If you make a mistake when calculating the VAT you owe HMRC on a return and overpay as a result, you can only correct this if you let HMRC know within four years. However, in some cases, businesses have sought to argue that errors can be corrected outside this time limit if a credit note (to reduce the VAT due on the supply) or a debit note (to increase the VAT due on the supply) is issued instead of altering the original VAT return.
In principle, this could make it possible to recover overpaid VAT an unlimited period of time after the original transaction, as there is no time limit on issuing credit notes. Many taxpayers are now seeking to reclaim VAT in relation to transactions going back decades, at a potentially significant cost to the Exchequer. The Government intends to put a stop to this from 1 September 2019 by changing the law. However, attempts have been made to deal with this issue before which the courts have found against.
When a buyer and seller agree the terms of a sale a price is agreed. However, what happens if the parties agree a price change after the invoice is raised? In particular, what about the VAT on this adjustment? Buried in secondary legislation, regulation 38 of the Value Added Tax Regulations 1995 sets out the approach which should be adopted. In the case of a decrease in the value of a supply the seller will reduce the VAT due to HMRC on the next VAT return and the buyer (if it is able) will make an opposite adjustment on its VAT return – usually the evidence will be a credit note and often a payment (from the supplier to the customer) will be made. Conversely a debit note (and additional payment from the customer) records a price increase.
If the buyer is not VAT registered, then there is no offsetting VAT adjustment made by the buyer but the seller can still reduce the VAT it pays to HMRC. Importantly, such adjustments can apply to a supply which took place at any time – there is no need to restrict this to transactions which took place in the last four years.
This has prompted many businesses to consider whether the errors they have made should be corrected by adjusting the original VAT return submission (capped at four years) or by issuing a credit note to alter the value of the original supply (which is not capped).
HMRC has amended regulation 38 several times over the last few years but its efforts to prevent uncapped claims have frequently been overturned by the courts. This latest announcement is designed to shut the door on any more claims.
From 1 September 2019, it is proposed that the amended regulation 38 will effectively stipulate that, where the value of a supply is reduced, the VAT due to HMRC can only be reduced if a credit note in a prescribed format and including prescribed information has been issued within 14 days, and a refund has been given to the customer. A customer that receives a credit note and is VAT registered must, of course, make the offsetting adjustment on its VAT return. There are similar provisions in respect of debit notes.
Price adjustments and offsetting payments are all too common in a variety of business to business transactions and the proposed amendments may lead to situations where unnecessary VAT costs are incurred unless care is taken to ensure that the correct documentation is prepared and the correct processes are followed at the correct time.