COURSE: ACCA – TAXATION (TX)

Lecture Topic: Value Added Tax (VAT) - Basics

Introduction
o Value Added Tax (VAT) is a tax on consumer expenditure. It is a tax on turnover (sales), not on profits.

o VAT is chargeable on any taxable supply of goods or services in the UK by a taxable person in the course or
furtherance of a business carried on by him.

o A taxable person is someone who is, or is required to be, registered for the purpose of VAT. This includes
individuals, partnerships and companies.

o A taxable person is required to charge and collect VAT from his customers (the output VAT). Against this
he is allowed to reclaim the VAT he has paid to his suppliers (the input VAT).

o The basic principle is that VAT should be borne by the final consumer.

o Because traders account to HMRC for VAT charged less VAT suffered, their profits for income tax or corporation
tax purposes are based on sales and purchases net of VAT.

1. Supplies
Supplies fall into three main categories:

(i) Standard rated supplies - These are taxable supplies on which VAT is charged at 20 %. A business whose sales
(supplies made) are standard-rated can recover the Input VAT on their purchases and expenses.

There is also a reduced standard rate of 5% which applies to certain types of supply e.g. fuel and power for
domestic or charity use and the installation of energy saving materials in homes.

(ii) Zero-rated supplies – These are taxable supplies on which VAT is charged at 0%. A business whose sales
(supplies made) are zero-rated can also recover the Input VAT on their purchases and expenses.

(iii) Exempt supplies - An exempt supply is not chargeable to VAT. A business whose sales (supplies made) are
exempt is unable to recover Input VAT on their purchases and expenses.

1.1 Zero-rated supplies

Examples of items on the zero-rated list are food, water, books and newspapers, construction work on new homes,
transport, drugs and medicines on prescription, clothing and footwear for young children.

1.2 Exempt supplies

Examples of items on the exempt list are financial services, insurance, postal services provided by the Post Office, betting
and gaming, certain education and vocational training, health services, burial and cremation services

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2. Output VAT
VAT charged on sales (supplies made) is called ‘Output VAT’.

2.1 Valuation of supplies

(a) The value of a supply is the VAT-exclusive price on which VAT is charged.

(b) Where consideration other than money is used, then VAT is charged on the open market value of the goods or
services.

(c) Where a discount is offered for prompt payment, VAT is chargeable on the net amount if the discount is taken
up.

(d) For goods supplied under a hire purchase agreement VAT is chargeable on the cash selling price at the start of the
contract.

(e) Note that no distinction is made between revenue and capital, so Output VAT is chargeable on the sale of trading
stock as well as fixed assets.

2.2 Time of supply (the tax point)

o VAT is normally accounted for on a quarterly basis. Therefore, it is important to know the time of a supply to
identify the quarter it falls in, for the following reasons:

1. To calculate the turnover for registration purposes.

2. To include the sale in the correct VAT return.
3. To identify the correct rate of VAT (if there is a change).
4. To identify the correct category of VAT (zero, standard or exempt – if there is a change).

o As a general principle:

 Goods are treated as supplied when they are collected, delivered or made available to a customer.

 Services are treated as supplied when they are completed.

This is known as the ‘basic tax point’.

The ‘basic tax point’ is changed in two situations:

(i) If an invoice is issued or payment is received before the basic tax point, the earlier date becomes the
effective tax point.

(ii) If the earlier date rule does not apply and if an invoice is issued within 14 days after the basic tax point,
the invoice date becomes the effective tax point.

o There are special rules for certain supplies of goods that do not fit naturally into the above scheme. In particular:

1. Goods on sale or return - The time of supply is the earlier of the date when the sale is adopted by the
customer or 12 months after the dispatch of the goods.

2. Continuous supplies - Supplies such as electricity (goods) and tax advice (services) do not have a basic
tax point. The time of supply is the earlier of a tax invoice being issued and a payment received.

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3. Input VAT

Input VAT is the VAT paid by taxable persons on goods and services supplied to them (i.e. on purchases and expenses).

