1

Tax Centre of Excellence Best Practice Guidance

The VAT Return Process

Contents

Introduction ........................................................................................................................................................................ 3

Principles underpinning the VAT Reporting process ........................................................................................................ 4

Making Tax Digital ........................................................................................................................................................ 4

Business/non-Business ................................................................................................................................................ 4

Practical application and system controls ..................................................................................................................... 5

Purchases ......................................................................................................................................................................... 5

Sales ................................................................................................................................................................................. 6

The VAT Reporting Process ............................................................................................................................................. 6

Overview ....................................................................................................................................................................... 6

Compliance and Assurance .......................................................................................................................................... 7

Input VAT ...................................................................................................................................................................... 8

General checking of the Input VAT figures ....................................................................................................................... 8

Contracted Out Services non-Business VAT recovery ..................................................................................................... 9

Business-related VAT recovery ......................................................................................................................................... 9

Partial Exemption/Residual Tax Calculation ................................................................................................................... 11

Output VAT ................................................................................................................................................................. 11

General checking of the Output VAT figures .................................................................................................................. 11

Purchases from overseas suppliers – the Reverse Charge ....................................................................................... 13

Consolidating and reconciling the VAT Return ........................................................................................................... 14

Uploading the VAT Return .............................................................................................................................................. 15

Additional Considerations ............................................................................................................................................... 15

Glossary .......................................................................................................................................................................... 16

Annexes .......................................................................................................................................................................... 17

Annex 1 VAT Return form and supporting VAT21 ...................................................................................................... 17

Annex 2 Global Processes ......................................................................................................................................... 20

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VAT Return Process (VAT 100 and VAT 21 Forms)

Start

Start VAT Reporting Process

. Extract

Information for returns (P5)

Review information -

Compliance and Assurance (P5)

Uploading the VAT Return (P12)

Consolidating and reconciling the VAT Return

(P11)

End

Return received (VAT100, VAT21)

(P12)

Output VAT > Rec Input VAT

Make payment to HMRC

Input VAT COS non-

business (P7)

Output VAT (P9)

Input VAT Business (P7)

Financial Accounting and Purchasing System

Reverse Charges (P10)

Input VAT Partial

Exemption (P8)

Making Tax Digital (P2)

Business/non-business (P3)

Practical application and system controls

(P3)

EC Sales List & Intrastat Return

Rec Input VAT > Output VAT

Refund received from HMRC

Update the general ledger for

VAT payments.

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Tax Centre of Excellence Best Practice Guidance

The VAT Return Process

Introduction

1. This document gives an overview of the end-to-end system and operational processes which need to be in place

to provide appropriate figures for the VAT Return, including links to external guidance where relevant. There are

more detailed sections on the assurance of the data and the processes surrounding the creation of the VAT return

itself, with recommendations for good practice gathered from a range of Departments. These can be targeted and

proportionate to the inherent VAT risk within your organisation as you set up or review your own processes,

depending on:

the complexity, volume and value of the transactions;

the amount of control within the underlying procurement and financial systems;

the degree of centralisation on expert domains within the purchasing process;

the service provided by any Shared Services provider;

the resources available to you for undertaking the assurance activity

any specific reporting arrangements agreed with HMRC

❖ Individual Departments should clearly document the processes and assurance checks they undertake to

validate the information within the VAT Returns. This will promote consistency across reporting periods and

provide clarity on the control environment, which in turn will support any external scrutiny.

2. VAT (Value Added Tax) Reporting by Government Departments and other Crown bodies is done in accordance

with VAT legislation, VAT Notice 700, and the HMRC Guidance Notes for Government Departments. Crown

bodies, as described in Section 41 of the VAT Act 1994 need to be registered for VAT even where their taxable

supplies do not exceed the normal VAT Registration thresholds, and there is a Treasury directive (VAT refund

mechanism) allowing VAT incurred on purchases (Input VAT) for certain non-Business Contracted Out Services

(COS) to be recovered via HMRC.

3. Non-Crown public sector bodies in general are liable to register for VAT once thresholds of taxable supplies are

reached, and normally follow the standard VAT rules and guidance. However, under Section 33E of the VAT Act

1994 and the VAT power to provide refunds to certain persons Notice, Non-Departmental Public Bodies may seek

permission from HM Treasury to be eligible to recover non-Business Input VAT via the Contracted Out Services

Directive.

4. The Cabinet Office Finance Global Design Principles also provide guidance on the high level processes which

need to be in place across government for good governance and risk management in taxation issues. (See Annex

2) References to the relevant Global Principles (GP) are provided throughout the document, for example: (GP 3

Each entity has registered for and holds a VAT registration number from HMRC where appropriate to do so).

