VAT errors and how to correct them
- What typically goes wrong?
- What next?
- How do you correct an error?
- Self-correction without penalty
VAT law only confers one fundamental right on VAT registered persons – the entitlement to input deduction. In contrast, as VAT is a self-assessment tax, legislation, regulations and case-law impose extensive obligations on taxpayers including the responsibility to correctly account for, collect and pay over VAT to taxation authorities.
With an ever-changing tax landscape, increasing complexity of transactions on a global scale, technological advances and legislative changes coupled with staff turnover within businesses, it should come as no surprise that taxpayers sometimes make mistakes. Regardless of the nature and extent of an error, timing is absolutely key when it comes to correcting it.
This article provides a brief overview of some of the VAT errors which are often seen and the process involved for taxpayers to correct such mistakes and regularise their position with Irish Revenue.
What typically goes wrong?
A sample list of errors often seen in practice is as follows:
- Failure to register for Irish VAT when obliged to do so
A business may exceed the Irish VAT registration threshold contained in law, say in relation to domestic supplies here in Ireland, the Intra-Community Acquisition of goods into Ireland or making distance sales from another EU Member State to Irish consumers.
- Incorrect VAT rate(s) applied
A taxpayer should ensure that they are charging the appropriate VAT rate(s) on their supplies. As VAT is a transactional tax, the business needs to consider the appropriate rate for each and every transaction. Given that businesses normally make repeated supplies of identical goods or services, it is crucial that the correct VAT rate is applied to each transaction.
Given that transactions may be considered VAT exempt or attract an Irish VAT rate of 0%, 4.8%, 9%, 13.5% or 23%, the decision on the rate is not always straightforward especially for businesses that make a significant variety of supplies. Take, for example, businesses making supplies of food or beverages in different settings, the same products may be liable to different rates depending on whether they are supplied for take away or eating on the premises.
- Failure to account for VAT on the reverse charge basis
Taxpayers acquiring taxable goods or services in Ireland from abroad within the EU generally must ensure that VAT is being accounted for on the reverse charge basis (this is where a business ‘self-accounts’ for the VAT due). This obligation is particularly important where the business receiving the supply has limited or no VAT recovery entitlement, as an absolute VAT cost then arises.
While businesses with enterprise resource planning (‘ERP’) solutions may have separate accounts and features to manage and record reverse charge VAT, other businesses have to manually calculate such VAT based on a list of foreign suppliers. Either approach is acceptable provided all relevant supplies are taken into account.
- Incorrectly recovering VAT on non-deductible expenditure
While there are some important exceptions, VAT is typically not recoverable on expenditure incurred on food, drink, accommodation, entertainment, petrol and certain other motor related costs.
- Failure to make an adjustment for unpaid purchases
Legislation introduced in recent years provides that where a taxpayer deducts VAT in a return but has not, within six months of the end of that VAT accounting period, paid the supplier for the goods or services, then the amount of VAT originally claimed as a deduction should be adjusted. The adjustment equals the proportion of VAT which relates to any unpaid supplier invoices, or part thereof.
A re-adjustment can be made to reclaim the VAT incurred once the supplier is paid.
- Property transactions
It is well-recognised that VAT on immovable property is an inherently complex area of Irish VAT law. For what is a supposed to be a harmonised EU tax, the VAT rules applying to property transactions vary considerably between EU Member States. One only has to compare the Irish and UK VAT laws to appreciate that considerable differences can arise when it comes to land and buildings.
Given that such transactions are often high in value, it is imperative to ensure the correct VAT treatment is applied. Failure to charge VAT (where correctly applicable) or incorrectly charging VAT (where it is not applicable) can lead to significant issues for the parties involved. Furthermore there can be significant hidden VAT liabilities that may unexpectedly arise under capital goods scheme adjustments which claw back VAT deduction claimed by previous owners on inflated property values before the property crash.
Our recent article ‘VAT and Property Sales’ covers this area in greater detail.
- Mergers, acquisitions and company reorganisations
Similar to VAT on property transactions, these types of transactions frequently gives rise to VAT issues.
Depending on the fact pattern of the transaction(s) involved, transfer of business relief (i.e. Ireland’s version of transfer of a going concern (TOGC) relief which applies in many other European jurisdictions) may be applicable.
While the EU and Irish law underpinning this relief – which automatically applies once the necessary conditions are satisfied – spans no more than a few lines, it is an area which has given rise to countless disputes and a body of case-law across Europe. One could certainly be forgiven for holding the view that this ‘simplification’ measure is not so simple.
