Deducting VAT: Should come with a health warning!

Monday, June 20, 2011

by Nick Ryan

I can, if pushed, count on my two hands the amount of businessmen, finance managers and other professionals I meet who tell me with such assurance that VAT is in their comfort zone and they are happy with their lot. This is where the hairs on the back of my neck usually begin to rise, not through anger or frustration, but in anticipation of the contradiction to follow.
Many years ago I met an alternative animal therapist who promoted his expertise and use by providing examples of his work which demonstrated that his experience generally provided for misdiagnosis at the first step. It was not until he dug deeper, referred to others etc. that he understood the facts and could provide for a more appropriate diagnosis and cure.
My experiences in VAT have identified a similar position. Recently a finance manager expressed his confidence in the management and control of VAT by telling me with complete assurance that he had applied the wrong rate of VAT to a supply for over twelve months and, it was not until he had spoken to a third party had he realised his error.
Deducting VAT is a key component of any businesses armour in the war on costs, fail to get it right or recover at the right time then costs have increased and the bottom line profit reduced.
We all generally have no problems in understanding the general disallowable VAT bearing costs a business might incur and Revenue have clearly emphasised these in their guidance leaflets. It is the other costs where the deduction of VAT might not be possible for a business that can create the problems.
Often where a business enters into a new venture or line of business does it fail to consider whether its overall VAT status has been affected. Also, how a business acts in making a particular type of supply can determine whether there is an entitlement to recover VAT borne on the associated costs. This can also have a wider impact on other general business costs. For instance a business which acts as an agent for an insurance provider could be providing both VAT exempt and VAT taxable supplies of services depending on its role and responsibilities. Where the service is VAT exempt then there is the direct loss of VAT on operating costs attributable to the insurance service provided but there is also the secondary loss of some of the VAT incurred on costs which can neither be attributed directly to either their taxable services or the insurance service. Now the headaches begin!
There are two key areas which can provide for problems in deducting VAT that are both simple and yet can provide for complexities.
Firstly it is the activity the VAT bearing cost is connected with. For example, one activity that it prevalent within the accounting industry and which provides for such concern is that of the provision of Wealth Management services.
The area of Wealth Management services as seen provided by a number of accounting practices is one where the issue of VAT deduction is key. Wealth management is the umbrella title used to cover the provision of financial services advice to private clients. Such services can qualify as either VAT taxable or VAT exempt depending on the nature of the role and service provided. Where a business makes both taxable and VAT exempt supplies then it falls into the arms of partial exemption. This means a number of increased management tasks which, if not managed correctly, can lead to mismanagement of VAT and the resultant costs this can bring to bear on a business. Key issues to focus on are:
• Is the VAT treatment of each supply correct?
• Has the costs incurred been identified for each supply and attributed accordingly
• For those costs has the right to deduction of VAT been agreed?
• For all other costs, “dual use”, is a method to calculate the level of recovery used?
• Is this method reflective of the nature of the business and its activities?
• Does the method provide for the best level of recovery possible?
• Is an annual adjustment carried out for the method to take account of fluctuations in business activities?
These questions are key drivers in determining the overall VAT deduction position of a business and cover any business which has a mix of taxable and VAT exempt supplies. From experience, most businesses fail to correctly identify the VAT treatment of the supply, especially when the supply falls within the area of financial services. Businesses also do not put in place either a method that reflects its activities and which provides for the best level of recovery. Often businesses are drawn down the path of the easiest option and, in some cases, fail to manage the position.
Treasury activities and holding companies within VAT groups can provide for similar issues for VAT deduction
Another area which provides for potential pitfalls is a business’ internal accounting processes in place that manage the deduction of VAT. In essence the over-riding aim of a business in the management of VAT should be to minimise its VAT throughput i.e. the difference between the VAT payable and the VAT deductible. This can be achieved in a number of ways though speeding up the recovery of VAT borne on operating costs should be the key driver.
In all these cases this can directly impact on their overall VAT position with a potentially negative impact but can also have a major impact on the business’ bottom line profit. Get it wrong and pay the price.
Over my time in VAT I have advised and assisted a number of businesses and non profit making organisations in firstly managing their VAT costs and in developing and agreeing appropriate dual use methods with Revenue that both accurately reflect the activities undertaken and maximise VAT recoveries to the full.
If you have any questions or concerns on this or require assistance in the management of VAT then contact Nicholas Ryan at advice@thevatpractice.ie or by telephone, 0238838181.

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