If a business incurs Input VAT on their purchases and expenses, they can recover this from HMRC provided certain
conditions are met:

1. The claimant must be a taxable person when the VAT was incurred.
2. The supply must be to the taxable person making the claim.
3. The supply must be supported by evidence (e.g. valid VAT invoice).
4. The claimant must use the goods or services for business purposes.

Note that Input VAT can also be recovered on capital items, i.e. the purchase of fixed assets.

The Input VAT is recovered from HMRC by netting it off against the Output VAT on the VAT return.

3.1 Pre- registration input VAT

VAT incurred before registration is called pre-registration Input VAT. This can be recovered from HMRC subject to certain
conditions.

If the claim is for input tax suffered on goods purchased prior to registration, then the following conditions must be
satisfied:

1. The goods were acquired for the purpose of the business.

2. The goods have not been supplied onwards or consumed before the date of registration (although they may have
been used to make other goods which are still held).

3. The VAT must have been incurred in the four years prior to the effective date of registration.

For pre-registration services the conditions are:

1. The services were supplied within the six months prior to the date of registration.

2. The services were supplied for the purpose of the business.

3.2 Relief for impairment losses (bad debts)

o Where a supplier of goods or services has accounted for VAT on the supply and the customer does not pay, the
supplier may claim a refund of VAT on the amount unpaid.

o Relief relating to VAT on bad debts is claimed by including the irrecoverable amount in the total of input
VAT on the VAT return.

o The conditions for obtaining the relief are:

1. The supply must be made for consideration.

2. Output VAT has been accounted for and paid (to HMRC) by the supplier.
3. The debt has been written off as irrecoverable.
4. At least six months has elapsed since the due date of the debt.
5. Claims for bad debt relief are subject to a three-year time limit.
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3.3 Non- deductible Input VAT

The following input tax is not deductible (not recoverable):

(i) Input VAT is not recoverable on purchased motor cars unless the car is acquired new for resale or is acquired
for use in or leasing to a taxi business, a self-drive car hire business (car rental business) or a driving school.

(ii) Where a trader leases a car for the business and there is any private use, only 50% of the input tax can be
recovered.

(iii) VAT on business entertaining where the cost of the entertaining is not a tax-deductible trading expense unless
the entertainment is of overseas customers in which case the input tax is deductible.

(iv) VAT on non-business items passed through the business accounts.

(v) VAT on expenses incurred on domestic accommodation for directors.

(vi) VAT which does not relate to the making of supplies by the buyer in the course of a business.

3.4 Motor expenses

o Regardless of whether input VAT is recoverable on the cost of a motor car, all input VAT on repair and
maintenance costs is recoverable (including motor expenses relating to private use).

o If a business provides fuel for an employee’s private use and charges that employee for the full cost of the fuel,
then VAT can be accounted for in the normal way, i.e. all of the input VAT can be claimed with output VAT
calculated on the charge to the employee.

o If a business provides fuel for an employee’s private use at less than the full cost, the business will account for the
VAT on that fuel as follows:

1. All input tax incurred on the fuel is recoverable by the business, and

2. The business must calculate VAT on the fuel scale charge and include this as output VAT on the relevant
VAT return, (the scale charge will be given to you on the examination paper).

Alternately, the business can choose to not claim any Input VAT on the fuel and no Output VAT will be charged.
In effect, the fuel is not brought into the VAT system at all.

4. VAT Returns
o Traders who pay VAT normally have VAT periods of three months, while traders who normally receive
repayment of VAT can elect for Vat periods of one month.

o A VAT return shows the total output VAT and total input VAT for the VAT period to which it relates.

o Where the output Vat exceeds the input VAT the trader will be in a payable position. If the input VAT exceeds the
output VAT, the trader will be due a refund from the Revenue.

o VAT returns must be completed and returned to the Revenue together with any VAT payable due within one
month of the end of the relevant VAT period. Businesses which pay VAT electronically automatically receive a
seven-day extension to this time limit.

