Claiming VAT on business expenses

As we've previously mentioned when to register for VATwe're now going to discuss the principal rules for claiming VAT on business expenses.

Claiming VAT on business expenses

Overview

If you're a VAT registered business you'll most likely charge your clients/customers VAT for your goods or services. Furthermore, you'll also suffer VAT on many of your expenses. 

Therefore it is important to understand the rules for claiming VAT on business expenses so you can be both tax efficient and remain compliant with HMRC.

When a VAT-registered business purchases goods or services, the VAT paid on these purchases is known as 'input tax'. In many cases, businesses can reclaim this input tax, provided certain conditions are met. This process is known as VAT recovery.

The ability to recover VAT on business expenses not only reduces the overall cost of your expenses it also enhances your cash flow efficiency. However, it's important to establish what is regarded as a recoverable VAT expense and ensure that all the necessary conditions are met. 

Conditions for claiming VAT on business expenses

HMRC sets strict guidelines and criteria for VAT recovery, and it's imperative for businesses to adhere to these to avoid complications or denials of their VAT claims. Moreover, not all input VAT can be recovered and recovery is not automatic. Input VAT must be reclaimed as part of the VAT return.

To ensure a successful VAT claim on business expenditure, the principal conditions that need to be met are as follows:

  • Firstly, your business must be registered for VAT in the UK. Therefore, if you're VAT registered, this not only allows you to reclaim VAT on your purchases, but charge VAT on your sales.
  • Secondly, for your business to reclaim VAT, the expenses must relate to goods or services used for making taxable supplies. In other words, the expenses must be incurred conducting business activities selling goods or services subject to VAT. However, this excludes activities that are exempt from VAT or outside the scope of VAT.
  • Lastly, the expenses on which VAT is reclaimed must directly relate to the business. In this tax caseit was ruled that VAT must be incurred by a taxable person in the course of an economic activity. However a 'person' can be a company or partnership as well as an individual. Additionally, the Input VAT incurred on costs must be directly and immediately linked to the supplies made by that taxable person.

What are valid business expenses?

Understanding what expenses qualify for VAT recovery is crucial for businesses. Also not all expenses incurred by a business will be eligible for a VAT reclaim. Here are some key types of expenses that do not  qualify as a general rule:

  • Entertaining: HMRC interpret this strictly and scrutinise PR events and travel expenses for non-employees. Therefore, try to itemise large invoices that could have a mix of recoverable (e.g. marketing/advertising) and irrecoverable entertaining.
  • Motor cars: However except in those instances where it can be proved they are used exclusively for business purposes.
  • Director’s accommodation.
  • Use of assets by builders not usually installed in a new build.
  • Second-hand goods.

The importance of maintaining proper business records

To successfully reclaim VAT on business expenses, maintaining proper documentation is essential. Therefore, obtaining a valid VAT invoice is the starting point. Moreover, this invoice should include the supplier's VAT number, the date of supply, a description of goods or services, and the VAT amount charged. HMRC have set out the specific criteria required here.

Businesses are required to keep their VAT invoices and other VAT records for at least six years. So these records should be readily accessible in case HMRC requests to see them, either for routine checks or audits.

With the advent of Making Tax Digital (MTD) for VAT, keeping digital records has become more important. Therefore businesses must ensure that their digital records meet HMRC’s requirements and are capable of submitting VAT returns digitally.

Avoiding pitfalls and compliance issues in VAT recovery

Navigating the VAT recovery process can prove challenging. So awareness of common pitfalls and compliance issues is key for a successful claim VAT on business expenses. Also this will also avoid penalties. We set out below some common problem areas below:

Incorrect VAT Rate Application

One of the most common mistakes is applying the wrong VAT rate. The UK has different VAT rates (standard, reduced, zero-rated), and applying the incorrect rate can lead to miscalculations in VAT recovery. Therefore, It's crucial to understand which rate applies to each type of expense.

Claiming VAT on Non-Eligible Expenses

Businesses sometimes incorrectly claim VAT on expenses that are not eligible for recovery - see above. 

Incomplete or Incorrect Documentation

Failing to maintain proper VAT invoices or keeping incomplete records can lead to denied VAT claims. Therefore it's important to ensure that all VAT invoices are complete, accurate, and stored securely for the required period

Not Accounting for Personal Use

When an expense has both a business and personal element, only the business proportion of the VAT can be reclaimed. So businesses must accurately apportion VAT between business and personal use. This is equally important in cases like utility bills for premises used for both purposes.

Late Filing and Errors in VAT Returns

Late filing of VAT returns or errors in your VAT returns can result in penalties and interest being charged. Ensuring timely and accurate VAT return submissions is crucial for compliance.

Overlooking Partial Exemption Rules

Businesses that make both taxable and exempt supplies may be subject to partial exemption rules. These rules can complicate the VAT recovery process, and failing to apply them correctly can lead to errors in VAT claims.

Neglecting Changes in Legislation

VAT legislation is subject to change, and you must stay informed about any updates or changes in the law that could affect their VAT recovery.

Misunderstanding the Capital Goods Scheme

The Capital Goods Scheme affects the VAT recovery on high-value capital assets. Misunderstanding the rules of this scheme can lead to incorrect VAT recovery over the adjustment period.

Summary

If you're vigilant about the rules, common pitfalls and compliance issues, you can avoid any issues arising in the VAT recovery process. As a result you'll ensure you reclaim the correct amount of VAT and remain compliant with HMRC regulations.

For more useful information, check out our Ebooks here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].

Alternatively, please feel free to complete our Business Questionnaire here.

Spread the word!

Why Friendly

We work with businesses and contractors/freelancers who want to embrace the world of online software and the benefits this brings. Using technology to help our clients is at the core of everything we do.

So if you'd like to find out more, just give a call or drop us an email - no hard sell.

Just friendly, professional advice!

Who we are

We're a small team with over 50 years experience of working with small businesses.

So we're in a unique position to understand the challenges that you face every day in your business.

And what's more, we're fully professionally qualified so you can be sure that your affairs are in safe hands.

Copyright 2016 by TFA Accountants Limited