Contractor guide to VAT inspection 1) what to expect and when
VAT inspections are not what they used to be, writes Karen Mulcahy, a consultant at the VAT Consultancy, who has more than 20 years’ professional experience in VAT.
How VAT inspections changed
In my days with the department (HM Customs & Excise), every business would receive an initial VAT inspection during the twelve months following VAT registration. The main purpose was to identify any significant ‘howlers’, ensure that the business understood its obligations, and often involved issuing public notices. Sometime later these ‘educational visits’ were replaced by New Trader Seminars. This meant that valuable visiting resources could be targeted to larger and more complex businesses.
Sharper focus on VAT compliance
This targeted approach to VAT inspections has become ever more refined over the years, with visits allocated by point scores, i.e. the larger and more complex the business, the greater the likelihood of regular VAT inspections.
The largest businesses are ‘managed’ by HM Revenue & Customs’ Large Business Service, which tend to develop good relationships with the businesses and are often able to deal with issues before they become problems, albeit that when issues arise they tend to be big in nature.
For a smaller business, there is a chance that it may never receive a VAT inspection. While this may seem like a significant benefit, it also means that such businesses do not have the opportunity for a one-to-one on the effectiveness and / or correctness of its accounting processes for VAT purposes.
For example, many IT contractors will be entitled to use the Flat Rate Scheme, Cash Accounting and / or Annual Accounting, but may be unlikely to know of these schemes if their accountants have not introduced them. They may also be missing out on claiming VAT for certain expenses if the rules for recovery are not fully understood, or if they do not understand the recently revised place of supply rules for services.
Nevertheless, HMRC has an alternative to full VAT inspections – the desk audit. This involves reviewing the complexity and compliance history of a ‘ripe’ business by reference to the VAT returns submitted, as well as any correspondence, such as voluntary disclosures. [A ‘ripe’ business is one that has collected enough ‘points’ to be picked for an inspection or review.] If everything looks to be in order, the file will be returned to storage until it gathers enough points for another review –whenever that may be! Where VAT return declarations, previous assessments or correspondence indicate a problem, HMRC may issue an audit questionnaire.
The questionnaire that can lead to an inspection
The desk audit questionnaire will generally include several generic questions as well as some specific to the business, as well as a request that certain documents, such as annual accounts, are made available to the VAT officer for inspection. Where sufficient concern is aroused, HMRC will contact the business for an on-site inspection – the old fashioned way.
What’s the point of a VAT probe?
For HMRC, the purpose of a VAT review or inspection is to ensure compliance (or continued compliance) and identify errors for assessment, plus interest and penalty as applicable. Penalties may be subject to mitigation (or suspension) but any error and relevant interest will be additional costs to the business, which the business may not be able to recover from its customers.
What contractors should expect from HMRC
During an on-site inspection, businesses should expect the tax official to inspect the premises – not a great issue for most IT contractors (although you may ask that the visit be carried out at your accountant’s premises).
The officer will want to make a detailed review of VAT records. This could include for example:
- A review of annual accounts
- Bank statement – for reconciliation
- Evidence to support VAT recovery claims
- Evidence to support sales with no VAT, such as documents supporting where the work was done or where the customer belongs
- Evidence of export or dispatch of goods from the UK
- Fuel scale charges for cars and other private use charges
- Accuracy of EC Sales Lists and Intrastat declarations (where applicable)
- Any other documents which support the VAT treatment applied, such as contracts and / or correspondence.
What contractors should beware
It is worth bearing in mind that HMRC is not keen on surprises, therefore, it is often considered better to notify HMRC of any errors or uncertainties in order that corrective action can be taken. Yet, as above, the more correspondence with HMRC the higher the point score which may lead to an inspection.
It is now nearly six years since HM Customs and Excise and the Inland Revenue merged, and while the two legacy departments are not fully entwined there is a single song-sheet and common aims. For example, the department has, for many years, been able to use information submitted under the direct tax regime to identify businesses trading above the VAT registration threshold which appear not to be registered for VAT. This is then followed up with a letter asking for an explanation, or a belated notification to register.
No room for error, or complacency
VAT is a complex business, and businesses are encouraged to take professional advice, from accountants or specialist VAT advisors in order to understand the consequence of any errors or oversights. The absence of a VAT inspection does not mean that all is well!
Editor’s Note: This is Part One of a CUK series on VAT inspections, offering IT contractors the inside track on VAT reviews and inspections from the UK’s leading independent VAT practice, The VAT Consultancy. Part two, How to prepare for a VAT inspection, will follow.