VAT enquiry: what contractors can expect

With all attention firmly fixed on the ‘when not if’ question of private sector IR35 reform, it would be easy for contractors to take their eye off the VAT-man, writes Amanda Swales, director of Go Simple Software.

I’m talking about that VAT-man who last quarter was embarrassingly accused of being simply unable to say ‘yes you’re right,’. And it’s the very same VAT-man who an IR35 adviser recently described as ‘very active’ and, according to another tax firm, seamlessly segues into VAT probing once he gets up close with small companies.

Some might say that dealing with an active threat like this one is better time-spent than speculating about the ‘when’ moment of IR35 changing.

VAT: when it kicks in

Gaining VAT status is a key milestone of a successful business. Whatever stage you’re at as a non-umbrella contractor, you’ll end up collecting and paying VAT eventually once your profit exceeds £85,000 (as of 2018).

But the government won’t leave you to it. Sometimes, they will issue a VAT investigation, just as a matter of routine. This is to check whether you’re declaring the right amount, and if you owe any additional VAT on top of a potential fine, or a refund if you have paid too much.

Some of this will be familiar to readers of this ContractorUK VAT inspections article but, just as the author of that piece opened with ‘How VAT inspections have changed,’ the mere fact that the guidance within dates back to 2011 indicates change has indeed occurred again

An interview and an evidence request

For the above, VAT inspectors will contact you. Some recent wording the authorities use in their letters of approach has already been outlined by an adviser. Almost regardless, they'll state what's happening and arrange an interview time.

You’ll sit down together to pore over the facts. Or maybe 'you' -- personally, won't. In fact, this is because as a contractor you are likely to use the services of an accountant or professional tax adviser. So in the event of a VAT investigation (including an interview/evidence request) by HMRC, we would recommend you consult with them before responding to -- or meeting with -- HMRC. The typical course is that the contractor instructs their adviser to represent the contractor and deal with HMRC.

Either way, the inspector will ask about the business, and the ways in which client or customer payments are processed. At the end of the interview, HMRC will ask that data is gathered to prove the VAT history.

This will often include:

  • Bank statements
  • Documents related to the VAT account
  • The certificate of VAT registration
  • All sales and export invoices from the tax year

As a contractor, you are likely to be using the Flat Rate VAT scheme. In the event of an enquiry, you or your adviser will also need to show you are using the correct rate.

The enquiry VAT process  

Once they have everything, the inspector will spend a few hours – or a couple of days, depending on the scale of your business model – analysing their findings. What are they looking for? It’s simple: things that don’t add up in your books.

Funds in your bank, for instance, should match up with your earning declarations. Loans and cash injections may distort that view, but it’s a matter of telling the inspector and proving it. They’ll also want to examine any land purchases (not relevant for most contractors), goods and services for non-business use, any stolen/replaced items or stock, and how well you’ve paid VAT on the deadlines for any given financial period.

When they’re done, the inspector should issue a report detailing their conclusions. If you’re liable to pay more VAT, they should explain why, drawing on as much evidence as they can. The same is true of VAT you have overpaid -- however, this is less of a priority to HMRC, which is why you/your adviser should check the report.

HMRC’s VAT fines (and how to help head them off)

Penalties for a poor VAT assessment scale up, or down, with the severity of what’s been uncovered and whether it was admitted of your own volition. As the table below shows:

Reason Minimum penalty Maximum penalty
Careless (you didn't take due care of the process) 

0% unprompted

15% prompted

30% for unprompted and prompted
Deliberate (falsified documents) 

20% unprompted

35% prompted

70% for unprompted and prompted
Deliberate and concealed (falsifying documents and trying to hide the VAT inaccuracies) 

30% unprompted

50% prompted

100% for unprompted and prompted

So it depends whether you’re deemed to have hidden things on purpose, or merely been a victim of oversight. HMRC is usually honest in what they conclude, yet it’s still worth you challenging a decision believed to be unfair by going to an external source -- such as your adviser.

Final considerations

Being organised during a VAT enquiry is an asset if you want it to close quickly without cost. To that end, and to reduce the chance of a VAT investigation bringing up anything suspect altogether, consider calling on software. And by ‘external source’ – above – software is also what you should keep in mind to provide you with more certainty than a spreadsheet can offer.

Right now, in 2018, the best platforms in the contractor market not only quickly show you what your VAT and financial activity over the tax year actually looked like, but they also build your VAT demands over a shorter period, such as quarters, or even longer than the last year. This is ideal for the time-pressed contractor because every payment, record and transaction get saved, which can prove immeasurably helpful if a VAT inspector calls. Fortunately, unlike private sector IR35 reform, that is an ‘if’ not a ‘when,’ but complacency is unaffordable.

Wednesday 3rd Oct 2018
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Written by Simon Moore

Simon writes impartial news and engaging features for the contractor industry, covering, IR35, the loan charge and general tax and legislation.
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