Why is it relevant?
Most tax systems work on the concept of value rather than money itself and VAT especially has its own concepts of supply and consideration – where the ‘consideration’ for a supply is deemed by law to be everything given in exchange including any VAT payable. It is only a short step to then realise that if something is paid for in kind, rather than in money, or perhaps by a combination of the two, that the tax consequences for both parties could be far greater than first thought.
Who does it affect?
Broadly speaking, this affects any business that sells goods or services where the customer pays by doing something in return. There may be no money passing hands, or perhaps only an agreed balancing payment in cash, but the implications can be significant.
HM Revenue & Customs (HMRC) provide a simple example in their guidance of a window cleaner who offers to clean the local football club’s windows for free if they give him a free advert in their club magazine each month. Of course, his window cleaning is not free, and neither is the advert. Each party is providing a service and being paid for that by receiving a service back. For tax purposes though, rather than the window cleaner simply providing a service and being paid so that he has taxable income, and the customer has an expense, now both parties have taxable income to report – i.e., both are suppliers, and both are customers.
How does this affect VAT?
Where we have supplies of goods or services in both directions, both parties are making supplies for VAT purposes, and both must issue a VAT invoice for their respective supply under the normal VAT rules. Both may have an output VAT liability, and both may have incurred input VAT. There are two critical points to bear in mind:
- The VAT treatment of each party’s supply does not have to be the same, so one could be standard-rated and the other could be exempt for example.
- Each party’s input VAT is deductible under the normal rules for a cost in the course of business according to the business activities carried out.
Therefore, if one party is otherwise partly or even wholly exempt, they may end up with a significant VAT cost when no money changed hands at all.
There is also the technical point mentioned above that for VAT, the ‘consideration’ is everything paid including any VAT due. So, in a barter situation, one party could argue that the value of what they have given in exchange is inclusive of the other party’s VAT charge, leaving the other party liable to pay VAT out of the value they have received even if no cash has passed hands. Hence why it is normally best for suppliers to agree contracts on VAT-exclusive terms since, in barter situations, this point can cause considerable friction between parties after the event.
In the property sector, it is relatively common for two commercial parties to come to a deal for their mutual benefit where each provides land or services to the other, perhaps with a cash balancing payment included as part of the deal. If one of the parties is a wholly or partly VAT-exempt organisation, the ‘hidden’ supplies in the deal could have significant VAT consequences creating unexpected non-recoverable VAT costs.
Even in situations between two VAT registered businesses where the VAT due in each direction is all fully recoverable, the need to apply the full value to any land being transferred can significantly increase any SDLT payable or have other tax consequences.
What should you do next?
In simple terms, look out for any business arrangements where there is either no cash passing hands or any payments that are made which are not at full value. You may also find that one party has received something of a greater value than the apparent payment made.
Needless to say, correcting the tax and VAT treatments to full value in each direction after the transaction has completed can be painful.
If you would like to discuss the above further, our team would be delighted to discuss this with you. Please get in touch with your usual Blick Rothenberg contact or Simon Newark using the details below or this form.