It is important to firstly indentify if the buying, modifying and selling of the cars can be classed as trading. This is necessary because non-trade transactions are taxed differently. Therefore a number of tests have been developed to asses this. These are what as known as "Badges of Trade" which I have outlined for you below.
• Profit Seeking Motive
When a transaction is entered into it is necessary to determine if there has been a profit seeking motive. It is not necessarily the existence of a profit that is important, it is the motive to earn one. If this motive has been the initial factor behind it then this is strong evidence of trading, but is in itself conclusive.
• Frequency and number of transactions
A one off or low number of transactions typically indicates the non-existence of trade. However on the other hand if the same transaction is systematically repeated on frequent occasions this could be sufficient to establish trading.
• Changes to the asset
Supplementary work on assets to increase its value and therefore increase profit made on its sale can be a pointer towards trading.
• Reason for the Acquisition or Sale
If an asset is purchased with the intent of selling on for profit then this could be held as trading. However if the assets is received as a gift or inheritance and or the sale of the asset is forced or sudden then typically this would be seen as indicators of non-trade.
• Length of Ownership
If an asset has been owned for a long period of time before selling then it could be argued that it was bought for personal enjoyment and would not be considered as trade. If however the asset was owned for a short period it could be assumed the asset was purchased with the aim of selling and therefore profits made could be treated as trading profits.
• Financing Arrangements
If an asset is purchased with funds secured from finance which cannot be repaid without reselling the asset then it can be easily argued that trading has taken place.
• Connection with an Existing Trade
If there is link to an existing trade of the same description then this could be a pointer towards trading.
All evidence from the badges of trade need to be considered, however there are circumstances in which only one of these badges is sufficient to show trading. Although in most situations there needs to be a combination. In your case Ali, from what you have told me I would say that you trigger at least five of the eight badges detailed above. I therefore feel that you should consider theses carefully as a failure to register as self employed and to submit self assessments could result in legal difficulties and hefty penalties.
Section Two
Value Added Tax
Value added tax (VAT) is in essence a tax on sales. It is overseen by HM Revenue and Customs (HMRC) who ensure businesses comply with VAT regulations. A business were income is earned through trade may have to register for VAT as well as record and account for it.
Registration for VAT is required for all businesses when they reach a threshold of turnover, also known as taxable supplies.The person or business registering for VAT can be an individual, partnership or organisation. For VAT purposes the person registered is known as a "Taxable Person".
All VAT registered businesses need to charge customers VAT on all of the sales it is applicable too. This is what is referred to as "Output Tax" as it is VAT added to goods going out of the business. This VAT needs to be declared to HMRC and paid. However the business is also able to reclaim any "Input Tax" this is VAT charged on goods coming into the business, such as raw materials bought from suppliers.
In order to declare its output tax and reclaim its input tax, the business must complete a "VAT Return" This is a form in which the total amounts of output and input taxes are identified and the difference is either paid or reclaimed. Typically VAT returns are submitted quarterly (every three months) however other arrangements can be made which I have outlined later in this memo.
Section 3
VAT principles
3.1 - Categories of Supply
In order to help identify if a business is required to register for VAT. We must first look at the types of supply that it deals in. Supplies for goods or services falls into one of the three below categories:
• Outside the Scope of VAT
• Exempt Supplies
• Taxable supplies
Supplies outwith the scope of VAT are not deemed as taxable with VAT. These include the payment of wages and or dividends. Exempt supplies are supplies which do not have VAT charged, Such as postal and financial services along with education and insurance and taxable supplies are supplies which have one of three VAT rates applied which are detailed below.
• Standard Rate of 20%
These supplies cover a vast majority of goods and services. This rate covers all supplies which do not fit specifically into one or the other two rates.
• Reduced Rate of 5%
This rate is applied to supplies of a domestic nature such as fuel or power
• Zero Rate of 0%
Supplies with a zero rate of VAT are supplies which are deemed as taxable but with a rate of zero. This is due to the fact that these supplies are classed as essential and adding a higher rate of VAT would be an additional burden to those who are less well off. Examples of these are bus and train fares, most foods purchased in shops (not restaurants) and young children's clothes and shoes.
3.2 - Imports and Exports:
We must also consider where the supplies are coming from in order to determine if VAT is applied and at what rate.
If goods are bought from a non EU country, it is classed as an Import. In this case the VAT would be applied at the same rate as it would on the same supply within the UK. The VAT would be paid by the customer as it enters the country to HMRC. This can later be reclaimed back as in input tax via a VAT return.
