Tax planning: Swings and roundabouts on the VAT front

Being registered for VAT, which many more financial advice businesses may have to be post-RDR, is not all bad news, says Mike Barnard. Some of the tax paid on bottom-line costs can be reclaimed.

Some financial advice services will be liable to VAT when adviser charges replace commissions, as explained in ‘How to minimise the impact of VAT’ (Adviser workshop, 20 July). However, there are benefits to being VAT registered that must not be ignored.

If you run one of the vast majority of financial planning companies or network companies that are not registered, the VAT you incur on overheads is a bottom-line cost. But if you have to register because your taxable (standard and zero-rated) income exceeds the threshold or you opt for voluntary registration, you will be able to claim some of that VAT back.

The amount you claim will depend on the method you adopt under HM Revenue & Customs (HMRC) guidance on partial exemption – VAT Notice 706. Partially exempt is the term applied to businesses whose turnover is a mix of taxable and exempt sales. Due to the level of VAT on costs relating to the latter, they must restrict the VAT they claim.

Advantages of VAT registration

Once charging VAT to clients becomes accepted practice, many companies will exceed the registration threshold so it is worth looking at the advantages.

For example, a financial planning or network company could be operating from premises where the landlord has opted to tax the building and so charges VAT on the rent. This can be a significant bottom line cost. But a company that is VAT registered can reclaim a proportion of the tax.

If the partial exemption method adopted is the standard method, then VAT on costs that cannot be directly attributed to either the taxable or exempt side of the business goes in a pot and is apportioned in the ratio of taxable sales to total sales.

Effective tax calculation

You have a vested interest in ensuring the taxable side of the business is maximised and at the same time ensuring compliance to HMRC law. However, you can apply for HMRC agreement to a special method of tax calculation if you believe the standard method does not fairly reflect the use to which purchases are applied.

To elaborate, you may earn fees at a ratio of 50% taxable and 50% exempt but the cost attribution or time spent in achieving your turnover may not be in the same ratio. That is when you should negotiate with HMRC to ensure the most effective (and reasonable) method is approved and the VAT you reclaim (input tax) is maximised.

The de minimis rule

An extra benefit under partial exemption is the de minimis rule that allows you to reclaim all VAT on costs and be treated as fully taxable rather than partially exempt. This rule applies if the VAT that relates to your exempt business is less than £625 per month (on average) and less than half the total VAT on costs (quarterly or annually).

So, if managed carefully, you may be able to claim back all the VAT on your costs even if £7,500 relates to exempt income – a gift from HMRC.

Other items involved are:

• VAT is only claimed provisionally (monthly or quarterly) during your partial exemption year.
• An annual calculation is made at the end of that year, with an appropriate debit/credit adjustment in the VAT return after the partial exemption year-end.
• Business and non-business costs must be identified before partial exemption calculations are undertaken.
• Income that arises outside the UK or sales to persons belonging outside the EU must be reviewed for potential VAT recovery.

Grey areas in sales

On the sales side, there are grey areas where both advice and products are involved.

Although it may be tempting to apply the adage ‘if in doubt charge VAT’, which increases the taxable level of income and consequently the VAT claimable, a retrospective assessment (plus interest) from HMRC if you get it wrong for four years (the new statutory limit) is not good. The key focus for VAT liability is the nature of the service(s) provided, not how payment for the service is made.

There is also the possibility of one or more financial products being given taxable status rather than exempt status when the outcome of a European Commission review of financial services across the EU is published. That would increase the number of financial planning companies and network companies that are required to register for VAT – but with a considerable cost to the government because financial institutions’ VAT claims will increase significantly under its partial exemption methods.

The professional angle

A significant part of the ethos of the retail distribution review is to change the nature of financial planning remuneration and create a higher level of IFA qualification and professionalism, akin to that of solicitors and accountants.

The public have always been charged fees plus VAT for legal and tax advice, so why not for financial advice?

Mike Barnard is an independent VAT consultant.