VAT

VAT

Contents:

Scope

Key Points

Background

Public Bodies

Government Departments

VAT Liaison Officers

VAT Returns

Payable VAT

VAT Rates

Importing and Exporting

Chargeable VAT

Taxing Directions

Statutory Cover

Deductible / Recoverable VAT

Contracting-out (CO) Directions

Tax Invoices

Tax Point

Agents

Accounting for VAT

Budget Managers

Use of VAT Consultants

Further Guidance

Annex 1: Zero Rated and Exempt Supplies

Annex 2: VAT Invoices

Annex 3: Tax Point for Supplies of Goods and Services

Annex 4: Contracting-Out Direction

Annex 5: VAT Terminology

Scope

1. This section gives guidance on the application of VAT with particular regard to bodies registered with HM Revenue & Customs (HMRC) as Government Departments (GDs).

Key Points

2. Each separately registered GD should appoint a VAT Liaison Officer (VLO) to act as a source of expertise and to liaise with HMRC and Treasury.

3. VAT is payable by GDs on the importation or acquisition of most goods and services. However, it is the legal responsibility of VAT-registered suppliers to decide the tax liability of the supplies that they make.

4. GDs shall charge VAT on any taxable supplies made in the course or furtherance of business activities specified in Taxing Directions.

5. GDs are entitled to reclaim or deduct from the output tax they are due to pay the input tax they incur on purchases for their business activities, including those activities deemed to be business in the Taxing Directions. GDs can also reclaim VAT on those non- business activities specified in Contracting-Out Directions.

6. Budgets for programme and administrative expenditure should exclude recoverable VAT.

7. Staff involved in authorising invoices for payment or charging for goods and services should ensure that they reclaim or charge the correct amount of VAT.

Background

8. VAT is a tax which is paid by each business on the value which it adds to any goods (or services) during its particular stage of the process of production or distribution. Although the tax is collected from businesses, in effect the tax falls ultimately on the final consumer. Generally speaking each business that supplies goods or services to another business must add VAT to the price it charges. The VAT charged by the business is known as output tax as it is levied on the taxable outputs from the business. Hence the price paid by the customer consists of the net cost of the goods or service, which the business will treat as income, and the output tax which the business will pass on to HMRC.

9. In most cases the business will have also paid VAT included in the cost of goods and services purchased. This VAT is called input tax as it is part of the cost of the inputs to the business. In most cases the business is entitled to recover this input tax from HMRC. At the end of each VAT accounting period (normally three months) each business totals all the output tax due by it to HMRC and all the input tax due by HMRC to it. It then remits to HMRC the amount by which the tax on its outputs exceeds that on inputs. Thus the taxable business has to account to HMRC for the tax on all goods or services it supplied (its "output tax") in each accounting period, but in paying tax to the authorities it can take credit for the tax on goods and services supplied to it (its "input tax"). The majority of GDs do not have high levels of business activities and so their input tax is likely to exceed their output tax. The result is that most GDs will have a net reclaim of VAT from HMRC, rather than a net payment.

10. This process will repeat itself right through the supply chain with suppliers and customers passing their excess output tax to HMRC. The tax therefore rolls forward at each stage until the point of sale to the final consumer. The final consumer cannot treat the VAT on their day to day purchases as input tax. It is a principle of the tax that, so far as possible, it should apply in the same way to public bodies as it does to ordinary traders.

11. The VAT Act 1994 (VATA) is the main legislation concerning VAT in the UK. Although the VATA is a UK statutory document and the level of VAT is set by the UK Government, much of what can be covered within the Act is set out within the European Communities Sixth Directive.

Public Bodies

12. The scope of VAT on taxable supplies is defined in section 4(1) of the VATA. VAT is chargeable on any supply of goods or services made in the UK, where it is a taxable supply made by a taxable person in the course or furtherance of any business carried on by him / her. A transaction is therefore within the scope of UK VAT if, among other conditions, it is made by a taxable person. However Article 4(5) of the EC 6th VAT Directive lays down different conditions for certain bodies that meet the definition of a "body governed by public law". These different conditions result in government and public bodies not being treated as taxable persons when they engage in certain activities or transactions. In the UK non-taxable activities undertaken by a public body are generally referred to as "non-business".

