Business Taxation Introduction This report is divided into two main parts. In the first part, the badges of trade are considered and how they would be applied to Ali situation. In the second part, the principles of VAT, i. e. taxable persons, registration and deregistration, imports and exports, categories of supplies, different accounting schemes, and the administration of VAT, are discussed. I. Income tax is charged under the trading income provisions of Income Tax (Trading and Other Income) Act 2005 Part 2 on the profits of any “trade, profession or vocation whether carried on in the UK or elsewhere” .
Accordingly, all self-employed have trading income regardless of their business activities. In the absence of a satisfactory statutory definition of “trade”, the Royal Commission on the Taxation of Profits and Income suggested certain objective tests, known as “the badges of trade”. There are said to be six badges of trade as follows: * The subject matter of the transaction. The sale of goods that neither produce direct income nor give personal enjoyment to its owner is likely to be a trade. Therefore, it is unlikely that commodities or manufactured articles will be a form of an investment rather than a trade.
The purchasing and selling the lands or houses is more difficult to assess. * Length of ownership: a quick sale is likely to be a trade. The short period of ownership in Wisdom v Chamberlain 1968 was a factor to the advantage of trading as was the fact that, in Johnston v Heath 1970, the individual had contracted to sell the asset before he had acquired it. * Frequent similar transactions. * Work being done to the property before resale. * Forced sales to realise cash are unlikely to be a trade. * Motive – the intention to make a profit suggests trade.
Applying all these tests to the given case, it can be stated that Ali’s activities are in the nature of trade. First of all, Ali purchases boats to sell them later even if his hobby is renovation. He does it to yield an income not for a “pride of possession”. Ali trades the boats as soon as they are ready. The transactions are systematic and repeated. Ali undertakes supplementary work to raise the value of the asset. Also, he spends money on improvements and modifications before every sale. Clearly, Ali’s purpose is to resell renovated boats at a profit.
His intention is to set up his own business in the future. Moreover, such factors as connection with existing trade (Ali works in a machine shop in a shipyard during the week) ; sales organisation (Ali trades trough the local press and the Internet); and method of finance (the business is self-financing: the new purchase is paid out of the proceeds of the sale), may be examined. II. The VAT legislation is to be found in the Value Added Tax Act 1994, as amended by subsequent Finance Acts. A taxable person is one who is either registered or required to be registered.
It can be an individual or partnership, company, club, association or charity. If the taxable supplies reach, or will reach, the registration threshold (usually adjusted annually) the taxpayer is required to register with HMRC. However, any trader making a taxable supply can register voluntarily irrespective of his turnover level. To be a taxable person you must be making supplies in the course of a business, which is any form of economic activity even without an intention to make a profit. A taxable person pays the tax to the Customs, having charged the customer for it.
The VAT registration requirement is laid on the person. Therefore, an individual may operate several businesses but will have only one VAT registration. On the registration process, the taxpayer submits Form VAT 1 to his local VAT office at the end of any calendar month, if the value of his taxable supplies over the previous 12 months exceeds the registration threshold exclusive of VAT. Registration is also required if at any time there are reasonable grounds for believing that the value of the taxable supplies that he will make in the next 30 days will exceed ? 77,000 (2012/13 tax year) exclusive of VAT.
HMRC must be informed within 30 days of the end of the relevant month or 30 days after the date on which reasonable grounds first existed. . Deregistration takes place when HMRC cancels a registration if satisfied that the business (excluding supplies of capital assets) will not exceed the deregistration threshold of ? 75,000 (2012/13 tax year). A registered trader must notify HMRC within 30 days when ceases to make taxable supplies, otherwise penalties may be imposed (compulsory deregistration). The general rule is that all supplies that are made in the UK are subject to VAT at the standard rate of 20% as from 4 January 2011.
