Are you paying too much VAT?

You may be paying too much VAT if you are using the flat rate scheme and based your choice of business sector on the guidance issued by HM Revenue & Customs (HMRC).

A business using the flat rate scheme for small businesses bases the calculation for how much VAT it pays to HMRC on a percentage that is applied to its VAT inclusive turnover. The percentage varies depending on which of the 55 sectors (listed in the VAT regulations) the business falls into. The choice of sector is not always obvious and the following extracts (in italics) are from the 3 May 2013 edition of HMRC’s guidance on the subject (VAT Notice 733):

‘We will not normally check your choice of sector when we process your application. So if you have made a mistake you may pay too much tax or too little. Paying too little could mean that you are faced with an unexpected VAT bill at a later date.

However, if we approve you to join the scheme, we will not change your choice of sector retrospectively as long as your choice was reasonable. It will be sensible to keep a record of why you chose your sector in case you need to show us that your choice was reasonable.

Note: Some business activities can reasonably fit into more than one sector. So changing your sector does not automatically make your original choice unreasonable.

The table below gives the trade sector for particular business activities, which have been the subject of common enquiries to our VAT Helpline.’

Business activity Trade sector
Engineering consultants and designers Architects, civil and structural engineers
Agents Business services that are not listed elsewhere
Barristers Lawyers or legal services
Florists Retailing that is not listed elsewhere
Agronomists Management consultancy
Television cameramen Film, radio, television or video production

The key points from the above extracts are that some business activities can reasonably fit into more than one sector but HMRC should not change a choice of sector retrospectively as long as the choice was reasonable.

The First Tier Tribunal considered HMRC’s guidance in in the separate cases of Idess Ltd (TC03638) and SLL Subsea Engineering Ltd (TC04256). In particular, the Tribunal considered the HMRC guidance that engineering consultants and designers fall into the category for architects, civil and structural engineers or surveyors. This category currently has a flat rate percentage of 14.5%.

In both cases the companies, which provide mechanical engineering services, chose the ‘any other activity not listed elsewhere’ category, which currently has a flat rate percentage of 12%. In both cases HMRC decided that the companies should have used the higher percentage for the ‘architect, civil and structural engineer or surveyor’ category.

HMRC decided that the original choice of category by both companies was unreasonable and decided to change the choice of category retrospectively. The Tribunal was not convinced by HMRC’s argument, which was essentially that the choice of category was unreasonable because it was not made in accordance with its guidance in VAT Notice 733. In both cases the Tribunal decided, based on the wording of the VAT regulations rather than HMRC’s guidance, that the choice of category made by each company was reasonable.

Another controversial extract from HMRC’s guidance on the flat rate scheme is quoted in italics below:

Note: if you act as a consultant and you do not fit into another specific sector, you should choose management consultancy. This sector is not restricted to businesses that fit the traditional idea of management consultant.

The above extract is controversial because there is no indication in the VAT regulations that consultancy services that do not fit into another specific sector must be management consultancy services.

The wrong choice of sector may result in a business paying too much VAT because the flat rate percentage that is applied to turnover when calculating how much VAT is paid varies depending on the choice of sector. Has your business chosen the wrong sector, or has your business chosen the right sector but had the choice challenged by HMRC?

The Tribunal decisions in Idess Ltd and SLL Subsea Engineering Ltd confirm that a choice of sector is not necessarily wrong simply because the choice is not made in accordance with HMRC’s guidance.

For more information on VAT, please contact Alex Millar or enquiry@garbutt-elliott.co.uk – 01904 464 100