13. There are a number of different categories of public bodies, and their ability to recover input VAT will be determined by which category they fall into, but all must charge VAT on their business supplies. The VATA defines the bodies' ability to recover VAT. The categories include, but are not limited to:

  • GDs
  • Local authorities and other "Section 33" bodies
  • Health authorities
  • Non-Departmental Public Bodies
  • Trading Funds
  • Police Authorities

14. The Scottish Government is a GD as defined by the VATA and associated Treasury directions and these then define the limits on what input VAT it may reclaim, and what output VAT it must charge.

Government Departments

15. On the face of it, establishing whether or not a body is classed as a Government Department (GD) would seem straightforward. However, experience has shown that this is not the case. The definition of what is or is not a GD, or a part of a GD, is sometimes difficult to determine. If there is any doubt over the status of a body seeking to be registered as a GD HMRC will consult the Office of Public Service. HMRC will consider requests for independent VAT registration from parts of a GD (e.g. Executive Agencies) if such a request is endorsed and supported by the parent GD. However, separate VAT registration means separate accounting for VAT. Separately registered GDs must also appoint a VAT Liaison Officer and be added to the Treasury Taxing and Contracting-Out Directions. Supplies between separately registered bodies may be business activities and thus liable to VAT. Supplies between parts of a GD operating under an umbrella VAT registration do not attract VAT. Sponsored bodies are not considered to be GDs for VAT purposes and must comply with the relevant VAT regulations.

16. Guidance on the VAT relationship between GDs, NDPBs, Executive Agencies and Trading Funds is provided in the table below:

 

If . . .

Then . . .

A GD makes a supply to another GD.

If the supply is a business activity then VAT must be charged

A GD receives a supply from another GD.

If the supply is in support of a business activity then VAT may be recovered. No recovery under the CO Directions will be possible.

If the supply is not in support of a business activity then, if the supply falls within any of the categories specified by the CO Direction, VAT may be recovered.

A GD makes a taxable supply to an NDPB.

The NDPB must be treated as an ordinary customer and VAT must be charged.

An EA makes a taxable supply to a GD.

If the EA forms a part of the same VAT registration as the GD, then no VAT is chargeable.

If the EA is separately registered for VAT then VAT must be charged.

A GD receives a supply from an EA or trading fund.

If the supply is in support of a business activity then VAT may be recovered.

An entire GD becomes a trading fund

It is likely that no VAT can be refunded via the CO Directions.

Part of a GD becomes an EA or TF

For VAT purposes it will remain part of the parent GD unless an application for independent GD VAT registration is made.

Part of a GD becomes an NDPB

A VAT registered NDPB can recover all or a proportion of the VAT incurred on taxable supplies used to support its business activities. VAT incurred in other circumstances is unlikely to be recoverable.

Note: Unless the NDPB is involved in making business supplies it is unlikely to be able to register for VAT, and so be unable to recover any VAT.

17. The guidance in the table above is not exhaustive. For example, VAT issues must be taken into account where the setting up of a new body, or the merger of bodies, is under consideration. The VLO should be consulted at this stage and he/she will, where necessary, seek clarification/guidance from HMRC.

18. GDs are issued with VAT and EU VAT numbers prefixed with the letters GD. However, the VAT number that should be shown on tax invoices and correspondence relating to taxable supplies made by GDs is the full EU VAT number. The EU VAT number must also be used for trading with other EU member states.

VAT Liaison Officers

19. Each separately registered GD should appoint a VAT Liaison Officer (VLO) to act as a source of expertise and to liaise with HMRC and HM Treasury. GDs may also wish to consider appointing local VLOs. Members of staff or local VLOs in separately registered GDs should not deal directly with HMRC on VAT matters. Liaison with HMRC should be undertaken by the VLO. The VLO for the core Scottish Government is based within its Treasury and Banking Branch.

