MONTHLY FOCUS: COMMENCEMENT AND FORMING A VAT GROUP

AT is complex. However, there are particular considerations in certain business situations. What special rules apply on commencement of a business, and when forming a VAT group?

1. Commencing a business

Special VAT rules apply on the commencement and cessation of a business to ensure that traders are not unduly discriminated against during these periods. The intention is to enable a smooth entry into, or exit from, the mainstream VAT regime.

Additionally, there are certain issues that will arise on:

• a sale or purchase of a business; and
• the death, insolvency or incapacity of a trader.

VAT is an important issue that must be considered from the start by any person commencing a trade or intending to do so (irrespective of whether that person is currently registered for VAT).
Issues of particular importance to a trader commencing business are:

• registration; and
• recovery of VAT paid on purchases made before registration.

What are the considerations on registration?

Depending on the circumstances, registration may be obligatory or advantageous.
A trader must register for VAT if the value of taxable supplies exceeds a certain limit (currently £90,000), which would possibly include the supply which arises on a transfer of a business.

Voluntary registration facilitates the recovery of input tax. This may be done at any time from a date when the trader can demonstrate an intention to trade, even if this is before any actual supplies are made.

For full details of registration requirements, see HMRC’s guidance.

The acquisition of a right to the future transfer of property (which was yet to be constructed), with a view to renting out the property, entitled the person to be registered for VAT (even if the business never in fact materialised) at tribunal. 

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What happens when a business is transferred? 

A trader who acquires assets on the transfer of a business may be required to register immediately. In this case the relevant value of taxable supplies is the sum of:

• the taxable supplies made by the transferred business in the 12 months prior to the transfer; and
• any taxable supplies made by the purchaser in the 12 months prior to the transfer.

If the total value of these supplies:

• exceeds the registration threshold in force on the day of transfer, the purchaser will be required to register for VAT from that date, unless an exemption applies; or
• does not exceed the registration threshold, the value of taxable supplies should be continually monitored.

What about starting a new business?

If not choosing to register at the outset, a trader starting a business from scratch is unlikely to be affected by compulsory registration at the date of commencement of trade (as it is unlikely that the business will have made sufficient taxable supplies). However, all traders should be wary of the prospective registration threshold.

Throughout the trading period, a detailed record of supplies made must be kept to ensure a timely registration if supplies exceed the threshold.

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2. Recovery of input tax

Can pre-registration input tax be recovered?

A trader can recover VAT incurred on purchases made before registration, provided that certain conditions are satisfied. Similar rules allow recovery of VAT before a company is incorporated.
The amount that can be recovered is calculated in the usual manner, on the assumption that the trader was registered at the time that the expense was incurred. The claim must be made on the trader’s first return.

Are unincorporated traders eligible?

To recover input VAT on purchases made before registration:

• the goods or services must be used, or be intended to be used, for the purposes of the newly registered business; and
• the following conditions must be satisfied as shown in the table below.

Type of supply	Qualifying conditions
Goods	Any goods must be:
	–  purchased no more than 4 years before the date of registration; and
	–  on hand at the date of registration i.e. they have not been consumed or supplied before registration
Services1	Any services must be purchased (meaning invoiced) no more than 6 months before the date of registration
Note:
1. There is no restriction on services being consumed before registration (as there is for goods).

Example

Mr A, a printer, registers for VAT on 1 December. Large printing machines were bought a year ago. There is a stock of inks and paper on hand at registration, which were bought in July. Mr A also commissioned a business plan from a local firm of accountants back in January, which was invoiced in February. Payroll processing costs have been invoiced monthly since then. Mr A can recover input tax on the machines and stock, as well as the payroll costs incurred since 1 June. The invoice for the business plan is outside the 6-month time limit for services received.

What about companies? 

As a company cannot register until it is formally incorporated, VAT on pre-incorporation expenditure can also be recovered if, in addition to the conditions above, it is both:

• incurred by a person who:
  • subsequently becomes an officer or employee of the company;
  • is fully reimbursed by the company; and
  • was not a taxable person (one who was, or was required to be, registered for VAT) at the time of purchase; and
  • purchased for the purpose of a business to be carried on by the company (without being put to any other use in the meantime).

Input tax incurred on expenditure which has a tax point falling after the date of incorporation cannot be recovered under these rules. It is therefore vital that suppliers are aware of who to invoice.

Example

Mr B is to be a director of C Ltd, which is incorporated on 20 January. He incurs £500 of VAT on a feasibility study, and the invoice is made out to him. C Ltd then reimburses Mr B.