However, goods or services may be subject to a lower, but positive, rate of 5% such as fuel and power supplied for domestic or charity use, certain sanitary products or smoking cessation products (eleven groups in total). VAT may be also charged at the zero rate, e. g. on food other than luxury foods and food supplied in the course of catering; books, newspapers; children’s clothing (sixteen groups in total). As a result, a taxable person is not required to charge output VAT on the supply, however, he retains the right to reclaim input tax incurred on costs attributable to make an exempt supply. Lastly, a supply may be exempt from VAT.
By contrast with zero-rating, the taxpayer cannot register for VAT, charges no output tax, is not a taxable person and cannot recover input tax. Amongst fifteen groups, there are: insurance; betting, gaming and lotteries, cultural services, and education. Generally speaking, tax on the import of goods to the UK from places outside the member states will be charged at the same rate as if the goods had been supplied in the UK and must be paid by the person to whom the goods are supplied. The register trader is able to reclaim input tax. Exports of goods from the UK to non-UK countries are zero-rated.
Inside of the EU, VAT should be applied as if both parties were in the same state. In reality, if a registered person dispatches goods to a registered person in another EU country, the supply is zero-rated, if the customer’s VAT registration number is obtained and shown on the sales invoice. However, if the number is not known, or the person is not registered in another EU country, VAT should be normally charged. Usually VAT is paid quarterly. The taxpayer must pay the difference between output and input tax applicable to supplies, whilst any excess of input tax over output tax is repayable by HMRC.
A VAT return must be submitted within one month following the end of the relevant quarter period, together with any tax due. “Very large” taxpayers, defined as those whose annual VAT liability exceeds ? 2m in a year, are required to make monthly VAT payments on account to HMRC. Businesses whose annual value of taxable supplies does not exceed ? 1. 35m may apply to join the annual accounting scheme and submit only one VAT return per year. The businesses mentioned above, may also be assisted by electing to make VAT returns on a cash basis, i. e. by reference to output tax collected in the quarter less input tax paid in the same period.
Flat Rate Scheme is available to smaller businesses with a taxable turnover which is not expected to exceed ? 150,000, excluding VAT, in the next 12 months or estimated total business income in the next year will be no more than ? 191,500, including VAT. This scheme allows calculating VAT liability as a flat percentage of total turnover paid to HMRC every 3 months. It is not necessary to keep a record of the VAT charged on every sale or pay on every purchase. The basic tax point is the date on which a supply of goods or services is deemed to take place.
Once a trader is registered for VAT the trader must supply a tax invoice to other registered traders. It is optional if a supply is made to non-taxable person. The purpose of the invoice is to provide documentary evidence of the transaction. Records must be kept for six years in Scotland and must be available for inspection. VAT is a self-assessed tax unless a taxable person has failed to make a VAT return or made an incorrect or incomplete VAT return. VAT assessments and claims for a refund of overpaid VAT must be made within four years after the end of the related tax period.
A person who disagrees with appealable VAT decision made by HMRC may ask for reviewing this decision internally in relation to most VAT matters in writing within 30 days of the date of the decision. The review is completed within 45 days. Also, an appeal to the independent First-tier Tribunal of the Tax Chamber within 30 days of the date on the decision letter (without being reviewed before), the date on the review conclusion letter, or the date HMRC refused to do a review which was requested late, is possible. If any of the parties is still dissatisfied, a dispute on a point of law may be referred to the Court of Appeal.
The main penalties regarding VAT are as follows: * Tax evasion – registered business pays to HMRC less than it should; it is illegal, e. g. not charging VAT on goods and services even though it is legally obliged to, or cash-in-hand jobs by tradesmen. A civil evasion penalty may be charged up to the statutory maximum of ? 5,000 or three times the amount of tax evaded, whatever is the greater. * Failure to notify registration or late notification. The penalty is calculated as a percentage of the “potential lost revenue” and it varies between 30 and 100 per cent. VAT “wrongdoing” – VAT invoices issued by a person who is not registered for VAT, e. g. “carousel fraud” – criminal gangs trade goods with VAT across UK countries but fail to pass the VAT to HMRC. The amount of penalty varies from 30 to 100 per cent of the amount shown as VAT on the unauthorised invoice. * Incorrect VAT returns. The penalty rates for inaccuracies can be up to 30 per cent of the potential loss revenue if the inaccuracy is careless; up to 70 per cent if the inaccuracy is deliberate; up to 100 per cent if the inaccuracy is deliberate and the person attempts to conceal it. Default Surcharge. It is a civil penalty to encourage business to submit their VAT Returns and pay the tax due on time. The taxable person is default if by the due date HMRC has not received VAT Return and/or full payment of VAT has not cleared to HMRC’s bank account. The surcharge is calculated as a percentage of the VAT that is unpaid at the due date. For the first late payment the surcharge will be 2 per cent of the VAT outstanding at the due date, and then the rate will increase progressively to 5, 10 and 15 per cent.
