Contractors' Questions: How to pay VAT if I'm unpaid?

Contractor’s Question: After being made redundant a few months back I set up a company to work as a software contractor for a company run by a former colleague. Although the contract started in August, I went without earning a single penny until the end of October, when he terminated the contract, adhering to the due notice of 24 hours.

He claims he will pay me soon, so I have kept my company going but I am doubtful that his company has any assets worth suing him for. Problematically, I have received a VAT demand from HM Revenue & Customs. It states an estimate, because I didn’t submit a VAT return, that I owe £150.

In the event that I am never paid, will I be able to claim back the VAT I’m being asked for by HMRC? Surely I would only be liable for the VAT on invoices that were paid, not every one I issued? Any guidance would be appreciated.

Expert’s Answer: It sounds as though you have registered the company for VAT, but have yet to prepare and submit your most recent VAT return, resulting in HMRC issuing you with an estimated VAT assessment. It is imperative that you complete and file your outstanding VAT return.

You could have applied to use the cash accounting scheme, assuming that your annual turnover is less than £1,350,000 but one of the conditions is that your VAT returns are filed and any liabilities settled on time. If you are permitted to use the cash accounting scheme, you do not have to account for VAT until the services have been paid for, and you do not get credit for input VAT on costs until you pay your suppliers.

Clearly this is advantageous if you have not been paid some of your fee accounts because you get immediate bad debt relief.

If you are not in the cash accounting scheme, you can claim back the VAT on the sales debtors that have not paid once the debts are six months old.

Another reason for bringing your VAT returns up to date is that if in the future you file a VAT return with a refund due to the company, it is quite likely that you will not receive the refund from HMRC because there is a quarter with a missing return. It might be worth speaking to HMRC to see if they will let you use cash accounting if you file the missing return and settle any liability.

If the company does not have sufficient cash to settle the VAT liability you can make a loan to the company to enable it to settle the debt and the loan can be repaid when the company has sufficient funds.

The expert was Adrian Houstoun, VAT partner at Kingston Smith LLP.

Friday 10th Dec 2010