If the tax point of the invoice:

• is 10 January, the input tax can be recovered by C Ltd; or
• is not until the end of the month, the input tax is irrecoverable, because C Ltd has already been incorporated, and the invoice is made out to Mr B.

How much should the claim be for?

In general, the claim is made on the assumption that the trader was registered at the time that the expense was incurred. Therefore, any restrictions that would otherwise apply (for example where there is a mixture of business and non-business use need to be considered.

What if the pre-registration tax is unknown?

Where the trader has a genuine reason for being unable to calculate the pre-registration input tax, HMRC will permit an estimate to be used. HMRC does not elaborate on what is meant by a genuine reason, so presumably each case will be considered on its respective merits.

A claim can be made (in writing) for an early repayment of input tax if, due to serious shortcomings by HMRC, a registration is delayed. It is only possible to recover VAT incurred overseas under special procedures.

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3. Administration

When should the claim be made?

The claim must be made on the first return that the trader is required to make (as distinct from the first return actually made), in box 4 of the VAT return.

HMRC has discretion to allow a late claim for input tax recovery. In general, a late claim cannot be made more than four years after the original time limit. However, this four-year cap does not apply if the trader is subject to compulsory backdated registration.

What evidence is required?

Original supporting documentation and other evidence must be kept detailing the:

• date of purchase;
• description of the purchase including, for goods, details of the:
• quantity; and
• volume that has been used in making other goods; and
• date of any disposals made after registration (including the disposal date of manufactured goods made from the original goods purchased).

A trader registered for VAT and reclaimed pre-registration input tax for an invoice issued by a company which he controlled, which had ceased trading 6 days before the date of the invoice.

In the absence of a credible explanation as to the background and circumstances of the supply, the trader’s claim for a deduction was rejected as he had not provided other evidence that a genuine supply had been made to him for consideration.

4. Particular situations 

Is recovery permitted for pre-registration expenditure on property? 

Special rules apply for recovery of VAT when a trader becomes newly registered as a result of opting to tax land and property. HMRC has discretion to allow a deduction for input tax incurred on land (or services relating to land) prior to registration on a fair and reasonable basis, rather than applying the strict test set out above for goods and services.

Where a trader is already registered and opts to tax land and property, it is not necessary to meet the qualifying conditions in order to recover any pre-option input tax. Instead, the trader can request recovery on a fair and reasonable basis. The discretionary treatment given to traders who are newly registered therefore simply aims to treat the two types of traders similarly. In practice, a trader must be able to prove that pre-option input tax relates to intended taxable supplies.

What about continuous services?

In general, payments received by a trader for a supply of continuous services are treated as being supplied at the date that the payment is received. VAT must therefore be charged on any payment for such services which is received after registration, even if the services were performed before registration.

However, this rule is modified if the supply ceased prior to registration when such payments will not be liable to VAT.
A continuous supply of services is essentially a service that is performed over a period of time (as opposed to a one-off service). For example, an accountant providing ongoing advice to a client.

What about post-registration expenditure and pre-registration supplies?

It has been held that no input tax can be recovered for expenditure incurred after registration if it relates to a supply that was made by a trader before registering.

Example

Two individuals provided consultancy services to an accountancy partnership. Invoices were issued which were not paid. The individuals subsequently registered for VAT as a partnership and incurred solicitors’ fees to chase up the earlier debts.
It was held that the input tax on the solicitors’ fees could not be reclaimed, because the individuals were suing in respect of work done before registration, rather than after the creation of the partnership.

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5. Groups

What are VAT groups?

VAT grouping enables associated entities to account for VAT as a single taxable person. Further, intra-group supplies are usually ignored for VAT purposes.

While the recent changes enable unincorporated businesses to access an administrative and possibly financial benefit, the joint and several liability shared by all members of a VAT group could leave such businesses exposed.

Who can form a VAT group? 

Historically, only bodies corporate were able to register in the UK as a group and essentially be treated as a single taxable person. However, from 1 November 2019, non-corporates (who are the head of a group) are also eligible.

As is much the usual case, the remainder of this Focus will refer to companies, which can however be taken to include non-corporates with effect from 1 November 2019.

Bodies corporate include not only companies limited by shares but also:

• limited liability partnerships;
• companies limited by guarantee;
• unlimited companies; and
• industrial and provident societies.

To be in a VAT group, non-corporate bodies i.e. an individual or a partnership must satisfy all of the following criteria by having:

• control over all of the other members of the VAT group i.e. on a 51% group basis, treating the non-corporate body as a quasi-company for this purpose only;
• a business establishment in the UK; and
• a liability or entitlement to be registered for VAT in the UK on its own account i.e. it must be trading.