Interest, at a commercial rate, is payable on a VAT assessment and where there has been over-declaration of input tax or under-declaration of output tax, or the taxpayer paid an amount that was not due as VAT. HMRC will also pay an interest if by their mistake the taxpayer had to wait an unreasonable time to receive payment. Conclusions Ali, as a self-employment person, has to be registered for a VAT purposes if his earnings from selling the boats, subject to VAT at the standard rate, exceed ? 77,000 per annum in 2012/13 or he goes over that figure in the next 30 days alone.
Despite the fact that Ali failed to register, he is still a taxable person and is personally responsible for the output tax due in relation to supplies made since the date on which registration should have occurred. I would suggest Ali to register for VAT immediately in case he is liable to VAT registration and disclose his income since he has started trading. In cases of fraud, HMRC has power to assess retrospectively for unpaid VAT over the past 20 years. After registration, Ali will have to pay HMRC for VAT on his sales from the date he should have been registered, even though he have not charged his customers VAT.
Additionally, Ali may be liable to a late registration penalty and/or a failure to notify a penalty. The penalty will depend on how much VAT is payable and how late the registration is. For the reason that Ali disclosure is unprompted, it will reduce any potential penalty. Under the new penalty system, binding after 1 April 2010, if Ali makes a full and unprompted disclosure within 12 months of becoming liable for a failure to notify penalty, the penalty can be reduced to zero. Furthermore, if HMRC recognises that Ali’s failure is not deliberate, the penalty can also be reduced to zero.
This is because HMRC want to encourage people to discuss their tax problems. BIBLIOGRAPHY Table of Cases Cape Brandy Syndicate v IRC 1927 Cohan’s Executors v IRC 1924 Customs and Excise Commissioners v Lord Fisher 1981 Harvey v Caulcott 1952 IRC v Reinhold 1953 IRC v The ‘Old Bushmills’ Distillery Co Ltd 1927 Johnston v Heath 1970 Martin v Lowry 1927 Mason v Morton 1986 Pickford v Quirke 1927 Rutledge v IRC 1929 Wisdom v Chamberlain 1969 Statutes Income Tax (Trading and Other Income) Act 2005 Income and Corporation Taxes Act 1988 Value Added Tax Act 1994 Textbooks Lymer A. and Hancock D. Taxation.
