Common VAT Mistakes and Corrections in the UK

Correcting UK VAT Errors and Returns

What are the most common VAT mistakes businesses make?

Businesses frequently make several VAT errors, leading to penalties, interest charges, and HMRC investigations. Key mistakes include:

1. Reclaiming VAT Without Invoices: Claiming VAT without valid VAT invoices to support the reclaim, which HMRC requires.
2. VAT on Entertainment: Mistakenly reclaiming VAT on client entertainment expenses, which is generally not reclaimable unless it’s for staff welfare.
3. Claiming VAT Twice: Reclaiming VAT on an expense more than once due to poor record-keeping.
4. VAT on Fuel: Incorrectly calculating or claiming VAT on fuel, especially when a vehicle is used for both business and personal purposes.
5. VAT Calculation Mistakes: Manual errors or misunderstandings of VAT rules leading to incorrect VAT due.
6. Import VAT: Underpaying or overpaying import VAT due to a lack of understanding of current rules and documentation.
7. Entering The Wrong Figures: Simple typos or misinterpretation of financial data when inputting figures onto the VAT return.
8. Not Charging VAT on Non-standard Supplies: Failing to apply VAT to services provided to overseas customers or other non-standard supplies. Understanding VAT definitions like “input tax,” “output tax,” “exempt supplies,” and “zero-rated supplies” is crucial to avoid these errors.

What are the two primary methods for correcting VAT errors in the UK?

There are two main methods for correcting VAT errors, depending on the net value and nature of the mistake:

1. Method 1 (Adjustment on next return): This method is for smaller errors. You can make an adjustment directly on your next VAT return if the net value of errors found on previous returns is:

• £10,000 or less.
• Between £10,000 and £50,000, but does not exceed 1% of the total value of your sales (Box 6) for the return period in which the errors are discovered. You must record the error details (date discovered, period occurred, input/output, calculation) in your VAT records.

1. Method 2 (Formal Notification to HMRC): This method is required for larger or deliberate errors. You must notify HMRC using Form VAT652 if the net value of errors found on previous returns is:

• Greater than £50,000.
• Between £10,000 and £50,000 and exceeds 1% of the total value of your sales (Box 6) for the current return period during which the error was discovered.
• The errors on previous returns were made deliberately. You also have the option to use Method 2 for errors of any size, even if they fall below the Method 1 thresholds.

What is the time limit for correcting VAT errors?

Businesses can correct errors in VAT returns for the preceding 4 years. This 4-year limit applies to both making adjustments on your next return (Method 1) and formally notifying HMRC (Method 2).

It’s important to note that transitional arrangements were in place when the time limit increased from 3 to 4 years (effective 1 April 2009). For instance, adjustments made between 1 April 2009 and 31 March 2010 could not be made for accounting periods ending before 1 April 2006. After 30 April 2010, the full 4-year limit was in effect.

How do “non-reconciled” and “reconciled” VAT transactions affect the correction process in accounting software?

When correcting VAT transactions in accounting software like Sage 50 Accounts, the process differs based on whether the transaction has been “VAT reconciled” (included in a submitted VAT return) or is “non-reconciled.”

• Non-Reconciled Transactions:
• Editing: If you edit a non-critical field (e.g., transaction details), the amendment is made directly. If you edit a critical field (e.g., date, net/VAT amount, tax code), the original transaction is marked as “deleted” or “cancel,” and a new, corrected transaction is created.
• Deleting: If a transaction is not VAT reconciled, it can simply be marked as deleted and will not be included in future VAT returns.
• Reconciled Transactions:
• Editing: If a non-critical field is edited, the amendment is made. If a critical field is edited, the original transaction is reversed by posting a new transaction (e.g., a sales credit to reverse a sales invoice). A new transaction with the correct details is then created.
• Deleting: If a transaction has been VAT reconciled, it cannot be simply deleted. Instead, you will be prompted to reverse the transaction, which posts another transaction with the opposite impact of the original. In both reconciled editing and deleting scenarios, these reversal and new transactions will appear as “Earlier unreconciled transactions” in the next VAT return generation, requiring inclusion to report the correction to HMRC. For VAT cash accounting, reconciled transactions cannot be automatically deleted or amended; a manual reversal must be posted.