A partnership may comprise individuals, bodies corporate, Scottish partnerships or a mixture of any or all of these.

Companies can form a group if they are associated, in other words if:

• each has a UK business establishment; and
• they are under common control (i.e. one controls the other, or they are both controlled by one person or group of individuals carrying out business in partnership).

In addition, further conditions must be satisfied by large VAT groups with a turnover in excess of £10 million.

What counts as the UK for these purposes?

The UK includes the Isle of Man, although HMRC must be notified if a group company acquires an establishment located there when the group has had no previous local presence for VAT purposes.
Overseas companies can join a VAT group if they have a UK business establishment. There are restrictions on supplies between overseas members.

As an anti-avoidance measure, a tour operator is not eligible to be treated as a member of a group if any other member of the proposed or existing group:

• has an overseas establishment;
• makes supplies outside the UK which would be taxable supplies (including zero-rated) if made within the UK; and
• supplies goods or services which will become, or are intended to become, a designated travel service.

What is control? 

A company, A Ltd, controls another company, B Ltd, if it is:

• empowered by statute to control B Ltd’s activities; or
• B Ltd’s holding company within the meaning of the Companies Acts.

An individual or partnership controls a company if they would, were they a company, be the company’s holding company.

A company is empowered by statute to control a company’s activities if it:

• holds the majority of the voting rights in its subsidiary; or
• is a member of the subsidiary company and either:
• has the right to appoint or remove a majority of the subsidiary’s board of directors; or
• alone controls the majority of the voting rights pursuant to a shareholders’ agreement.

A company will be a holding company if it:

• controls the other company; or
• is a holding company of another holding company.

While dormant companies can belong to a VAT group, any individuals or partnerships wishing to join a VAT group must be carrying on a business.

What are “large” VAT groups?

Special rules apply to a large VAT group, which is defined as having turnover exceeding £10 million, either in the previous year or as projected for the coming year.

Where such a group has a subsidiary which is a specified body (broadly partly owned), a VAT group registration is prohibited unless the following conditions are met:

• benefits generated by the subsidiary are not diverted away from the person controlling the VAT group; and
• the results of the subsidiary are included in the group’s consolidated accounts.

For this purpose, turnover is defined as the value of all supplies made by the VAT group to persons outside the group.

Projected turnover is calculated on the basis that the company is a member of the group. If the applicant is a general partner in a limited liability partnership, the projected turnover must take into account the partnership’s supplies to persons outside the group.

What are “specified bodies”?

Subject to the exemption discussed below, a specified body is a partly owned subsidiary company that makes relevant intra-group supplies.

Excluding groups with specified bodies from a group registration is an anti-avoidance measure. Historically, partly exempt purchasers were setting up joint venture companies within their VAT group with their third-party suppliers. The aim of such arrangements was to buy in goods and services without incurring irrecoverable VAT, although in reality such joint venture companies were run by, and for the benefit of, the third-party suppliers.

What is the exemption?

A company is exempted from being a specified body if any of the following apply:

• it controls all the other VAT group members or is itself controlled by another company;
• its only activity is acting as a trustee of an occupational pension scheme; or
•  it is a charity.

Unless exempt, a specified body is defined as a company:

• that makes relevant intra-group supplies of goods or services; and
• either it:
  • is partly owned by a third party (i.e. it is not a wholly owned subsidiary);
  • has business activities which are managed by a third party; or
  • is the sole partner of a limited liability partnership.

A relevant intra-group supply is any supply of goods or services to the rest of the VAT group on which:

• VAT would be charged if the supplier was not a group member (i.e. the transaction is not zero-rated, exempt or outside the scope); and
• the representative member could not recover the related VAT in full.

 A third party is any person or partnership excluding:

• anyone who controls the whole VAT group;
• anyone controlled by the person who controls the whole VAT group i.e. all fellow subsidiaries;
• directors or employees of the company; or
• any individual who is a partner in a limited liability partnership (where applicable).

What are the consequences of group membership?

The aim of the group provisions is to ease the compliance burden on individual companies. However, there are some exclusions that arise as a consequence of being in a VAT group. For example, a VAT group member is not able to use the flat rate scheme or divisional registration.

The other consequences that flow from group membership are largely administrative, as follows:
 

Consequence	Comment
Group is treated as a single taxable person and a single VAT return is submitted by the representative member	Trades of the group members are treated as if they were carried out on by one group company (known as the representative member)
Registration is in the name of the representative member	All the VAT numbers of the group members are cancelled and a new “group” VAT number is issued, which all group members must use
Representative member normally accounts for any VAT due on supplies made by the group to third parties	Helpful if accounting is centralised but group members will need to ensure that all the necessary paperwork etc. is with the representative member on a timely basis
No need to account for VAT on supplies between group members	Subject to specific anti-avoidance provisions
All members of the group are jointly and severally liable for any VAT due from the representative member	If a representative member is unable to settle a debt of the group, each member is held liable for the debt until it is discharged
Partial exemption potentially applies to the whole group
The representative member retains the right to make claims for overpaid VAT, even if the group’s membership later changes

What about Making Tax Digital?