VAT Returns

20. Each GD separately registered for VAT is required to account quarterly to HMRC for VAT paid and collected. The Scottish Government's Treasury and Banking Branch, in co-ordination with other specialist finance staff, prepares the main Scottish Government return.

Payable VAT

21. In common with other organisations VAT is payable by GDs on the importation or acquisition of most goods and services. However, it is the legal responsibility of suppliers to decide the tax liability of the supplies that they make. Where GDs wish to query the liability determined by suppliers, the first step is to ask the supplier to obtain a written ruling on the liability of its supply from its local VAT office. In most cases this will resolve the matter. However, if it still appears that a liability has not been correctly determined, it is open to the GD to pursue the matter direct with HMRC.

VAT Rates

22. The rate of VAT payable will depend upon whether or not the supply is within the scope of VAT, whether or not the supply is exempt, and the applicable rate of VAT at the time of supply (known as the "tax point" - see below)

23. Business supplies may be either within the scope of VAT, or outside the scope of VAT. To be within the scope of VAT there are three criteria that need to be met:

  • there must be a supply of goods or services;
  • the supply must take place in the UK; and
  • the supply must be made by a taxable person.

24. Some supplies which meet these criteria might also be exempt from VAT (see below), but if the supply is within the scope of VAT and the supply is not an exempt supply, then VAT will be charged.

25. There are three rates of VAT on business supplies:

  • a standard rate, currently 20%;
  • a reduced rate of 5% on qualifying fuel and power; and
  • a zero rate. No tax is payable on zero-rated supplies but they are treated as taxable supplies in all other respects, including the right of GDs making the supply to recover the VAT included in the business costs of making it.

26. Some supplies are exempt from VAT, which means no tax is payable - but, equally, the person making the supply cannot normally recover any of the VAT on their own expenses. The more common supplies that are zero-rated or exempt from VAT are listed in Annex 1. Care should be taken to ensure there is no confusion between supplies that are outside the scope of VAT, exempt from it, or zero-rated. These are different categories of supply and the terms are not interchangeable. VLOs should be consulted if there is any doubt over the VAT liability of a particular supply.

Importing and Exporting

27. VAT is not only a tax on supplies - it is also a tax on the importation of most goods and some services. When goods are imported into the UK from outside the EU, VAT is normally due at the same rate as on a supply of those goods in the UK. Exports of goods to customers outside the EU are normally zero-rated provided that certain conditions are met. VAT on goods traded between EU member states are normally zero-rated on despatch, and any VAT due is payable on acquisition of the goods by the customer. There are occasions when VAT will be incurred in another member state of the EU. This VAT is not recoverable from HMRC, although it may be possible to recover the VAT from the other member state. It is advisable to refer to the VLO for the VAT implications of any arrangements involving importing or exporting.

Chargeable VAT

28. Most of the activities of GDs are not "business" for VAT purposes and they are therefore outside the scope of the tax. However, to avoid distortion of competition between GDs and normal traders GDs must charge VAT on any taxable supplies made in the course or furtherance of a business. Some other supplies of goods and services by GDs must also be treated as business supplies. The test used is "are the supplies of a kind often made by way of business by normal traders?". However the Treasury Taxing Directions (see below) provides the definitive list of those supplies on which GDs must charge VAT.

Taxing Directions

29. All business activities of GDs which are subject to VAT will be specified in Treasury directions - the "Taxing Directions" - which are published regularly in the London, Belfast and Edinburgh Gazettes in the form of two lists. List 1 is of GDs that are currently registered for VAT and List 2 is of services that Treasury deems to be business supplies. Thus a supply by a GD included in List 1 of any goods or services described in List 2 shall be treated as a supply in the course of a business by that GD and output tax must be charged.

30. Occasionally an activity conducted by a particular GD will be regarded by HMRC as non-business depending on unique circumstances, even though it is listed in the Taxing Directions e.g. the secondment of staff where, for security reasons, this is not in potential competition with the private sector.