What are the consequences of not correcting VAT errors, or making deliberate mistakes?

Failing to correct VAT errors can result in significant consequences, including:

• Penalties: HMRC can impose penalties for “careless or deliberate inaccuracies.” The penalty amount may be reduced if you make an unprompted disclosure (reporting the error before HMRC begins an enquiry).
• Interest Charges: Interest may be charged on any underdeclared VAT.
• HMRC Investigations: Repeated or large errors can trigger an investigation by HMRC.
• Civil Penalties or Criminal Prosecution: Deliberately failing to correct an underdeclaration of VAT can lead to civil penalties for dishonest evasion or even criminal prosecution.

HMRC expects businesses to take reasonable care, but acknowledges that mistakes happen. However, if an error is deemed careless and not reported separately (even if corrected via Method 1), you may not receive the maximum penalty reduction.

Can VAT journals or manual adjustments be used to correct errors?

Yes, VAT journals and manual adjustments can be used to correct errors, particularly within accounting software.

• VAT Journals: Journals can impact the VAT return if posted using a VATable tax code. If posted to purchase or sales tax control accounts, they will show as VAT values; otherwise, they will show as Net values. It is generally recommended to consult an accountant if you intend to use journals to amend VAT return figures due to their complexity.
• Manual Adjustments: Accounting software allows for manual adjustments to the final figures on your VAT Return before reconciliation. These adjustments are typically used to correct past errors that meet HMRC’s adjustment criteria. Making a manual adjustment usually creates a journal entry between the VAT liability and a dedicated VAT manual adjustment nominal code. Supporting documents can be attached for audit purposes.

It’s crucial to understand how these impact the specific boxes on your VAT return (e.g., VAT amount in Box 1, Net amount in Box 6 for UK returns) and to ensure they accurately reflect the correction required.

What is Form VAT652 and when is it used?

Form VAT652 is the official document used by UK businesses to notify HMRC of significant errors on past VAT returns. It is specifically required for:

• Net errors over £50,000.
• Net errors between £10,000 and £50,000 that exceed 1% of the Box 6 (net outputs) value of the current VAT Return.
• Deliberate errors of any size.

Businesses can also voluntarily submit a VAT652 for smaller errors (those that would typically qualify for Method 1) as a sign of good faith, which may lead to reduced or waived penalties.

To complete the form, you must provide your business and VAT details, specify each error with the affected VAT period, a clear description, the correct amount, and the net effect. You also need to explain how the errors occurred (e.g., honest mistake or negligence) and calculate the total net error. The completed form should be signed by an authorized person and submitted to the HMRC VAT Error Correction Team via email or post.

What happens after a VAT error correction notification is submitted to HMRC?

Once you submit an error correction notification (especially via Form VAT652), HMRC will undertake several steps:

• Checks and Clarification: Each notification undergoes checks. HMRC may contact you to clarify details or, in some cases, visit to verify the information.
• Confirmation and Statement: Upon processing, HMRC will send a “Notice of Error Correction” confirming the adjusted amount and any calculated interest. A “Statement of Account” will also be issued, showing the current balance payable to HMRC or repayable to you. If a repayment is subject to unjust enrichment provisions, a separate letter will be sent instead of these documents.
• Payment or Repayment:Payment Due: If the statement shows an amount payable to HMRC, you should make the full payment as soon as possible. Further interest may be charged if payment is not received within 30 days of the calculation date.
• Repayment Due: If a repayment is due to you, HMRC will credit your account and use it to reduce any outstanding liabilities. Any input tax related to output tax wrongly charged (e.g., on exempt supplies) will be set against the claim. The remainder will be repaid by Bacs or Payable Order.
• Unjust Enrichment: HMRC may refuse claims for unjust enrichment if you would benefit without passing the refund to customers who bore the burden of the mistaken VAT charge. A “reimbursement scheme” is available where businesses agree to refund customers to avoid unjust enrichment, subject to specific conditions and record-keeping requirements.