Policy and practice, 9th Edition. London: Thomson, 2002/2003 Revenue Law Principles and Practice. 25th Edition. Tolley Lexis Nexis, 2008. Melville A. Taxation. Finance Act 2005. 11th Edition. Edinburgh: Pearson Education Limited, 2006. Reports The Final Report of the Royal Commission on the Taxation of Profits and Income (1955: Cmnd 9474) HMRC Business Income Manual BIM20050 Aricles “Dorchester yacht broker James Williams jailed for VAT fraud”, http://www. bbc. co. uk/news/uk-england-dorset-17482296 (23 March 2012) Webpages http://customs. hmrc. gov. uk/channelsPortalWebApp/channelsPortalWebApp. portal? nfpb=true&_pageLabel=pageLibrary_ShowContent&id=HMCE_CL_000086&propertyType=document – accessed (17th of December 2012) http://www. hmrc. gov. uk/manuals/bimmanual/bim20205. htm – accessed (17th of December 2012) http://www. legislation. gov. uk/ukpga/1994/23/contents – accessed (17th of December 2012) http://uk. accaglobal. com/uk/members/technical/advice_support/tax/income_tax/2011/badgesoftrade – accessed (17th of December 2012) http://www. opsi. gov. uk/acts/acts2005/20050005. htm – accessed (17th of December 2012) http://www. taxationweb. co. uk/tax-articles/business-tax/the-badges-of-trade. tml – accessed (17th of December 2012) ——————————————– [ 1 ]. Hereafter referred to as ITTOIA 2005. [ 2 ]. ITTOIA 2005, ss. 5,6. [ 3 ]. An example of an unhelpful approach may be found in Income and Corporation Taxes Act 1988: trade “includes every trade, manufacture, adventure, or concern in the nature of a trade”. It suggests that a single adventure may constitute a trade (Martin v Lowry 1927). [ 4 ]. HMRC BIM20245. [ 5 ]. See: Rutledge v IRC 1929; Martin v Lowry 1927. [ 6 ]. IRC v Reinhold 1953; Mason v Morton 1986. [ 7 ]. HMRC BIM20310. [ 8 ]. Ibid. [ 9 ].
Pickford v Quirke 1927. [ 10 ]. HMRC BIM20275. [ 11 ]. Cape Brandy Syndicate v IRC 1927. [ 12 ]. Cohan’s Executors v IRC 1924, IRC v The ‘Old Bushmills’ Distillery Co Ltd 1927. [ 13 ]. HMRC BIM20210. [ 14 ]. HMRC BIM20270. [ 15 ]. Compare Harvey v Caulcott 1952. [ 16 ]. HMRC BIM20280. [ 17 ]. HMRC BIM20300. [ 18 ]. Hereafter referred to as VATA 1994. [ 19 ]. VATA 1994, s. 3. [ 20 ]. For VAT purposes a partnership is treated as a separate taxable entity, VATA 1994, s. 45. [ 21 ]. The definition of business for these purposes is illustrated in the case of Customs and Excise Commissioners v Lord Fisher 1981.
There are six indications of business, these being: a serious undertaking earnestly pursued, not necessarily for profit; reasonable continuity; a degree of substance as evidenced by the quarterly or annual value of taxable supplies; the undertaking is conducted in a regular manner and on recognised business principles; there is regular making of taxable supplies to consumers for consideration; the taxable supplies are commonly made by those who seek to profit by them. [ 22 ]. By contrast, a company is a distinct entity from its proprietors. [ 23 ]. VATA 1994, Sch. 1. [ 24 ].
VATA 1994, Sch. 1, para. 13(2). Http://www. hmrc. gov. uk/vat/forms-rates/rates/rates-thresholds. htm. [ 25 ]. VATA 1994, Sch. 1, para. 11. [ 26 ]. VATA 1994, Sch. 7A. [ 27 ]. VATA 1994, Sch. 8. [ 28 ]. VATA 1994, Sch. 9. [ 29 ]. Provisions are outlined in VATA 1994, s. 6. [ 30 ]. VATA 1994, Sch. 11, s. 2(1). [ 31 ]. Including business and accounting records such as orders, delivery notes, business correspondence, purchases and sales books, cashbooks, bank statements; a VAT account; a copy of each tax invoice issued; tax invoices; documentation relating to imports and exports. 32 ]. VATA 1994, s. 60. [ 33 ]. i. e. the amount of VAT for which the taxable person is liable between the date on which registration should have taken place and the date on which registration actually takes place. [ 34 ]. VATA 1994, s. 59. [ 35 ]. VATA 1994, s. 12. [ 36 ]. Assuming that boats are not boat trips under zero-rating passenger transport, vide HMRC Reference:Notice 744A (December 2009). [ 37 ]. Sheet CC/FC 11. [ 38 ]. A disclosure is unprompted if the person making it has no reason to believe that HMRC has discovered or is about to discover the inaccuracy or failure.