated policy is that a retrospective application to FRS should only be allowed in “exceptional circumstances.” Merely showing the FRS to be financially disadvantageous, as Mr Yeabsley did with his business, isn’t sufficient. Enforcing this point, HMRC made clear that the FRS’s purpose was to simplify administration for the taxpayer, not to hand him a financial benefit.

What the tribunal said

Unfortunately for the taxpayer, Judge Mure agreed with HMRC that the circumstances at hand – that the limited company owner paid more tax under the FRS than he would have under the normal VAT arrangement, were not exceptional.

The judge offered a degree of sympathy to Mr Yeabsley but maintained: “While it [the FRS] had proved financially disadvantageous, the Appellant has had the benefit of simplified administration, which was the purpose of the Scheme. There is nothing before us to suggest that the Appellant company was treated in a discriminatory or unfair way by HMRC.”

Moreover, it was the taxpayer’s “responsibility to access the full financial and other implications of joining the FRS.” It was also Mr Yeabsley’s responsibility, adds the judgement, to correctly complete his company’s VAT Returns which, had he filled in accurately, “he would have discovered the financial disadvantage” of the scheme to his business.

What the case means for contractors

By refusing the appeal, the judge’s decision serves as a reminder that joining the FRS can result in taxpayers having to pay more tax than they would otherwise have paid under the normal accounting rules. VAT-registered contractors must therefore precisely establish the pluses (and minuses) of the FRS well in advance of joining it, bearing in mind that any withdrawal from it must be timely and NOT put forward on the sole basis that it leaves them worse off.