Q) We are a small business who try and comply with our VAT obligations. We have found lately that the VAT we have to pay over to HMRC is more than what we are getting in payment from our customers. We account for our VAT on an invoice basis; do you have any suggestions that might alleviate our cash flow with regards to VAT payments?

A) My initial thoughts are that the terms and conditions you have in place with your customers sound like they need tightening up; you should negotiate for seven to ten days with interest to be applied for late payments.

Don’t be afraid to use HMRC’s ‘Time to Pay’ arrangements. Give them a call and try to set-up an agreement to settle any outstanding VAT liability by a schedule of smaller instalments; any arrangements need to be adhered to.

Have you considered offering your customers prompt payment discounts; for instance a 5% discount offered if payment is received within seven days? The VAT charged on the invoice will be based on the discounted value, irrespective of whether the customer takes up the offer.

If you have accounted for the output tax on your VAT return for supplies made to customers but haven’t received payment within six months from the date of the supply or when payment was due (whichever is the later date) you can claim bad debt relief by adjusting the box 4 figure on your VAT return; by adding the outstanding VAT on to your input tax figure, effectively increasing your claim to input tax. Keep a reference of the ‘bad debt relief’ in your VAT summary showing details of when it was paid over as output tax, in what VAT period it was accounted for, along with a copy of the sales invoice so that if required at a later date you have a clear audit trail to demonstrate that bad debt relief is recoverable. Bad debt also needs to written off in your accounts. If payment or part payment is subsequently received output tax will need to be accounted for again in respect of the supply.
It should be noted that the same treatment applies to your creditors; so if the business has recovered VAT on purchases based on the invoice date, but payment for the supply hasn’t been made within the six month time frame (as above) you will have to repay the VAT already recovered. For further information, have a look at HMRC’s 700/18 Notice.

The bad debt relief provisions apply to invoice based accounting, however there is an automatic bad debt relief built in with the Cash Accounting Scheme, which allows the taxpayer to account for output tax and recover input tax on the basis of payments received and made. There is a generous turnover requirement; expected annual sales of £1,350,000. Once using the scheme, you will have to leave if at the end of a VAT period the value of taxable supplies in the year then ending has exceeded £1.6 million (with certain exceptions). However, certain transactions will have to be accounted for under the normal invoice based method; including goods on hire purchase, lease purchase, conditional sale or credit sale. Or when a VAT invoice is issued and full payment is not due within six months of the date of issue. Or when a VAT invoice is issued prior to delivery.
Another scheme which may benefit you is the Flat Rate Scheme. The Flat rate Scheme cannot be used at the same time as Cash Accounting, however, it does have its’ own cash based method of accounting.

If your business has a substantial level of zero rated and exempt supplies and/or a substantial level of VAT incurred on business purchases, then the Flat rate Scheme may not benefit you. The flat rate is applied to all business income, with the exception of outside the scope services under the place of supply of services.

The scheme works by applying a flat rate percentage (depending on the business activity; different rates apply; have a look at Notice 733 available on HMRC’s website). VAT invoices are issued in the usual way and the gross amount recorded in box 6 on the VAT return. The appropriate flat rate percentage is applied to the box 6 figure and this is the VAT amount recorded in box 1. Effectively the business charges and collects 20% (for standard rated supplies) from its’ customers, but only pays over the flat rate amount to HRMC. The difference is to compensate the business for not recovering input tax, as you would for normal VAT accounting.

Recovery of VAT on capital items is allowed; essentially goods costing £2,000 or more paid for in a single purchase (with the exception of goods purchased for resale, or that generate income by being leased, let or hired, goods consumed/used entirely within one year or goods covered by the capital goods scheme). It’s worth noting that if your business buys goods from other EU member states it will be disadvantaged by the flat rate rules; as acquisition tax at the usual 20% is accounted for in box 2 on the VAT return as output tax payable without the corresponding input tax recovery normally allowed (for fully taxable businesses) in box 4 of the return.

Our tax specialist can be contacted on 01455 852550 should you require any further advice.