Indirect Tax series
This two part article is going to illustrate how accountants have shifted into strategic consultancy by contextualising VAT schemes in a role play.
This role play is between a forward thinking accounting technician and a client whose business turnover is likely to reach the registration threshold in the next quarter.
Accountant: As you know I’ve been monitoring your taxable turnover for a while now and it looks like you will be required to register for VAT in a couple of months’ time. I thought it would be a good idea to have a quick chat about what your options are at this stage so that you have plenty of time to decide which scheme is the best for your business.
Client: Yes that’s great. Isn’t it a case of just registering? I didn’t realise there were any options. What choices do I have?
Accountant: There are a number of special schemes that are designed to help small to medium size organisations, as they can be disadvantaged if VAT is collected in the normal way. Your business would be able to utilise one or maybe two of these schemes if you wanted.
Client: That sounds interesting. I thought I would have to complete a VAT return every three months, so four times a year, and pay HMRC the VAT due. Have I got that wrong?
Accountant: No, not at all. Fundamentally, that’s how it works. Once the business is registered, you’ll have to charge VAT on sales and that money is owed to HMRC. However, the VAT that you pay on expenditure will become reclaimable.
Client: Right, so what difference do the schemes make?
Accountant: The standard scheme is based on invoice dates, specifically the tax points. This is date of supply and is relevant to you as the majority of your customers pay on 30 day terms. This means that if you were on the standard scheme you would have to pay HMRC the VAT due on sale invoices that you have raised within the VAT period but that customers haven’t settled.
Client: Let me get this right. I sent an invoice for £5,000 to a customer yesterday and I’m already a bit concerned about it as they’re slow payers. If we were on the standard scheme now, I would of invoiced an additional £1,000 VAT and might have to pay that to HMRC before I get it myself?
Accountant: Yes that’s right. If this was the last month in the VAT quarter then the VAT would be due to HMRC before the invoice is due to be settled by the customer, even if they pay on time. Another important thing to be aware of is that if any of your customers don’t pay and the debts are written off, the VAT is reclaimable but only after six months. The good news is that expenditure is treated in the same way so you’re able to offset VAT due on purchases that you have yet paid for.
Client: That would be a real headache for me. Cashflow is tricky at the best of times so I can do without money going out before I’ve even got it.
Accountant: Absolutely and it’s why I wouldn’t recommend the standard scheme for you. Let me tell you about the cash accounting scheme, which, based on your turnover, cashflow challenges and customer payment profiles, I think could be a good option to consider.
Accountant: Well, this scheme would allow you to account for the VAT based on payment and receipt dates. In other words, the dates of transactions in and out of the bank account as opposed to the tax point dates on invoices. This means that you don’t owe HMRC any VAT until you have received it from your customers and if for any reason they don’t pay, you get what’s called automatic bad debt relief.
Client: Because the VAT has never been paid you mean?
Accountant: Yes that’s it. When I analyse your accounts I can see that you generally pay your suppliers promptly but that a number of your customers are regularly late to settle their accounts and a couple were written off last year. So, whilst the cash accounting scheme wouldn’t improve your cashflow situation as such, it will help in comparison to the impact that the standard scheme would have.
Client: Alright I can see the advantages. What are the downsides?
Accountant: Not that many for you really. Because the business only makes standard rated supplies it’s likely to owe HMRC at the end of most quarters. If you could regularly reclaim more than your owe, you would generally receive the repayments more quickly under the standard scheme. However, that doesn’t apply and because the business is established, there are no significant start-up expenses so not being able to reclaim VAT until you’ve paid for that expenditure, isn’t an issue either.
The only potential disadvantage is not being able to reclaim VAT paid on regular purchases until you’ve paid for them. However, there’s no issue with your cash purchases and the impact of paying credit suppliers can minimised with a bit of planning before the end of each quarter.
In an advisory role you’re likely to refer the client to further information. However, if you’re currently studying for an assessment, my advice is to double check the facts about the standard and cash accounting schemes in the AAT’s reference material .
Read part two now, where we re-join the conversation about the annual and flat rate schemes.
Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.