HMRC Checks During VAT Inspections
Andrew Needham explains what HMRC look for during a VAT inspection, and what checks are carried out.
The purpose of a visit
In theory, HMRC is supposed to visit businesses to ensure that the correct amount of tax is accounted for at the correct time. The VAT inspector is also supposed to help with any queries that the business owner (or professional adviser) may have.
In reality, the VAT inspector has a number of targets to achieve in order to make his bosses happy. This means that he is looking for quick and easy assessments so that he can get out and see somebody else. He is not, therefore, interested in seeing if HMRC owes its ‘customers’ money, or getting involved in detailed and complex liability queries (unless he thinks he can get an assessment out of it). They have often been known to issue an assessment for underpaid VAT, without making allowances for overpaid VAT in the same period.
What sort of checks are made?
Apart from the usual checks (annual accounts reconciliation, checking purchase and sales records, etc.), they will also check that the correct VAT liability has been applied to sales, particularly in the catering industry, and check that exports and EU sales have got the correct export evidence to support zero-rating the sale. They will also check the VAT numbers of EU business customers to check that they are valid, and that zero-rating has been correctly applied. HMRC also have a number of specialised checks that they carry out on businesses and on certain business sectors.
These checks can be very useful for HMRC, but they rely on ratios and extrapolating the results. This is not necessarily good for the taxpayer, as the results can be inaccurate, particularly if the VAT inspector doesn’t have all the information available, and can cost time and money for taxpayers to sort out. It can, therefore, be useful to know how these checks work so that the taxpayer can spot them if the VAT inspector uses them, and the taxpayer can make sure that he gets the right information.
The most popular types of checks are cash reconciliations, mark-up exercises, and a ‘parts and labour’ exercise. In a cash reconciliation, HMRC will check that the amounts banked or held in cash do not exceed the declared sales. If they do, it would tend to indicate that sales have been suppressed and HMRC will want the VAT on the difference. If cash has been introduced into the business, this could distort the figures, so business owners should keep a record of cash introduced or loans obtain to account for any differences.
If the VAT inspector carries out a mark-up exercise, make sure it is a ‘weighted’ mark-up, as this takes into account the different proportions of goods sold and gives a more accurate figure. Make sure they are aware of any wastage, damaged or stolen goods, or increases in stock levels, as these can lead to distortions and prolonged arguments to have an assessment reduced or withdrawn. If the business has had thefts of stock, make sure they are documented and reported and copies of any insurance claims retained.
Parts to labour exercises for repair businesses such as garages, or food to drink ratio exercises for restaurants (the same principle but different types of goods), rely on there being constant ratios between different types of goods or between goods and services. In most cases, the invoices they issue split the total charge between the costs of the parts, including mark-up and the labour costs, or in a restaurant, between the food and drinks purchased.
The HMRC inspector will look at a sample of sales invoices and add up the total of the parts and the total of the labour and work out the ratio of the two. He will then look at a sample of the purchase invoices for the parts and establish the sale price so that he can arrive at a mark-up. He should do this for each line and then work out what is known as a weighted mark-up that takes account of the proportion of sales for each line. Having achieved a figure for the mark-up, he will then mark-up the parts purchases for a period (VAT period, year, etc.) to give an expected sales figure for the parts. He will then apply the ratio of the parts and labour to give an expected sales figure for the period. If this is markedly different from the figures on the VAT return, the VAT inspector will issue an assessment for the difference.
If the HMRC inspector does do one of these ratio checks, make sure that they take into account stock levels and any variations in stocks held. Inspectors also make mistakes, and in one case that came before a tribunal the inspector had included delivery notes as well purchase invoices, vastly inflating the purchases figure.
Andrew Needham BA CTA is a Director of VAT Specialists Limited (email@example.com) and writes on VAT subjects for several publications.
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