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5. Registration for VAT

Businesses (companies, sole traders or partnerships) have to compulsorily register for VAT if the value of their taxable
supplies (sales) exceeds the registration limits, but they may also be voluntarily registered if they so require.

5.1 Compulsory registration

(a) A trader is required to register if their cumulative taxable turnover (excluding VAT) for the previous 12 months
to date exceeds £85,000.

(Taxable turnover for a period, for registration purposes, does not include the sale of capital assets (except for non-
zero-rated taxable supplies of interests in land)).

The person is required to notify HMRC within 30 days of the end of the month in which the £85,000 limit is
exceeded.

HMRC will then register the person with effect from the end of the month following the month in which the
£85,000 was exceeded, or from an earlier agreed date if they and the trader agree.

Registration under this rule is not required if HMRC is satisfied that the value of the trader’s taxable supplies
(excluding VAT) in the year then starting will not exceed £83,000.

(b) If a trader expects that his taxable turnover for a future 30-day period will exceed £85,000, he must notify HMRC
no later than the end of that 30-day period and will normally be registered with effect from the start of that same
30-day period.

Only taxable turnover of that 30-day period is considered, not cumulative turnover.

5.2 Voluntary registration

A person may decide to become registered even though his taxable turnover falls below the registration limit. Possible
reasons for voluntary registration include:

(i) To recover input tax on purchases.

(ii) To give the impression of a substantial business.

5.3 De- Registration

o A registered trader ceases to be liable to registration when they cease to make taxable supplies. The trader must
notify HMRC of this event within thirty days and is then deregistered from the date of cessation or a mutually
agreed later date.

o A trader may also voluntarily deregister if the value of their anticipated taxable turnover for the ensuing year does
not exceed £83,000. The trader is deregistered from the date of request or a mutually agreed later date.

o Traders are deemed to make a supply of their business assets (e.g. plant and trading stock) when they cease to be a
taxable person, and so, must account for the output VAT. If the output VAT is below £1,000 it can be ignored.

5.4 Transfer of a business as a going concern

o Where a business carried on by a taxable person is transferred as a going concern this is not treated as a supply of
goods or services, but rather as a change in the taxable person carrying on the business.

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 o Both parties may make a joint election for the transferor’s registration to be transferred to the transferee. In this
case the transferee assumes all rights and obligations of the registration including any outstanding liabilities.
Questions

1. Cathy will commence trading in the near future. She operates a small airplane and is considering three alternative types
of business. These are training, in which case all sales will be standard rated for VAT; transport, in which case all sales
will be zero-rated for VAT; and an air ambulance service, in which case all sales will be exempt from VAT.

For each alternative Cathy’s sales will be £85,000 per quarter (exclusive of VAT), and standard rated expenses will be
£15,000 per quarter (inclusive of VAT).

Show the VAT implications for each of the alternatives.

2. Banana plc is registered for value added tax (VAT). In the quarter ended 31 March 2016 it made taxable supplies
(before any discounts) of £100,000, exclusive of VAT. All supplies are standard rated.

Banana plc offers a discount of 4% to all customers who settle their invoices within 30 days. Only 40% of all
customers (representing 40% of the £100,000 above) are expected to pay within this time.

How much output VAT should Banana plc show on its VAT return for the quarter ended 31 March 2016?

3. Yee- ling is a sole trader and has recently registered for value added tax (VAT).

Yee-ling sold goods for £3,000. A £400 payment in advance had been received on 28 May 2016 and the stock was
delivered on 24 June 2016. Yee-ling sent an invoice for the balance due of £2,600 on 2 July 2016 and received this
amount from the customer on 1 August 2016.

Yee-ling’s quarterly VAT periods are the same as the calendar year.

In which quarter(s) will the above sales transaction be included?

4. Fred has the following bad debts for the quarter ended 31 December 2016 written off at the end of the quarter.

Debt Amount VAT Date on which payment due

A £6,000 £1,200 10 April 2016
B £5,000 £1,000 10 July 2016
C £1,000 £200 10 September 2016

How much Input VAT is recoverable for the quarter ended 31 December 2016 in respect of the bad debts that were
written off by Fred in that quarter?

