Did you know HMRC will disallow input tax on purchase invoices which are more than six months overdue for payment if the business can’t prove it has paid the suppliers. We look at how a small business can prove it's paid its suppliers. There are some important lessons for all businesses.
Date of Payment
Lots of small businesses use the cash accounting scheme for VAT, meaning they only account for VAT on sales when payment the customer pays, and only claim VAT on purchases they pay their suppliers. Any business can use the cash accounting for VAT if their turnover is less than £1.35m, but it tends to be only favourable for certain industries.
A problem arises for businesses not on cash accounting for VAT, because they account for VAT on sales and purchases according to the date of invoice, not the date of payment. So what happens if you receive an invoice from a supplier, claim the VAT back from it, but it remains unpaid many months later?
6 month deadline
The VAT regulations state that if payment to a supplier is overdue by more than six months, then any input tax claimed on an earlier VAT return must be repaid to HMRC. This clawback of VAT should be declared on the VAT return which covers the period in which the 6 month payment period ends. That 6 month period is deemed to commence on:
- the due date of payment for the invoice in question; or
- where an invoice does not show a due payment date, the invoice date.
For example. If a VAT registered builder not using the cash accounting scheme receives an invoice from a subcontractor for £1,000 plus VAT on 31 March 2017, on 30-day payment terms, so the invoice is payable by 30 April. John can claim input tax on his VAT return that includes 31 March. But if the invoice is not paid by 30 October, he must include an input tax credit on the VAT return that includes this date. He can claim input tax on a future VAT return if he pays the subcontractor.
Existing case of Capital SMA
Capital SMA - a high end commercial interior design company had a dispute with HMRC and lost. HMRC disallowed some VAT on purchases claimed by them on its April 2015 return suing the 6 month rule. The taxpayer’s appeal was based on the argument that it had paid for the invoices by cash, providing cash withdrawals shown on their bank statements to support its argument.
However, the tribunal agreed with HMRC that payment had not been made and dismissed the appeal. Unfortunately Capital SMA didn't provide any evidence from its suppliers confirming payment had been made, such as a payment receipt or correspondence. Additionally the amounts for cash withdrawals did not reconcile with any particular invoices.
HMRC also issued a suspended penalty for careless behaviour and the tribunal confirmed that this was correct both as a principle and the amount charged.
Lessons to Learn
In this case, Capital SMA's appeal was highly likely to fail due to their lack of evidence, but there are still important learning points from this case:
Pay electronically
It's so easy to pay electronically, but many businesses still deal in cash (mainly to save on bank charges). However, the business must be able to show some evidence of the supplier payment to HMRC. This is also sensible commercially. It might be useful to retain supplier statements to prove that payment has been made, or to ask for an email confirmation from them that the invoices have been paid.
Cash payment
In some cases, it might be worth asking suppliers to stamp or sign any invoices paid for with cash. Supplier invoices must clearly show the full details of the business ie. address, VAT number & items/service supplied. If the sale is less than £250, a supplier is allowed to use a less detailed tax invoice, but these invoices must still show all of the relevant detail about the transaction.
Disputed loophole
If an invoice is in dispute, then no input tax adjustment is needed only if the supplier has agreed to extend the payment deadline while the problem is being resolved. This also means that the supplier can’t claim bad debt relief on its sales invoices, so HMRC will not be out of pocket if the customer does not credit their VAT claimed on the purchase.