5. The cross-Departmental Tax CoE (Centre of Excellence) provides advice and support on the application of the

legislation and guidance, collaborating with HMRC to provide in-depth guidance on areas which are complex to

interpret. The guidance documents are published on the Tax CoE website Tax Centre of Excellence website. The

Tax CoE also works to promote convergence in processes to encourage good practice and create consistency

across government.

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Principles underpinning the VAT Reporting process

Making Tax Digital

6. HMRC has introduced a requirement for VAT Return information to be transmitted to them digitally; more

information is on the HMRC website and in VAT Notice-700/22. Initially this is limited to the electronic transfer of

the content of the VAT Return itself, but this will be expanded over time until organisations will need to

demonstrate that the figures in the VAT Return link directly to the transactional information held in the underlying

procurement/financial systems.

7. This drives a requirement, supported by the Cabinet Office Global Processes, for VAT-related information to be

system generated with minimal manual intervention. (GP12 VAT treatment is determined at the point of

procurement and is automated). Rules should be built into the procurement/financial systems to pre-determine the

VAT treatment on purchases and sales, removing/reducing the need for the user to separately manually identify

the relevant VAT treatment for a particular transaction.

8. The robustness of the system-based controls will directly affect the amount of compliance checks needed to

ensure users have followed the prescribed governance routes and used the system correctly; it will also determine

the assurance activity needed to confirm that the VAT data produced by the system contains robust information.

Business/non-Business

9. Organisations need to be able to differentiate between their Business and non-Business activities in VAT terms,

as there are different VAT implications for each area. (GP5 A process is in place for legal entities to manage and

differentiate between business and non-business activities and adhere to government reporting). In general,

activities carried out as an obligation under a statutory duty by public sector bodies are Outside the Scope of VAT.

Activities where an organisation is providing goods or services not covered by their obligatory statutory duties

would be considered Business activities. The supply of these Business activities would be subject to the standard

VAT regulations, therefore likely to generate taxable supplies (Output VAT).

10. HMRC Internal Manuals on Business/Non Business activity provides guidance. HM Treasury has also published a

list of activities - known as the Treasury Charging Directive - which, even though they may be done under an

organisation’s statutory duty, would have a distorting effect on competition with external suppliers if the

government organisation did not charge VAT for the service because a private sector supplier would be required

to add VAT to their charges. The Treasury Directive list (Part 2B of the Guidance notes for Government

Departments) includes areas such as Secondments, provision of IT Services and the supply of accommodation

(e.g. recharging Minor Occupiers for shared accommodation); services from the list have to be treated as

Business activities, and are subject to the standard VAT regulations and VAT needs to be charged where

applicable.

11. Procurement systems/processes need to have the capacity to differentiate between Business and Non-Business

activities where it is known at the point of purchase that goods and services are being used in the delivery of a

Business activity. The system will then need to treat the Input VAT on the Business-related purchases in

accordance with standard VAT regulations. This may be achieved by:

• flagging specific cost centres within an organisation as “Business-only” in the procurement system, assuming

the chargeable supply is all business

• creating procurement category codes which are always treated as Business

• having the facility to flag particular purchase orders as Business at the point of ordering, so the

procurement/financial system can account for the VAT automatically

12. Input VAT incurred on purchases which relate to non-Business activity, or to mixed Business/Non-Business use,

needs to be assessed under the Contracted-Out Services provisions, and an additional process will need to be in

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place to adjust the Input VAT recovery between Business/Non-Business once the share of costs relating to

Business use have been identified.

13. Accounts receivable systems need to have the capacity to apply the correct VAT rate to invoices issued to charge

external customers for Business services, in line with standard VAT regulations. Invoices raised to recover costs

for obligatory statutory services should be treated as Outside the Scope of VAT.

Practical application and system controls

Purchases

14. Purchases need to carry coding information to allow the procurement system to identify the nature of the purchase

and therefore treat the transaction in line with the VAT rules set up within the system. The Global Processes

recommend this coding is done via procurement category codes linked to a central list of product types (GP10

United Nations Standard Product Service Codes (UNSPSC) are set and maintained by Cabinet Office. Each legal

entity controls additions and deletions centrally). This means:

• Organisations need a process to set up and maintain procurement category codes, ensuring they are linked to

the correct VAT treatment depending on the nature of the purchase

• Procurement category codes relating to non-Business activities need to show if the Input VAT incurred can be

recovered under the Contracted-Out Services (COS) provisions as under Section 41 of the VAT Act 1994, or if

it is non-recoverable.

