The fallout from the coronavirus crisis means that now is a good time to check if your clients are overcharging VAT to customers on some sources of income. How can you identify potential savings and what can you do about errors made on past returns?

Check ratings

When the economy has been buoyant your clients may not have given too much thought to charging 20% VAT to their customers on all supplies, even though some activities might qualify for zero-rating.

Pro advice. Identifying potential zero-ratings would produce a saving for any customer unable to claim input tax and also give you the opportunity to possibly increase your selling prices due to the VAT saving.

Adopt a three-step strategy to this added-value exercise.

Review. Check over the list of categories in Groups 1-18 in Schedule 8 to VAT Act (VATA) 1994. Consider which of your clients might be interested in more details about the different groups based on your knowledge of their activities.

Identify. Find the relevant HMRC Public Notice that relates to the group in which you are interested. This can be easily done online, e.g. searching for “VAT notice construction industry” will take you to VATNotice 708 .

Forward. Send the notice link to your clients and ask them to consider whether any of their supplies might qualify for zero-rating.

Pro advice. If you or your clients need further information or detail on a VAT issue you can refer to the relevant HMRC VAT manual on the subject in question. Again, these links can be found by using a search engine, e.g. type in “HMRC VAT manual take-away food” and it will take you to the VFOOD manual.

Example. John sells clothes on a market stall and is registered for VAT. He has never been completely sure about the rules for zero-rating on children’s clothes. He has therefore played safe and charged VAT at 20% on all sales, unless they are obviously zero-rated as clothes for babies or infants. He has scope to reduce his VAT bill on future sales by reviewing VAT Notice 714 and checking the parameters for zero-rating.

It is possible that John has overpaid output tax on past VAT returns. He can correct any errors for the last four years. Errors over four years old are out of time and cannot be adjusted. However, he will need to consider the rules of unjust enrichment (see Follow up ) before he makes a claim, i.e. would any VAT rebate belong to his customers who have paid the incorrectly charged VAT, or has he absorbed the VAT within his own selling prices so can keep the refund?

Exempt sale

You can repeat the three-step strategy above for looking at the list of business categories that can have exempt supplies, specifically looking at Groups 1-16 in Schedule 9 of VATA 1994.

Pro advice. Exemptions are not as good as zero-ratings because there is an input tax block on related costs, so it is not a complete win-win situation.

As a compliance issue, some of your clients might have charged VAT on exempt income in the past, thinking they can then claim input tax on related costs. This is incorrect. The input tax block still applies because the supply is still exempt from VAT, and this cannot be changed by incorrectly charging 20% VAT.

Example. Marie owns the freehold of a property that consists of a ground floor shop and first floor flat, which she rents out to different tenants. She has opted to tax the property.

The option to tax is always overridden for residential parts of a building, meaning that the rental income from the first floor flat is exempt from VAT. If Marie has incorrectly charged 20% VAT to the tenant, she should do two things:

  • refund the VAT to her tenant(s) for the last four years, i.e. the error correction period mentioned above
  • review her input tax for the last four years and apply the rules of partial exemption. For example, if she paid a plumber to install a new bathroom in the flat, this expense directly relates to exempt income and is input tax blocked. She would also need to apply a partial block on costs relevant to the whole building, e.g. a new roof. If the net error figure is less than £10,000 as a result of the two adjustments, Marie can include the under or overpayment on her next VAT return. Otherwise, she must disclose the error to HMRC, usually on FormVAT652.

Pro advice. If the figures are kind for Marie, she might still be able to claim all input tax on the flat costs by applying the partial exemption de minimis limits.

Reduced rate sales

To complete the loop, are any of your clients involved with businesses where the 5% rate of VAT might be in point? These supplies are detailed in Groups 1-13 in Schedule 7A to VATA 1994.

Pro advice. To give a practical example, we recently learned of a retailer who did not realise that smoking cessation products were subject to 5% VAT. This rate was introduced in 2007 to encourage people to give up smoking.

The most common area where the 5% rate applies is for construction services. There are three main windows where your builder clients can charge 5% VAT rather than 20% if they work on dwellings:

Residential conversions. Converting a non-residential building into a dwelling, for example an office block is converted into apartments.

Empty properties. Work is carried out on a dwelling that has been empty (not lived in) for at least two years. However, make sure that your clients get third party evidence from the property owner about the empty period, e.g. council tax records.

Changing number of dwellings. This can be an increase or decrease in number. For example, the 5% rate applies to building work for converting two semi-detached houses into one detached house or vice versa. It is the change in number that counts.

Pro advice 1. If builder services qualify for 0% or 5% VAT, then the same rate extends to building materials supplied by builders as part of their work. This is a big VAT saving compared to buying materials from a merchant or supplier where 20% VAT is always charged.

Pro advice 2. Before agreeing to charge the lower VAT rate, your builder clients should ensure that the converted properties they are working on meet all of the conditions of a dwelling.

Coronavirus grants

Finally, some of your clients might be entitled to receive (if they haven’t already) a grant from local authorities or other organisations to cover the loss of trading income as a result of the coronavirus crisis. This has been happening in the hospitality industry, e.g. for many holiday cottages. The good news is that the grant will not be subject to VAT because it does not relate to any specific supply of goods or services. It is outside the scope of VAT and the income is excluded from your clients’ VAT returns. However, some grants received by your clients might be subject to VAT, if the grant results in them having to perform specific services in return.

Example. ABC Good Causes is a registered charity and receives an annual grant of £12,000 from the local council to help with its overheads. However, a condition of the grant is that the charity must open and close the public toilets next to its office each day. It must also check for and report details of any damage or repairs to the council. HMRC will argue that this grant is for standard-rated services. It makes sense for the charity to invoice the council for £12,000 plus VAT. The council should be able to recover this VAT on its own VAT return.

Pro advice. A final area you should look at is whether clients are correctly applying the rules in respect of non-refundable deposits. We covered this in yr.5, iss.10, pg.10 (see Follow up ).

Review the legislation for potential supplies that could be either zero-rated or exempt from VAT. Don’t forget that many supplies also qualify for a reduced rate of 5%, especially for builder clients. Errors can be adjusted going back four years but you will need to apply the test for unjust enrichment before any refund is claimed.

The next step

Schedule 7A to VATA 1994
Schedule 9 to VATA 1994
Guidance on unjust enrichment
Schedule 8 to VATA 1994

This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit or call 01233 653500.