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A VAT development that could spell trouble

TaxTalk - March 2024

Read time: 22 mins

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Tax

Publication: TaxTalk

Following a relatively unnoticed change to VAT law on 1 January 2023 which is likely to bring significant revenue to HMRC in future years, we provide an example to illustrate how these changes can affect your business.

A UK VAT-registered widget manufacturer sells part of the business to another UK VAT-registered widget manufacturer. It does this by way of a sale of trade and assets for a price of £100m, £60m of which is related to a factory. 

Both parties think the sale is obviously a VAT-free ‘transfer of a business as a going concern’ (TOGC). So the seller doesn’t charge VAT to the buyer, and therefore does not pay it to HMRC. The seller does not ask a VAT advisor to consider the VAT treatment of the sale, nor read HMRC’s VAT Notice on TOGCs. But just in case VAT is due, the sale contract states the price is “exclusive of any VAT due”. 

Hidden obstacles

So far so good. But there’s a catch. A VAT specialist review a year later, as part of an annual audit, showed the seller should have charged VAT on the property part of the assets transferred. 

Therefore, the seller raises an invoice today for £12m of VAT to the buyer. The buyer will reclaim £12m of VAT from HMRC through its next VAT return, pay it to the seller and the seller will pay it to HMRC.  You might conclude from all this that there is no issue to disclose in the seller’s annual accounts, right? Unfortunately not. Here’s what happens next:

• The seller has to submit a VAT error correction notice to HMRC in respect of the £10m of VAT that it should have paid to HMRC a year ago, i.e. the 20% VAT element of the £60m sale proceeds received at the time.
• HMRC issues assessments to the seller for the following:

• The seller appoints a VAT advisor who manages to persuade HMRC to suspend the £3m penalty for 12 months. One of the suspension conditions is that the VAT advisor reviews the seller’s VAT returns before they are filed to HMRC.
  
  
• After receiving a VAT invoice from the seller, the buyer reclaims £12m of VAT from HMRC via its VAT return form, then pays it to the seller.
  
  
• HMRC issues a VAT assessment on the seller for £10m and the seller pays £10m to HMRC.
  
  
• The seller pays the additional £2m of VAT to HMRC as part of its next VAT return payment.

What about the £775,000?

Before 1 January 2023, HMRC would normally have waived the interest charge. This was because the buyer could reclaim the VAT in full from HMRC upon receipt of a proper VAT invoice from the seller.  But UK VAT law changed on 1 January 2023.

Now, interest is due to HMRC in full, regardless of whether the buyer can reclaim from HMRC some or all of the VAT that the seller should have charged to the buyer.

The only way under the new VAT law to ask for a review of, or appeal, the interest charge is if HMRC has incorrectly calculated it and / or it was HMRC’s own fault the VAT wasn’t paid to it at the right time.

So, the seller now has a £775,000 interest charge that it has to pay to HMRC. Whilst the sale contract allows the seller to pass on the VAT charge to the buyer, it makes no mention of associated late payment interest and any penalties that the seller has to pay to HMRC at a later date. 

Fortunately, provided HMRC’s suspension criteria are met, the penalty will not be due. But the seller now has a £775,000 HMRC interest cost which is not a deductible expense for tax purposes.

Reduce the risk of interest charges

If you are the seller in this situation, how can you avoid an interest charge for late payment of VAT to HMRC?

There are several different ways to potentially reduce that risk:

• If in doubt, try to charge VAT to the buyer.
  
  
• If that’s not possible (because the buyer considers your sale to be VAT-free) then try to put a clause in the sale contract that allows you to increase the price, not only for VAT due but also interest and any penalty that you have to pay to HMRC (should HMRC disagree with the buyer’s view of the VAT treatment of the sale).
  
  
• If that’s not possible, you should try to obtain HMRC’s view of the VAT treatment as soon as possible after the sale completes. There are two ways to do this. You could seek a VAT clearance from HMRC (which usually produces a non-committal response a long time after the request is made). Or pay VAT to HMRC out of the sale proceeds, and seek a refund of that VAT from HMRC afterwards. This involves a detailed VAT repayment claim submission disclosing all the relevant facts and the sale contract.

From the buyer’s perspective, it should not reclaim via its VAT return any VAT that may have been incorrectly charged by a seller. If the buyer recovers from HMRC any ‘incorrectly charged VAT’, it will face its own HMRC interest charge and potential penalty. These are not normally recoverable from the seller, unless there are clauses in the sale contract that allow this.

So what to do next?

• Seek specialist support as early as possible from a VAT advisor – not after the sale is completed or on the day before it is about to happen.
  
  
• Involve the advisor in the drafting of the sale contract. This should ensure it contains VAT clauses that protect you as far as possible from any future HMRC interest and penalties relating to the VAT charged (or not charged) on the sale.
  
  
• Follow the VAT advice you are given in order to minimise the risk of HMRC interest and penalty charges being levied on you, or to at least keep the value of them as low as possible.

For further information or advice in relation to any of the issues raised in this article, please contact Mark Ellis.