Share issues, transfers, acquisitions and disposals tend to arise in the context of mergers, acquisitions and group reorganisations. Determining the correct VAT treatment is not straightforward with taxpayers typically seeking advice on whether VAT incurred on associated costs is recoverable or not. When the group structure also includes a holding company (or holding companies), the complexity increases.
The upcoming Court of Justice of the European Union hearing in the case of Ryanair Ltd v The Revenue Commissioners (expected on 14 March 2018) is eagerly awaited in this area.
We will explore this area in more detail in the next edition of Indirect Tax Matters.
Having identified some of the areas which frequently give rise to errors, we turn our attention to how to correct them below. However, before doing so, it is worth noting that there is a fundamental difference between an error and a difference in technical interpretation held by a taxpayer and Revenue. The right of appeal – which is essential to any equitable tax system – is available to Irish taxpayers against Revenue determinations in the area of VAT.
The remainder of this article proceeds on the basis that a historic error has been discovered rather than a matter in dispute which the taxpayer would appeal.
How do you correct an error?
Regardless of the nature and extent of an error, timing is absolutely key when it comes to correcting it. There are obvious advantages associated with taking prompt action, normally in the form of mitigating interest and penalties. That being so, there is a clear advantage to taxpayers who regularly review their tax affairs.
Taxpayers who discover historic VAT errors generally regularise their position with Revenue by way of self-correction or by making a qualifying disclosure.
Self-correction without penalty
As documented in the Revenue ‘Code of Practice for Revenue Audit and other Compliance Interventions’, Revenue wishes to facilitate taxpayers who discover mistakes after the filing of VAT returns. Revenue permit taxpayers to self-correct for errors by including an adjustment in a subsequent VAT return. The adjustment is typically the quantum of under-declared VAT.
While there are a number of conditions attaching to self-correction without penalty, taxpayers can generally avail of it provided the net underpayment of VAT for the period being corrected is less than €6,000.
Self-correction must take place before the due date for filing the taxpayer’s income tax or corporation tax return (as appropriate) for the chargeable period (normally a one year period) within which the relevant VAT accounting period ends. Once this time limit has lapsed, taxpayers will normally be required to make a qualifying disclosure in order to correct an error.
A qualifying disclosure is a written document which outlines full and complete information in relation to the error discovered. While there are some exceptions, this approach is generally available to regularise a taxpayer’s tax affairs. A qualifying disclosure is typically prepared by the taxpayer or their tax adviser and it is then furnished to Revenue along with payment of the under-declared VAT and associated statutory interest.
There are two types of qualifying disclosure – unprompted and prompted. While both are defined in law and also within the Revenue ‘Code of Practice for Revenue Audit and other Compliance Interventions’, their general meaning in practice is as follows:
- Unprompted qualifying disclosure – a disclosure that is made before a ‘Notification of a Revenue Audit’ is issued (that is, before the date on which the letter of notification was issued) or before the commencement of a ‘Revenue Investigation’.
- Prompted qualifying disclosure – a disclosure made after a ‘Notification of a Revenue Audit’ has issued from Revenue but before an examination of the books and records or other documentation has begun. Where a desk audit notification has issued, examination of the books and records will be regarded as having commenced on the day after the period of notice has expired.
Note, Irish Revenue frequently issue various ‘aspect’ queries to taxpayers which are not the same as a ‘Notification of a Revenue Audit’ and the right to make a qualifying disclosure is often highlighted in these aspect queries.
Where requested by or on behalf of a taxpayer, a 60 day period to prepare and submit a qualifying disclosure will usually be granted by Revenue. This allows the taxpayer to thoroughly examine their books and records and provides sufficient time to prepare a disclosure of full and complete information.
Two of the obvious benefits associated with making a qualifying disclosure are non-publication and a significant reduction in the penalty sought by Revenue. Unprompted qualifying disclosures give rise to further reduced penalties than prompted qualifying disclosures do.
If a taxpayer does not make any additional qualifying disclosures to Revenue within five years of a previous qualifying disclosure, any future qualifying disclosure is typically treated as a first qualifying disclosure. The primary advantage of this is a reduction in the quantum of penalty that Revenue would seek.
It is likely that most businesses will discover a historic VAT error at some point in their lifecycle, although the significance of the error will vary considerably between taxpayers. Timely action, full disclosure and co-operation with Revenue is always advisable when regularising tax affairs.
Should you have any queries on this article’s contents or would like our assistance with dealing with any taxation matter, please feel free to contact us.