There is growing concern that the Flat Rate VAT system for UK contractors will end up forcing some small businesses to pay more VAT. Reports of HMRC ignoring verdicts of tax tribunals and forcing small businesses to pay higher VAT rates than required have begun to surface.
The new “improved” Flat Rate VAT system
HMRC requires Flat Rate VAT users to categorise themselves in terms of their occupations for VAT purposes. Unfortunately, the list of categories does not cover all possible occupations. As such, business owners have begun arguing with the taxman about which category they should be in. Most who apply nominate their business in the “other/unlisted” category.
The reason for this is two-fold. Firstly, many business do not clearly fall into a category on the list. In addition to this, the “other/unlisted” category also enjoys a 12% VAT rate. However, HMRC argues that many of these applicants should in fact place themselves in the “management consultant” category, which is subject to 14.5% VAT.
According to the HMRC: “If you act as a consultant and you do not fit into another specific sector, you should choose management consultancy.” The revenue service then adds: “This sector is not restricted to businesses that fit the traditional idea of management consultancy.”
Why the courts and the ATT disagree with HMRC
UK courts and tribunals seem to disagree with the HMRC wish to lump most businesses into the “other” category. In a specific case, HMRC have explicitly stated that mechanical engineers fall under “architect, civil and structural engineer or surveyor”, which carries the higher VAT rate of 14.5%. However, a tribunal judge recently decreed that mechanical engineers belong in the “other/unlisted” category. The court reasoned that a mechanical engineer provides services linked to plant and machinery, not land. As there is no specific category for mechanical engineers, they would fall under “other/unlisted”.
According to Niel Warren, head of the Association of Taxation Technicians’ (ATT) VAT sub-group, there have been other recent court cases that have confirmed that a business owner should use ordinary everyday words when determining their category.
“So an advertising consultant would never describe himself as a management consultant and a mechanical engineer would never describe himself as a civil engineer,” Warren explained. “In continuing to go against the courts views, HMRC’s thought process is flawed.”
There are recent cases where HMRC has begun retrospectively collecting tax from UK contractors who have made an “unreasonable choice” when selecting their VAT category, exacerbating an already tense situation. The fact that HMRC appears to disagree with the courts over the categorisation of contractors is also worrying.
The president of ATT, Michael Steed, gave voice to these concerns: “We feel it is the right time for HMRC to amend its guidance to accept that honest small business owners have adopted the correct category as intended by the legislation and to ensure people are not paying too much tax.
“Furthermore, HMRC must provide clarity and certainty to scheme users that they will not be faced with the threat of receiving unexpected assessments or penalties for backdated VAT that, according to the letter of the law, should not be due.”
Are you paying the correct amount of Flat Rate VAT?
Evidence of accountants and their clients having to deal with HMRC investigations on the validity of their category selection is already surfacing. Some of these investigations have ended with the contractor being on the right side of the law, while others have resulted in in the contractor having to pay more tax.