Statutory Cover

31. GDs must act consistently in applying VAT to its supplies and should have full statutory cover for what they do. This can be achieved only if the Taxing Directions are consistent, comprehensive and up to date. GDs should therefore provide HMRC with a full description of any new supply for which a charge is to be made, so that HMRC may advise whether it should be regarded as made in the course or furtherance of a business and, if it should, whether it is covered by an existing Taxing Direction. If a new direction is required, HMRC will agree the wording with the GD concerned and arrange with the Treasury for the direction to be made at the next opportunity. HMRC should also be informed if a supply within an existing direction ceases or is made on new terms such that it might be regarded as outside the scope of the tax.

Deductible / Recoverable VAT

32. GDs are entitled to reclaim or deduct from the output tax they are due to pay the input tax they incur on purchases for their business activities, including those activities deemed to be business in the Taxing Directions. Input tax can only be reclaimed if the proper evidence is held to support the claim. In most cases, this will be the original tax invoice. Photocopies, fax copies and other facsimiles are not normally accepted as satisfactory evidence. Invoices marked "pro-forma" by the supplier are not tax invoices - even if the wording "tax invoice" appears - and cannot be used as evidence to support a refund of input tax.

33. VAT incurred on purchases will have to be apportioned between business and non-business activities where only the VAT attributable to business activities is reclaimable as input tax. Apportionment will also be necessary where VAT is incurred on purchases used in making both taxable (recoverable) and exempt (irrecoverable) onward business supplies. This is known as partial exemption.

34. When a GD engages in an activity as a public authority, and where this will not lead to a significant distortion of competition, it may be able to treat these activities as non-business activities. Tax incurred for non-business activities is not normally recoverable but certain GDs can claim refunds of the VAT that they incur on certain services - including services provided as part of capital contracts - acquired for non-business activities. VAT on related goods may also be reclaimed provided that the goods form an essential part of the service. Details of which services are covered by this section are provided in the Treasury "Contracting-out Direction" (see below). The purpose of this provision is to remove a possible VAT disincentive to the use of outside contractors to perform activities normally done in-house. The criteria for refunds are:

  • the service in question must not be for business purposes as specified in Taxing Directions; and
  • VAT may be reclaimed on goods only where they are clearly essential to the supply of the service.

35. The contracted out rules apply to certain elements of capital expenditure and not just to current expenditure. For example although VAT cannot be reclaimed in respect of any part of the payments that relate to the purchase of assets, it can be reclaimed in respect of any services provided as part of the same (capital) contracts. Therefore the treatment of VAT on contracted out services is the same for the service element of capital projects as it is for a straightforward services only contract.

Contracting-out (CO) Directions

36. The Treasury Contracting-out Directions are published regulary in the London, Belfast and Edinburgh Gazettes in the form of two lists and care should be taken not to confuse these with the Taxing Directions. In this case List 1 is of eligible GDs and List 2 - reproduced at Annex 4 - is of non-business related services on which Treasury agree that VAT may be recovered. Thus a contracted out supply on List 2 to a GD on List 1 will be eligible for a refund of VAT. Details of expenditure against each of these services must be submitted with each quarterly VAT return to enable the recovery of VAT.

Tax Invoices

37. When GDs supply taxable goods or services to a taxable person they must issue that person with a sales invoice (or similar document) showing the amount of VAT and certain other particulars. This is known as a tax invoice, which is an important document, because it is the principal evidence to support the customer's claim for deduction of input tax. Similarly, if a GD wishes to recover input tax then it must hold a valid VAT invoice for the supply. The key features of a VAT invoice are set out in Annex 2. Since it is impractical to ascertain whether each customer of GDs is a taxable person or not, tax invoices should be issued for all taxable supplies, except for any supplies from suppliers which share the same VAT registration as the customer. The sales invoices generated through the accounting system gives the VAT number of the GD raising the invoice, the VAT rate applicable to each line on the invoice, and report the total VAT payable. The VAT total shown on the invoice is the output tax that the GD has to account for to HMRC. If the customer is a taxable entity, the VAT total will form part of that organisation's input tax.

