HMRC’s approach to business compliance, as noted in their annual report, indicates that they consider that key areas of risk include overclaimed input VAT and under-declared output VAT.
The following are just some of the ways banks may overclaim input tax or underclaim output VAT:
- By incorrectly treating supplies as VAT exempt, when VAT should have been charged;
- Through errors in the operation of the bank’s partial exemption method for recovery of input VAT, including as a result of gaps in the method, or an out-dated method;
- When UK suppliers incorrectly charge VAT on supplies made to the bank, perhaps as a result of errors in determining the VAT treatment of outsourced services;
- As a result of the incorrect application of “reverse charge” VAT (discussed in more detail below).
Where errors are made in VAT returns, due to the types of errors mentioned above, banks run the risk of incurring penalties which may be in the region of 30% of the VAT error, if the behaviour resulting in the error falls within the definition of a “careless” error. Penalties may be as high as 70% where the behaviour resulting in the error is deemed “deliberate” or 100% where the behaviour is considered to be “deliberate and concealed”.
Banks can take actions to reduce the risk of errors, and these actions should also assist in demonstrating to HMRC that any errors which are made have taken place despite the bank having taken “reasonable care” (thus potentially reducing the penalty).
The incorrect application of reverse charge VAT is a major focus for HMRC and, in all enquiries raised by HMRC in relation to VAT returns submitted by banks, a variant of a question about reverse charge VAT is likely to be included, for example:“What expenditure have you incurred from overseas (including from sister-entities) on which you have determined that reverse charge VAT is not due, and why?”
The reference to “reverse charge” VAT is not always commonly understood. However, it simply refers to expenditure incurred from an overseas supplier, on which VAT would have been incurred if the same service had been purchased from a UK supplier. When a bank receives these services (for example, legal fees from an overseas lawyer), the bank must “self-account” for UK VAT so that they are in the same position, from a VAT perspective, as if the services had been purchased from a UK supplier. In practice, this means that the bank must charge itself output VAT, and reclaim a corresponding amount of input VAT (taking into account any restriction of input VAT recovery which may apply according to the bank’s partial exemption method for VAT recovery).
Banks should ensure that they are prepared for this question from HMRC, and that services received from overseas, (both EU and non-EU), including intercompany services, have been reviewed, and reverse charge VAT has been applied as appropriate. Where it is identified that reverse charge VAT should apply, care should be taken to ensure that the input VAT element of the reverse charge is assigned to the correct sector of the partial exemption method, so that input VAT is not over or under-recovered at this stage.
Of course, banks should also ensure that they do not apply reverse charge on services which would be exempt from VAT, if purchased from a UK supplier. Where it is identified that the reverse charge does not apply to services received, it is sensible to retain details of the reason why it is considered that the reverse charge does not apply. This both allows information to be provided to HMRC relatively easily, and provides evidence that the bank has taken reasonable care in considering the treatment of services it receives from overseas.
Reverse charge VAT is a favourite focus of HMRC. The review methods applied to the receipt of services from abroad can also be used to inform the bank’s review of all purchases made, to mitigate against under and over claims of input VAT.
Read more on VAT here.