A VAT inspection can be stressful, but it will go much more smoothly if you are prepared and know what to expect. What is the inspector looking for and what sort of checks are they likely to make?
Apart from the usual checks (annual accounts reconciliation, purchase and sales records, etc.) HMRC might also open a VAT inspection.
These inspections are usually focused on what it perceives as ‘high risk’ areas. It may check that the correct VAT liability has been applied to sales, particularly in the catering industry, and that exports and EU sales have the correct export evidence to support zero-rating the sale. It will also look at the VAT numbers of EU business customers to check that they are valid and that zero-rating has been correctly applied.
HMRC also has a number of specialised checks that it can carry out on businesses and on certain business sectors. These can be very useful for HMRC, but do rely on ratios and extrapolating the results. This is not necessarily good for you, as the results can be inaccurate, particularly if the VAT inspector doesn’t have all the information available. It can also cost time and money for you to sort out.
It’s useful to know how these checks work so that if the VAT inspector uses them you can make sure that they receive the right information. You can also employ the methods yourself to help spot problems.
In a cash reconciliation HMRC will check that the amounts banked and/or held in cash do not exceed the declared sales. If they do, it would tend to indicate that the sales have been understated and HMRC will want to recover the VAT on the difference.
Tip: If you have introduced cash into the business this could distort the figures so keep a record of cash introduced or loans obtained to account for any differences.
If the inspector carries out a mark-up exercise, ensure they’re aware of any wastage, damaged or stolen goods or increases in stock levels, as these could lead to distortions and prolonged arguments to have an assessment reduced or withdrawn. If you have had thefts of stock make sure they are documented and reported and copies of any insurance claims retained.
Parts and labour
A parts and labour exercise is appropriate for repair businesses such as garages, or a food to drink ratio exercise for restaurants (the same principle applies). The inspector will look at a sample of your sales invoices and add up the total of the parts and labour and work out the ratio of the two.
The inspector will then look at a sample of the purchase invoices for the parts and establish the sale price so that they can arrive at a weighted mark-up. This is then used to predict an expected sales figure. If this is markedly different from the actual figure, an assessment for the difference will be issued.
The VAT inspector will want to check that you are applying the correct VAT rates and may wish to carry out specialist checks such as a mark-up exercise, depending on your business type. Have a method of carrying out these checks yourself so that you can investigate any issues before an inspection.