Making Tax Digital has applied to VAT groups since the first VAT period beginning on or after 1 October 2019, albeit with an extended soft landing period that ran until the first VAT period starting after 31 March 2021.

• HMRC gives an example of a group using a spreadsheet to prepare the VAT return information in the following steps, where:
• each group member’s software calculates the required information needed for their part of the VAT return;
• this information is then sent by a digital link to a spreadsheet which is used to compile the group totals and prepare the VAT return for the entire group; and
• the return information in the spreadsheet is then sent through a mandatory digital link to either HMRC directly (where the spreadsheet is API enabled) or via bridging software.

Unless there is a need to transfer box 9 VAT return information between the members, there is no requirement for the software systems of each group member to be linked to that of other group members.

Does there need to be a representative member?

Yes. The representative member assumes all of the group companies’ VAT rights and duties and can be any company nominated in the application.

If a member of a VAT group was eligible for special treatment in respect of its supplies, acquisitions or imports before it was grouped, that treatment can be transferred to the representative member for those supplies, etc. For example, if a charity is entitled to receive zero-rated supplies of certain goods, the representative member of the group will be deemed to take on the status of the charity group member for the purpose of the transaction(s) in question, hence preserving the beneficial VAT treatment.

What if a group member makes exempt supplies?

When including a company that makes any exempt supplies within a group registration, the group will then become partly exempt, with the following consequences:

• the de minimis limits apply to the group as a whole; and
• only one partial exemption method can be used.

As no VAT is applied to management charges levied between the members of a VAT group, the amount of irrecoverable VAT suffered by a member of a group making exempt or partly exempt supplies may be reduced.

What happens to former group members?

A former member of a group remains liable for any VAT that arose during the time it was in the group.

In relation to VAT overpayments and bad debt relief, VAT is accounted for by the representative member which retains the right to make any relevant claim. The entity which physically made the supply involved in the overpayment claim is not relevant, since the private financial arrangements within the group cannot affect the VAT treatment. When a company leaves a group, it is likewise a private matter whether or not the group retains the right to the proceeds of future claims or whether they are ceded to the leaving company. In either case, only the representative member of the group at the time that the VAT was wrongly accounted for may make the claim. 

If the representative member of a group changes, the rights already accrued remain with the representative member that was in place when the relevant supplies were made.

If the group ceases to exist, or the relevant representative member ceases to exist, provision must be made for a claim to continue (it will likely accrue to the person who has in the end suffered the burden of the overpayment). However, this does not affect the principles stated above.

When can a group registration application be made?

An application can be made at any time. It will generally take effect from the date it is received by HMRC, although it is possible to backdate an application by up to 30 days to align with the commencement of the current accounting period of the existing or new VAT group.

What happens once the application is sent?

On receipt of a completed application for grouping, change of representative member, etc., there are three possible outcomes:

Outcome	VAT number	Grounds
Application accepted within 15 days of receipt	New number issued with immediate effect from the date of application	All the necessary conditions are met
Application refused	No new VAT number issued	The necessary conditions are not met
		Revenue protection (1)
Application acknowledged but not accepted or refused, pending further enquiries which must take place within 90 days of application’s receipt (2)	New number issued with immediate effect from the date of application
1. An application to change the representative member can only be refused on the grounds of revenue protection.
2. While any further enquiries are being raised, the company is still treated as if it were registered as part of a VAT group, and VAT is accounted for on this basis.

What if registration is refused?

If an application is refused after enquiries are completed, it will effectively be treated as if it had never been allowed in the first place. Where this happens, the position of the company before the provisional registration will be reinstated. Therefore if it was previously:

a. registered in its own right, its previous registration number will be reinstated from the date on which it was originally cancelled;

b. not required to be registered at the time of application but became liable to be registered in its own right during the period of provisional registration, it must register in its own right within 30 days after the letter of refusal of group registration; or

c. not registered, and has not subsequently become liable to be so, there is no requirement to register.

If any VAT returns were submitted during the enquiry period on the basis that the company was part of the VAT group, they will need to be corrected.
The VAT group will need to revise its VAT position to take account of the fact that the company was not part of the registration. Any supplies between companies in the intended group will need to be taken into account.

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