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Change of VAT rate

From midnight on 3 January 2011 the rate of VAT will increase from 17.5% to 20%. The increased administration for businesses and the problems caused by trading before, after and around the rate change cannot be under-estimated. Action is needed now to ensure your accounting systems are ready for what we hope will be the last change in the rate of VAT for a long time.

First, however, is the good news. The current VAT fraction, ie. the fraction that represents the VAT element of a VAT-inclusive price, is currently 7/47. This will become a much simpler 1/6 when the rate increases to 20%.
You will need to update your accounting system so that invoices charge the new 20% rate from 4 January 2011. Depending on how your purchase ledger system works, you may also need to review and update any automated system checks that are carried out at the data entry stage.

Of more immediate concern, however, is to decide what VAT rate to charge for sales that take place around the rate change itself; HMRC have issued comprehensive guidance around this. The full guidance is 50 pages long, which we do not propose to cover in detail, but the key issue is the ‘taxpoint’ which determines what rate of VAT to charge and when it must be accounted for.

Fundamentally, if you supply goods/ services, issue a VAT invoice or receive payment before the rate change, then VAT is due at 17.5%. Problems can arise where, for example, you receive an advance payment before the rate change for a sale made after, or invoice afterwards for a sale you made prior to the rate change. Also, supplying services over a period of time that spans the rate change can be problematic and HMRC have introduced some common-sense rules in these situations.

HMRC’s guidance regarding the goods or services supplied;

…after the rate change

Normally subject to VAT at 20%, you are able to charge VAT at 17.5% if you either issue a VAT
invoice or receive payment before the rate change. HMRC have introduced some complex anti-avoidance rules to prevent this being exploited but, although these need to be considered, it should only cause a problem in extreme cases, or where there are connected parties involved or such invoicing is completely outside your normal way of doing business.

…before the rate change

If you issue a VAT invoice or receive payment before the rate change then you are required to charge VAT at 17.5% as normal. However, if you issue a VAT invoice after the rate change, which would normally create the ‘taxpoint’ trigger for the rate of VAT to be used, HMRC will allow you to charge VAT at the old rate of 17.5% by concession.

…over a period of time

If you are supplying services over a period of time which spans the rate change, but will be invoicing later, again HMRC will allow you to charge VAT at the old rate of 17.5% on work carried out before the rate change and 20% on work carried out after.

…continuously

Finally, for those businesses providing continuous supplies of services such as leasing, property rental, long-term projects etc, where invoices are raised and payments are received from time to time, you can again charge VAT at 17.5% for services supplied before 4 January 2011.

Of course, the above concessionary approaches for invoices issued after the rate change are only beneficial where your customers cannot reclaim the VAT you charge. Where they can reclaim the VAT, you may feel there is little benefit in the additional administration needed.