38. If an error is made in issuing a sales invoice, or if it becomes necessary to refund some of the charge, GDs should generate a credit note on their accounting systems. The process and the principles applicable to credit notes are exactly as for sales invoices, but with the figures entered as negatives. GDs must not use credit notes to write off bad debts. Where a debtor fails to pay the debt, including the VAT element, it should be written off by journal. The debit (of the VAT-inclusive value of the sales invoice) should be to a bad debts account and not to the original income account. Special rules apply if the debtor is known to be insolvent, in which case it is possible for GDs to recover the output VAT on the sale.

Tax Point

39. The tax on the supply of goods and services becomes chargeable at a definite date called the tax point. The rate of tax to be charged is the rate in force at the tax point. The principal rules relating to the tax point are summarised in Annex 3.

Agents

40. Section 22 of VAT Notice 700, published by HMRC, sets out the requirements where a GD acts as an agent in purchasing or selling for another GD:

  • agents acting in the name of their principals (i.e. invoice between principal and customer) - the only supply by the agent is of services for arranging the transaction.
  • agents acting in their own name (i.e. invoice in the name of the agent) - the transaction is treated as if the agent both makes and receives the supply.

41. Where a GD acts as a purchasing or selling agent, and makes a charge for its own agency services which have arisen in the course of the transaction, VAT is due at the standard rate. The agent GD must issue a tax invoice to the principal and account for the output tax due.

Accounting for VAT

42. GDs must charge VAT on their business activities in the same way as a normal trader. Receipts from a GD's customers therefore consist of a payment for the service and a payment of the VAT charged on the service. The accounting for chargeable VAT is done in two stages. When a business area of the Scottish Government issues the sales invoice, it credits the income account with the net amount and credits a creditors account (in the balance sheet) with the VAT element. When the payment is received from the debtor, the full amount of the payment is credited to that debtor's account in accounts receivable and debited to the bank account.

43. Expenditure should be recorded net of VAT in the accounts, except:

  • irrecoverable input VAT identified and charged to the operating cost statement, and included therein under the heading relevant to the type of expenditure; and
  • where irrecoverable input VAT is incurred on the purchase of an asset, it should be included in the capitalised purchase cost of the asset.

44. The net amount due to or from HMRC in respect of VAT should be included within creditors or debtors in the balance sheet.

Budget Managers

45. Budget Managers should consider the effect of VAT on their budgets. Budgets for both programme and administrative expenditure should be based on the cost net of recoverable VAT. Only the rules on paying and reclaiming VAT and the allocation of reclaims have a bearing on budgets. Consequently Budget Manager's considerations should cover:

  • the VAT status of suppliers - non VAT-registered suppliers may have to pass on the VAT element of their costs to the GD. VAT registered traders will be able to reclaim the VAT in their costs possibly leading to reduced charges.
  • the VAT status of the supply - VAT will have to be charged on sales to the private sector or other separately registered GDs if they amount to business activities. VAT can be reclaimed on certain purchases but these may be retained centrally and not passed on to budget managers. The VLO / local VLO will be able to advise on specific arrangements within his/her area of responsibility.

46. Staff involved in authorising invoices for payment or charging for goods and services should ensure that they charge or reclaim the correct amount of VAT. In order to do so they will need to familiarise themselves with the rules that relate to the particular type of income or expenditure as well as the context (business or non-business) of the transaction. Staff should always consult their VLO / local VLO in cases of doubt or where there are new proposals.

Use of VAT Consultants

47. It would not be appropriate for GDs to employ tax consultants to advise on how to avoid or reduce their VAT liability - see the guidance on Tax Planning and Tax Avoidance - or to provide day to day advice on VAT. The latter is readily available from HMRC. There may however be circumstances where the commissioning of consultants to work on a specific project or to provide specialised assistance might be appropriate. In such circumstances contractual payment should be made on the basis of actual work undertaken and not related to VAT savings i.e. commission.

Further Guidance

48. Further guidance is available in a number of publications, such as the Value Added Tax - Guidance Notes for Government Departments and The VAT Guide both of which are published by HMRC. Copies of these should be held by VLOs. A glossary of some of the most commonly used VAT terms in relation to GDs is at Annex 5.

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Page Published / Updated: June 2012