Study tips: Indirect tax

It was the end of the VAT quarter for a client of mine recently, so I have been updating the accounting records in preparation for submitting the VAT return. 

As I left the director asked me, as he does every quarter, when the return needs to be submitted and the payment made.  Driving home I found myself thinking about the need all VAT register businesses have to produce accurate returns and submit them in a timely manner.

In reality, preparation for VAT returns happens daily as accurate bookkeeping will result in accurate returns.  Accounting software produces a VAT return with a few clicks of a mouse but the content of the boxes will only be correct if calculations and the accounting treatment of transactions were right when they were performed and processed.  My client has a fantastic administrator who does most of the routine bookkeeping but does not have an accounting background and understandably makes the occasional mistake.  These are usually minor and easy to correct but have the potential to result in an inaccurate VAT return.

Gross and Net

Recognising the difference between VAT-inclusive (Gross) and VAT-exclusive (Net) figures is crucial.  This is because the VAT is calculated differently for each and you will end up with significantly different figures if you mix them up.  For example, the VAT in relation to a sale of £6,000 could be £1,000 if it is a gross figure but it would be £1,200 if it is a net figure.

We’ve looked at how to calculate VAT in a previous article but it is worth mentioning here as often it is just a case of taking the time to read the invoice properly to see which figure is being used; most invoices will show both.  Therefore, any issues could be related to the option you select in your accounting software.  My client’s software is set up to process supplier invoices as VAT-inclusive so that the total figure is entered and the VAT figure is then automatically extracted.  However, the sales invoices are generated by entering VAT-exclusive figures and the software adds the VAT on to arrive at the correct invoice total.  Both ways are fine.  The point is that you simply need to ensure that the setting you select matches the VAT status of the figure you are processing.

Bank payment and receipts

When it comes to payments and receipts though these will, by default, be gross figures.  This is because the amounts that are paid to suppliers will be the total amount due, which have to include the VAT, unless you want lots of phone calls from unhappy suppliers!  Equally, I would be making lots of calls to customers, if the monies received in full settlement of sales invoices only covered the net amount and didn’t include the VAT.

Returns and credit notes

Whilst I was reconciling the bank payments and receipts, I came across a payment to a supplier that didn’t match the amount showing as outstanding in the accounting records.  I went back through the records and discovered that a credit note had been processed as an invoice.  As the only difference on the supplier’s paperwork between an invoice and credit note is the wording, it is easily done, however, the implications for the VAT return are significant.  Input tax is recovered in box 4 and is the VAT that has been paid on purchases less any VAT refunded, so to speak, on credit notes.  In this case, the original invoice was for £1,500 plus VAT and the credit note was for £500 plus VAT.  So the correct figures should be:

Box 4 = £200 (£300 from the invoice less £100 from the credit note)

By processing the credit note as an invoice not only would the VAT have been reclaimed in error, the error would in fact have been doubled as a credit note should reduce input tax:

Box 4 = £400 (£300 from the invoice plus £100 from the credit note as it was treated as an invoice)

This example effected the purchase ledger, however, the same issue is found with sales returns and would affect the box 1 figure.

Rounding

My client’s business is predominately in the service sector but it also has a small retail outlet as well.  This complicates matters when it comes to rounding calculations for VAT purposes.   The business must be compliant with VAT Notice 700*, which states:

17.5 Calculation of VAT on invoice – rounding of amounts

You may round the total VAT payable on all goods and services shown on a VAT invoice to a whole penny.  You can ignore any faction of a penny.

This section applies to the service invoices it generates and is the general rule most of us understand in terms of being able to round VAT down.  However, section 17.5 also says that this concession isn’t appropriate to retailers.  So, any invoices generated by the retail outlet must adhere to:

17.6 Calculation of VAT at retailers

If you calculate VAT at line level or invoice level, you must not round the VAT figure down.  But, you may round (up and down) each VAT calculation.

In effect, this means that the VAT needs to be rounded numerically.

Submission dates

Generally speaking, VAT liabilities can be monitored throughout the quarter and business owners can be kept informed of the likely position at the end of the period, so there are no unpleasant surprises.  Again, this is reliant on timely and accurate bookkeeping but cloud-based software has improved the ability of bookkeepers to provide useful information in real time.  What hasn’t changed is HMRC’s deadlines for submission and payment.  Information about them can be found on the VAT return or on HMRC’s website but in general they are:

  • Normal due date and electronic payment:
    • One calendar month after the end of the VAT period, unless using the annual accounting scheme.
  • Online filing and electronic payment:
    • One calendar month plus seven calendar days after the end of the VAT period, unless using the annual accounting scheme. Note, that the payment must have cleared in HMRC’s bank account by the end of the extra seven day period.
  • Payment by direct debit:
    • HMRC will collect the amount due three bank working days after the extra seven calendar days following the normal due date. Note, that if there are insufficient funds in the business’s bank account to cover the direct debit, a surcharge for late payment may be applied.

Mindful bookkeeping goes a long way to ensuring that accounting records are accurate.  All the issues discussed in this article are straightforward and integral to daily accounts preparation, however, they shouldn’t be underestimated as they are the foundation of significant reports and returns that are used to manage businesses and fulfil legal requirements such as VAT returns.

* https://www.gov.uk/guidance/vat-guide-notice-700#section17

Browse the full range of AAT study support resources here

Gill Myers is a self-employed accounts consultant. She has taught AAT qualifications since 2005 and written numerous articles and e-learning resources.

Related articles