Goods purchased from counties within the EU are known as Acquisitions. In this case the supplier will not charge VAT and neither will HMRC as the good enter the country. It is the responsibility of the purchaser within the UK to charge the VAT due on these goods as output tax via a VAT return. The purchaser is also able to claim this back via input tax.
When selling goods to non EU countries, they are classed as exports and are typically treated as zero rated supplies provided that there is adequate documentary evidence of the export and that this evidence is obtained by the supplier within 3 months of the supply.
When goods are sold to an EU country from the UK this is known as a Despatch. In this case there are two different senarios:
1. If the customer is a EU VAT registered business within the EU and can provide an EU VAT registration number the the goods will be classed as Zero rate supplies
2. If the customer is not an EU VAT registered business then the Standard rate of VAT will be applied.
3.3 - Registration and Deregistration
It is necessary for a business to register for VAT when its taxable turnover exceeds the registration limit, which of 1st April 2011 is £73000. This limit includes all standard rated and zero rated supplies.
There are two tests which can be used to determine if the limit has not been ans will not be reached. These are called the Historic Turnover Rule and the Future Turnover Rule.
• Historic Turnover Rule
If at the end of month, the value of a businesses taxable supply for the previous twelve months, or for the period since trading commenced, whichever is shorter, exceeds the registration limit of £73000, then the business must register for VAT. This must be done within thirty days of the month in which the limit has been exceeded and the registration will commence at the end of the month after the limit is exceeded.
• Future Turnover Rule
At any time if the taxable turnover of the business is expected to exceed the registration limit within thirty days it must then register for VAT. In this case, HMRC need to be notified before the end of the thirty days and the registration will commence at the beginning of this thirty day period.
However a business does not necessarily need to be turning over a minimum of £73000 in order to register for VAT. As it is possible to voluntarily register for VAT. The main reason for doing this is to be able to claim back input VAT. This is in particularly beneficial to business that make zero rated supplies as they can reclaim input VAT on its purchases. However there are some disadvantages such as a loss of business from customers if prices increase especially customers who are no VAT registered, potential of incurring penalties and don't forget the administrative work of completing regular VAT returns.
Similarly a business will also have the option to voluntarily de-register for VAT. They can apply to do so if it's turnover falls or is expected to fall (within the next 12 months) below £71000 which is the deregistration limit as of 1st April 2011. However if a business stops making taxable supplies the deregistration will be compulsory and HMRC should be notified within thirty days of this.
Section 4
Accounting for VAT
4.1 - Tax Invoice and Tax Point
When accounting for VAT it is necessary to understand what is meant by the terms "Tax Invoice" and "Tax Point".
A "Tax Invoice" is a bill containing VAT provided by a taxable person to another taxable person. A tax invoice must show the below:
• The suppliers name, address and VAT registration number.
• Customers name and address
• Transaction description and goods/services supplied
• Date of Issue
• Tax point (explanation below)
• Invoice number
• Rate of VAT
• VAT amount payable
• VAT Exclusive amounts
• Payable amount exclusive of VAT
• Rate of any cash/settlement discounts, if offered
The "Tax Point" is the point in a transaction when the supply has taken place and VAT needs to be accounted for. It is important to understand that this is not always when the supply physically takes place. Typically VAT is paid or reclaimed in the period of which the supply occurs. Therefore it we need to know the time of supply for transactions in order to ensure it is claimed on the correct VAT return at the correct rate. There is the basic tax point and the actual tax point. Both of which I have outlined below.
• Basic Tax Point
For goods, the basic tax point is when they have been made available to the customer by either collection or delivery.
Basic tax point for services is the point at which the service is performed.
• Actual Tax Point
The basic tax point outlined above can be overridden. If either of the two situations below has occurred.
The basic tax point can be brought forward if a tax invoice is issued and paid before the basic tax point date. This would make the tax point either the date the invoice is issued or payment is received.
If a tax invoice is issued 14 days after the basic tax point then this is when the supply is seen as taking place, therefore the tax point date would be the date the invoice is issued.
However businesses can, if they wish agree, a different tax point with HMRC if it suits their invoicing procedure.
There are circumstances in which special rules need to be applied as they simply do not fit into the situations above. For example continuous supplies such as gas or financial advice will not have a tax point. The time of supply will either be when a tax invoice is issued or when payment is received, whichever comes first.
