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A client query

A fellow contract mechanical design engineer has passed the following on to me regarding a recent VAT case of a companies flat rate VAT group being challenged by HMRC.

An engineering company which was not acting as an Architect, Civil or Structural Engineer or Surveyor (ACorSEorS) was using the VAT Flat rate of 12% (Any Other Business Activity)

That rate was contrary to HMRC Guidance Notes FRS7300 which includes engineering consultants and designers in the category of Architects etc. with a rate of 14.5%

HMRC felt that the company was unreasonable in selecting the 12% rate and levied VAT assessments, interest and penalties.

The Tribunal decision, which to date has not been appealed against, was that the engineering company was not involved in ACorSEorS activities and should not be categorised in that (14.5%) sector.

i.e. the company had made a reasonable choice in the first place.

Furthermore it was confirmed at the Tribunal that the HMRC VAT guidance notes have no legal standing; they are merely guidance.

COur reply

HMRC have always advised, and still do advise that it is the taxpayer who has to make the decision as to their FRS sector, not HMRC, not the accountants nor tax advisors. This is why we don’t ever recommend any particular FRS percentage, because there is always the risk of HMRC challenging it, and then it would all come back at us. You are running your business, so who knows it better, and who better to assert the FRS sector.

I tend to provide newly registering clients with the link to HMRC’s expanded trade sector list http://www.hmrc.gov.uk/manuals/frsmanual/FRS7200.htm and the even more expanded version http://www.hmrc.gov.uk/manuals/frsmanual/FRS7300.htm   Even these lists sometimes fail to include anything that is an exact match, and this is where you are forced to make a difficult decision, do you select the “any other business….” sector which carries the low 12% rate and can be challenged by HMRC, or do you play it safe and select a higher sector that loosely covers what you do?

What people tend to forget is that Flat Rate VAT was only ever intended to be a way of simplifying VAT for the smaller businesses. Making a profit out of it was never HMRC’s intention, but it’s not a precise science, so there will be winners and losers. On the whole contractors will always be winners when using FRS, even at 14.5%, which is why it is so attractive. But choosing between a 14.5% FRS rate and a 12% rate should not be driven by the wish to increase the profit. After all, making a profit out of HMRC is not what your business was set up for. Your decision must be based on sound judgement.

The Idess Ltd case has prompted much discussion amongst tax forums, and I found this one, which is particularly informative and helpful:

http://www.taxation.co.uk/taxation/Articles/2014/07/29/328551/using-force

I think you need to read through this very carefully, also the HMRC trade sector A-Z, and if you are then confident that you can legitimately amend your FRS percentage to a reduced rate, and are satisfied that you can defend it in the event of an HMRC challenge, then you should do so. You can go back 4 years with VAT adjustments, so you have plenty of time to think about it and make your decision. It is true that HMRC are currently challenging businesses over their choice of FRS rate; we have had a handful of clients who have experienced this. However, they won’t be doing this indefinitely; sooner or later they’ll move on to their next grand plan. That’s how they operate.