Practice guide: How to manage VAT cashflows

Effective management of VAT cashflows should form the basis of any robust VAT framework but this is an area that many businesses critically review on an infrequent basis at best, meaning slippage occurs and the business suffers negative cashflows. Standard rates of VAT are significant and the impact on working capital can be considerable regardless of the size of the business.

There is a basic principle at the heart of managing VAT cashflows – output tax paid as late as possible and input tax claimed as early as possible. Perhaps a more fundamental principle however is one of ensuring the business does not charge or incur VAT where this is not necessary.  The new VAT place of supply rules will continue to cause confusion and generate invoicing queries for the foreseeable future and it is worthwhile reviewing invoices for services known to be affected (eg cross-border supplies of work on goods services), both from a supply and purchase perspective, to ensure queries do not adversely impact cashflows.

Once you have determined that VAT is being charged and incurred only where necessary, the next question is one of when the VAT should be accounted for – it is fair to say that all of what follows is simply good housekeeping as opposed to aggressive planning but the key is in not dismissing the potential financial benefit of making sure the business is watertight in all relevant areas.

Common misconceptions

The following areas can create unnecessary, negative VAT cashflows:

• Assuming they can be treated as ‘continuous supplies of services’ for VAT purposes, it isn’t necessary for VAT purposes to raise intercompany invoices monthly or even quarterly. Less frequent invoicing can be beneficial where there isn’t a VAT group in place.
• It isn’t necessary for a business to wait until a supplier invoice has been approved before VAT is recovered. Most businesses don’t recover input VAT as soon as they can – under-recoveries of 20–30% of total input tax for the period are not uncommon.
• HMRC has not recently stopped businesses from making input tax estimations/accruals – rather it has stopped approving requests to estimate VAT recovery on staff expenses by calculating a notional rate of VAT incurred.

Output tax

The time of supply rules ultimately govern when VAT should be accounted for but there are best-practice, commercial approaches that can be adopted to drive this in many situations. It is fairly common practice commercially to raise invoices on the final day of the month. Where this month is the final month of the VAT quarter, it is highly unlikely that the client will have paid the invoice before the output tax is payable. Delaying invoicing until the first or second day of the following month can improve VAT cashflows. Clearly the commercial impact of delaying invoicing should be considered eg will customers delay paying invoices dated in the next month longer than they ordinarily would?

Input tax

Under normal VAT accounting rules input tax can generally be recovered when the business is in possession of a valid tax invoice from the supplier. However, regardless of the size of the business and level of sophistication in the accounts payable systems, the majority of businesses recover input tax later than they are entitled to. This is usually due to the business having approval controls in place that ensure the invoice does not enter the accounts payable system until the invoice has been signed off. This can take time regardless of whether the business uses an ERP system like SAP with inbuilt functionality to approve invoices electronically through workflow, or a manual system where invoices are sat in someone’s intray awaiting approval.

Software tools are available to help businesses calculate the percentage of input tax they typically recover late which then informs decisions about ways in which the cash flow position can be improved. Options included making adjustments to the accounts payable process to ensure earlier VAT recovery by way of a manual accrual, or consideration can be given to seeking HMRC approval to uplift the input tax figure on the VAT return by a fixed percentage each period. The added benefit of an exercise of this nature in the current climate is that it provides the business with a one-off injection of cash the first time it is done. See the Example.

Data mining tools can further enhance input tax recovery and cash flows by identifying invoices with VAT that have been entered into the AP system gross with no VAT being claimed – this may be due to uncertainty on the part of the AP staff as to whether they are in possession of a valid tax invoice to support input tax recovery. Again this is an area where even businesses with the most sophisticated of ERP systems are likely to be under-recovering VAT as these aren’t systemic errors as such but rather behavioural in nature.

An area often overlooked or pushed to the bottom of a lengthy ‘to-do’ list is the recovery of overseas VAT. Deadlines are tight and there is currently an extended window of opportunity for EU businesses to 31 March 2011 to file refund claims relating to EU VAT incurred in 2009. This area is often overlooked due to the perceived risk of uncovering overseas VAT registration liabilities. There are a number of overseas VAT refund businesses in the marketplace and the key in getting comfort around the overseas registration obligations is to ensure the service provider has technical VAT specialists heavily involved in preparing the claim before it is filed as opposed to after the event when the tax authorities have raised queries. Otherwise costs and cashflows can be seriously impacted by the imposition of stringent penalties. This is an area that can produce bottom line savings or cashflows can be improved by filing claims quarterly rather than annually.

VAT returns and payments: top tips

n If the business is within the Payments On Account scheme monitor these throughout the year to ensure the amounts are still appropriate, particularly if there has been a significant change in trading eg the disposal of a business unit. If the business is seasonal in nature consideration should be given to whether it would be more beneficial to make payments on account based on actual VAT liabilities.

• Take advantage of online filing and paying by BACS etc as this provides an extension of seven days to the deadline for paying.
• Don’t overlook the potential benefit of filing monthly VAT returns for entities in a repayment position.
• VAT grouping can provide a cashflow advantage if there are a number of entities in the corporate group making charges to each other. Alternatively single registrations can be more advantageous if some group companies are in a repayment position and making monthly returns. Similarly if group companies are registered separately and file returns in different periods, a VAT cashflow advantage may be obtained on any intercompany charges depending on the timing, whereby refunds of input tax are received in one entity before output tax is due in another.

Import VAT

Although much of the focus is on customs duty when considering bonded warehouse regimes and customs duty reliefs such as Inward Processing Relief (IPR), in the majority of cases the import VAT value will be by far the biggest cost from a VAT cash flow perspective, even though it will ultimately be recovered. Bonded warehouses and IPR suspend the payment of import VAT until the goods are cleared into the EU. If they never are, the import VAT (and duty) does not become payable. Similarly the SIVA system is a trade facilitation that allows businesses with a good compliance record to defer the payment of import VAT in the same way as other deferment accounts but without the need to provide a guarantee of the import VAT.

Repayment returns

If the business files monthly VAT returns due to receiving repayments regularly, it is worthwhile ensuring that processes are in place to file the return as soon as possible after the month end to ensure the repayment is received quickly. Whilst they technically have 30 days to make repayments before repayment supplements become payable, HMRC has undertaken to expedite the processing of repayments in the current climate. Businesses not receiving regular repayments within around 10–15 days would be well advised to query the reason for this with HMRC, particularly if they spot an upward trend in the amount of time taken to make the repayment.

Significant changes to the pattern of figures on the VAT return can lead to routine queries being raised by HMRC. It is worthwhile anticipating such queries eg by collating relevant documentation in advance of the query being raised so that this can be provided quickly, thus improving the speed at which the repayment will be made.

Most of the tips outlined above should apply equally in other countries so for a UK business with multiple VAT registrations overseas it is likely significant value can be added if these are also brought into the equation.

Julie Park , Director, The VAT Consultancy