5. Ivy Ltd provides one of its directors with a company motor car which is used for both business and private mileage.
The company pays for all running costs of the motor car, including petrol. The total cost of the petrol each quarter is
£720, of which 30% is for private mileage. The relevant quarterly scale charge is £506. Both figures are inclusive of
VAT.

Outline the VAT implications for Ivy Ltd.

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6. Yodel Ltd is registered for VAT, and its sales are all standard rated. The following information relates to the
company’s VAT return for the quarter ended 30 September 2016:

(1) Standard rated sales amounted to £120,000. Yodel Ltd offers its customers a 5% discount for prompt payment, and
this discount is taken by half of the customers.

(2) Standard rated purchases and expenses amounted to £35,640. This figure includes £480 for entertaining customers.

(3) On 15 September 2016 the company wrote off bad debts of £2,000 and £840 in respect of invoices due for
payment on 10 February 2016 and 5 May 2016 respectively.

(4) On 30 September 2016 the company purchased a motor car at a cost of £16,450 for the use of a salesperson, and
machinery at a cost of £21,150. Both these figures are inclusive of VAT. The motor car is used for both business
and private mileage.

Unless stated otherwise, all of the above figures are exclusive of VAT.

Calculate the amount of VAT payable by Yodel Ltd for the quarter ended 30 September 2016. (5marks)

7. Ulysses Valdano has been a self-employed builder since 2006. He registered for value added tax (VAT) on 1 January
2016 and is in the process of completing his VAT return for the quarter ended 31 March 2016. The following
information is relevant to the completion of this VAT return:

(1) Sales invoices totaling £44,000 were issued to VAT registered customers in respect of standard rated sales.
Ulysses offers his VAT registered customers a 5% discount for prompt payment, and all his customers received
the discount.

(2) Sales invoices totaling £16,920 were issued to customers that were not registered for VAT. Of this figure, £5,170
was in respect of zero-rated sales with the balance being in respect of standard rated sales. These standard rated
sales are inclusive of VAT.

(3) On 10 January 2016 Ulysses received a payment on account of £5,000 in respect of a contract that was completed
on the 28 April 2016. The total value of the contract is £10,000. Both of these figures are inclusive of VAT at the
standard rate.

(4) Standard rated materials amounted to £11,200, of which £800 were used in constructing Ulysses’ private
residence.

(5) Since February 2015 Ulysses has paid £120 per month for the lease of office equipment. This expense is standard
rated.

(6) During the quarter ended 31 March 2016 £400 was spent on mobile telephone calls, of which 30% relates to
private calls. This expense is standard rated.

(7) On 20 February 2016, £920 was spent on repairs to a motor car. The motor car is used by Ulysses in his business,
although 20% of the mileage is for private journeys. This expense is standard rated.

(8) On 15 March 2016 equipment was purchased for £6,000. The purchase was partly financed by a bank loan of
£5,000. This purchase is standard rated.

Unless stated otherwise all of the above figures are exclusive of VAT.

Required

Calculate the amount of VAT payable by Ulysses for the quarter ended 31 March 2016. (10 marks)

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8. Jimmy started business on 1 January 2019. Sales (excluding VAT) were £10,000 per month for the first year.

(i) In which month does Jimmy exceed the registration limit?

(ii) By what date should he notify HMRC?

(iii) From what date will Jimmy be registered?

9. Beck started to trade on 1 January 2016. Sales (excluding VAT) were £7,000 a month for the first year and £7,600 a
month thereafter.

(i) In which month does Beck exceed the registration limit?

(ii) By what date should he notify HMRC?

(iii) From what date will Beck be registered?

10. Leanna commenced trading on 1 October 2015. Her sales have been as follows:
£
2015 October 4,600
November 5,400
December 5,900

On 1 January 2016, Leanna receives an order for £92,700 worth of goods to be supplied in January 2016.

(i) In which month does Leanna exceed the registration limit?

(ii) By what date should she notify HMRC?

(iii) From what date will she be registered?