4.2 - Keeping of VAT Accounting Records
There is no specific form in which VAT records should be kept. However records of all goods and services supplied or received must be retained in order to complete VAT returns and comply with checks from HMRC. It is necessary for them to be up to date and to cover the previous six years. Therefore it is advisable to preserve all tax invoices issued and received, purchase and sale day books and any other supporting evidence for VAT reclaims.
4.3 - Methods of Accounting for VAT
Annual VAT Accounting
Filing quarterly VAT returns can be burdensome, especially for small businesses, therefore there is the option to enter into an annual accounting scheme. The annual VAT accounting scheme requires only one VAT return to be filed each year. A business can register for the annual VAT accounting scheme if their annual taxable turnover does not exceed £1350,000 and they are up to date with all other VAT returns. This Scheme has been outlined below.
• The VAT return needs to be filed within two months of the annual return end date
• Typically nine equal monthly payments will be made, each representing 10% of the VAT liability from the previous year.
• A VAT liability estimate for the year will be used for new businesses
• A final and balancing payment is made when the VAT return is filed
• It is possible to agree a quarterly payments instead of nine with HMRC
Accrual Accounting
Some businesses account for their VAT using accrual accounting. This means that the output tax on the VAT return is made up of the VAT contained on invoices sent to customers during the period and input tax can being reclaimed consists of the VAT contained on invoices received from the suppliers, even if the business has not yet been paid the customer or paid the supplier.
Accrual accounting can be advantageous to businesses that purchase supplies or conduct sales on extended credit terms as it can help to avoid cash flow issues.
Cash Accounting
Cash accounting is advantageous to businesses as the scheme allows the accounting for VAT to be based upon the date of receipt or payment instead of when invoices are received or issued. Therefore automatic relief from bad debts since no output VAT is due to HMRC if the customer does not pay, also if businesses are prompt in paying its suppliers the imput tax can be reclaimed earlier than with the standard rules.
This scheme is generally used by small businesses and the general rule is that if a business has a clean record with HMRC and it's expected taxable turnover for the next 12 month, inclusive of zero rated sales, does not reach £1350,000 then the business can apply for the scheme however they must leave the scheme if the taxable turnover in the previous 12 months exceeds £1600,000.
Section 5
Administration of VAT
5.1 - VAT Assessments and Errors
Businesses have a legal obligation to submit their completed and accurate VAT returns and pay funds due to HMRC by the due date. If no VAT return is submitted or if the return is incomplete and or inaccurate then a HMRC assessment can be issued which will show the amount of VAT that HMRC has estimated it is owed. Assessments can be issued within four years of the applicable period. However this can be extended to twenty years if lost funds have been due to fraudulent or dishonest handling. After an assessment has been issued the business has the option to request a review of the decision at this point if they are not satisfied then an appeal to tribunal can be issued within thirty days.
If a business discovers it has made an error on a VAT return which has already been submitted, then it needs to calculate the "net" value of the errors discovered, this is any under stated amounts of VAT less any over stated amounts. If the error is not deliberate but above £10,000 or 1% of turnover (whichever is greater) then the error should then be reported to the HMRC VAT Error Correction Team using VAT form 652 "Notification of Errors in VAT Returns" . If however the error is below the "error correction threshold" then this can be amended in the next tax return.
5.2 - Penalties and Surcharges
Errors may be liable to a standard penalty for submission of an incorrect VAT return. If the error is disclosed voluntarily and is under the error correction threshold then no defaulting interest will be applied, However if it is above the threshold then default or has been determined with a VAT assessment then interest will be applied on the owing VAT amount. The interest will be applied from the date owing amounts should have been paid to the date the payment is actually received, although it is limited to a maximum of three years after the date of assessment or voluntary disclosure.
Surcharges are liable on VAT returns which are submitted or paid late. When this happens a "Surcharge Liability Notice" this explains what happens if another deadline is missed within 12 months, this is known as the surcharge period. If within this period another deadline is missed then a "Default Surcharge" is applied on top of the unpaid VAT. The surcharge period will be extended in line with the missed deadlines and will only end when the business has submitted four consecutive VAT returns on time along with the payments due. Default surcharges are charges based on the owed amount of VAT which is outlined below.
• First Default - No Surcharge
• Second Default (within surcharge period) - 2%
• Third Default (within surcharge period) - 5%
• Fouth Default (within surcharge period) - 10%
• Fifth and Subsequent Defaults (within surcharge period) - 15%
