Learn how the VAT rules for refunds are changing

Some key changes in accounting practices for VAT after price adjustments have been introduced. 

Effective from 1st September 2019, the amendments tend to cover some legal loopholes to discourage businesses from taking tax advantages, which they previously took by reducing the price of supplies, without refunding their customers.

In order to get a better understanding of what these changes specifically target, it is important for readers to have a basic know-how about the background of the introduced amendments.

What do you need to know about past regulations?

The prices of goods and services provided by a business can be increased or decreased after the business has accepted payment for services provided to a customer, and has applied VAT on the supply is provided to fulfill the services.

For instance, a business fails to provide the quality goods or services it promised to a customer or any third party, and due to this, the business agrees for a reduction in the price of the supply provided to fulfill the services. When this happens, businesses usually issue a credit note to its customer, after which it refunds the customer or any third party.

According to VAT regulations (1995), the businesses are bound to reduce their output tax whilst the customers (If a VAT registered) are liable to adjust their input tax accordingly

Similarly, if businesses feel that the service they provided to a customer or a third party is undervalued and they need to charge more because of the unanticipated workload, they may increase the price of the supply required to fully provide the service. In this case, businesses can issue a debit note to their customers and work out the additional VAT on the proposed increase in amount. The customers (if VAT registered), according to VAT regulations, can work out how much they have to pay for the liable input tax which is added up due to the adjustment.

Prices of the supply may continue to fluctuate for a long time even after the services have been fully provided. Regulation 38 of the VAT regulations (1995) may be applicable to cases where prices have fluctuated after the business has correctly and completely worked out the VAT amount for their output tax on the supply, in their VAT returns.

Previous regulations did not impose a strict time limit on adjustments that were to be made on VAT after the change in prices. Even though there is no time limit, VAT must be adjusted as a requirement, soon after prices fluctuate or it may result in an error. Businesses are liable to correct such errors in light of the requirements, within the timeframe mentioned in the Regulations and the VAT Act (1994).

If the accounting period is specifically taken into account, then no adjustment for VAT is needed if the prices fluctuate (increase or decrease) in the same accounting period as when the original transaction took place, this is according to Regulation 38 of the VAT regulations (1995).

VAT can be complicated, especially when various rules and regulations are applicable to your business transactions, you should always seek expert advice from an accounting firm or a vat accountant before making any major decisions.

How did the need of changing VAT refund rules emerge?

The reason for introducing reforms in the regulations is due to the flexibility of past regulations, which allows many businesses to engage themselves in immoral accounting practices by making VAT adjustments for the decrease in prices, without refunding their customers. Whilst some engage in such practices, other businesses also tend to evade the 4-year time deadline by making failed attempts on treating errors as price adjustments.

To treat the errors correctly, instead of Regulation 38 (as it imposes no time limit), VAT notice 700/45 should be used, which allows errors to be corrected during a period of 4 years after the original transaction occurred.

Whilst HMRC’s recommendation on how the law is applicable is supported by the court, the new regulations will ensure that the use of Regulation 38 will be only used for the reduction of VAT paid to HMRC, given that the business refund the amount to its customers. If you are not sure about how the regulation works for you or how you can avoid complications when adjusting for price changes, it is recommended to speak to an accountant, hire an accounting firm nearby or locate online accountants, VAT Accountants or Tax Accountants that should be able to help.

What Amendments have been made by HMRC?

HMRC intends to address these problems by making amendments to Part 3 and Part 5 of The VAT Regulations (1995). Following are the amendments that HMRC believes are the solutions to immoral practices that have taken place:

1. If the price change occurs (increase in this case) and this change has been agreed between the business and the customer, then the business must issue a debit note within 14 days from the date when the price was increased. The business must ensure that it adjusts VAT on the supply accordingly in the same VAT period in which an agreement on the price change was made with the customer.
2. If the price change occurs (decrease in this case) and the business has already made a refund to its customer or a third party, then the business must issue a credit note within 14 days from the date when the price was decreased and make VAT adjustments on their supply accordingly in the same VAT period in which the refund was given or received. Customers are required to deduct their VAT tax amount proportionally to how much the business adds.

It is important to remember that if a business is unable to issue a credit or debit note within the 14-day time limit or fails to record any required accounting entry, then this shall be considered as an error that can be corrected in the light of normal rules.

If you think you are not prepared for the new rules or not sure about how this works, speak to a tax accountant or a vat accountant for detailed guidance.

What are the conditions to make VAT adjustments on a credit note?

Adjustment of VAT on a credit note is not necessary if both the business and customer already agreed on the price change. However, if the customer is VAT registered and tax does not count as a cost to the customer, VAT adjustments on the credit notes may then be required. 

Most importantly, Regulations 38 does not account for adjustments in the prices made in the same VAT period in which the original VAT was proclaimed.

Clear House Accountants are specialist Accountants in London, who have been working with thousands of businesses helping them keep compliant, save tax, grow their business and always stay one step ahead of new changes and legislations using smart solutions and effective strategies. Speak to us to learn more.

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