• Where the non-Business Input VAT does meet the COS recovery rules in the attached list the heading

number relating to the COS recovery activity should be linked to the procurement category code (GP11 VAT

rates and HM Treasury contracted out services have been aligned to product categories and in turn to

UNSPSC. These linkages are maintained centrally);

• The VAT expert domain within your organisation needs to be involved to agree the VAT treatment to be

applied to each code before it is built into the system;

• There needs to be a way of advising procurers/users (e.g. Buyers teams, Requisitioners & Approvers) which

procurement category code to use to achieve the required VAT treatment. As a minimum there should be:

o Published guidance on departmental intranet giving guidance for regular, uncomplicated purchases;

o A detailed description attached to the procurement category code that is visible on the purchasing

system to support users in selecting the correct code:

o Controls should be in place to prevent users from overwriting system based mapping inappropriately;

o Enquiry function to allow users to ask the VAT expert domain to provide guidance on complex areas;

records of advice given should be retained to support later compliance work:

o Category codes which route to expert buyer domains for approval where additional Governance

processes are in place and these have been set up to explicitly require VAT consideration prior to

purchase (e.g. where external Cabinet Office Controls are in place on Consultancy, Contingent

Labour, Marketing, IT spend etc.):

o VAT expert domain consultation to be part of governance process for large projects e.g. as

stakeholders in the sign off of an Investment Appraisal submission. (GP17… should be consulted and

informed on the tax implications of complex purchases contracts, projects, policy and legislation

changes).

• Where the purchasing system does not support the use of procurement category codes to drive the VAT

treatment automatically alternative methods must be identified e.g.

o VAT treatment linked to individual Account Codes in the financial chart of accounts;

o Adding a manual code to the purchase information to predetermine the VAT treatment (from an

agreed list of values) with rules built into the purchasing/financial system so it can automatically

determine the VAT treatment;

o Manual coding attached as an additional description on the purchase information, so data extracted

carries the information to allow off system identification of the VAT treatment, which is then applied

manually.

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Sales

15. Sales or invoices for the recovery of shared costs e.g. from another Government Department raised through the

Accounts Receivable Process need to carry coding to show the VAT rate to be applied to the transaction, and this

then needs to be reflected on the invoice issued. (GP 6 Every transaction must have a VAT rate applied via a

centrally controlled VAT system code). This can be achieved through:

• Lists of pre-set values for users to select from for each of the business activity/income streams linked to

accounting treatment and VAT rate required (known as “Memorandum Lines” or “Memo Lines” in some

operating systems – effectively the Accounts Receivable equivalent of procurement category codes);

o Organisations need a process to set up and maintain the memo lines, creating new ones when new

income streams are identified;

o Users should not be able to over-write pre-set VAT treatment (GP 32 System generated tax code can

only be overridden in exceptional circumstances with appropriate financial approval and corrective

action taken at source);

o Tax expert domain teams need to be involved to agree the treatment of each memo line before it is

built into the system;

o Where a Business transaction has taken place, coding should also reflect whether any Input VAT

incurred in the creation of the onwards service has already been recovered under the Business Input

VAT process (see below) or if there now needs to be an apportionment process and manual

adjustments. (GP 13 Business sales and related input VAT purchases will be coded utilising the

appropriate VAT system Codes).

• Manual coding (where a system can’t use pre-set Memo Lines) for the invoice based on an agreed list of

values for the Tax Code (Standard-rated, Zero-rated, Exempt etc.), coupled with manual coding for Business

or Non-Business, and where relevant also for sales to organisations outside the UK;

• Providing guidance to users to support them in selecting the correct pre-set value or code e.g.

o Published guidance on departmental intranet gives guidance for regular, uncomplicated sales or cost

recovery activity;

o A detailed description attached to the memo line that is visible on the accounts receivable system to

support users in selecting the correct code;

o Enquiry function to allow users to ask the Tax expert domain to provide guidance on complex areas;

records of advice given should be retained to support later compliance work.

The VAT Reporting Process

Overview

16. VAT registered organisations need to submit a periodic VAT return (see Annex 1) in line with HMRC deadlines

explained in the VAT Notice 700/12 on submitting your Return. This may be on an annual, quarterly, or for larger

organisations, monthly basis. Organisations which intend to recover non-Business Input VAT under the

Contracted-Out Services directive will also need to complete a VAT21 Return, which lists the amounts being

recovered against each of the COS Headings. (GP 36 A process is in place to recover excise overpayments and

/or claim refunds from relevant tax authorities).

17. The financial reporting system should be able to post any recoverable Input VAT identified within the Accounts

Payable process into a dedicated suspense account code within the general ledger. Non-recoverable Input VAT

should remain in the General Ledger expense account code along with the net costs to which it relates. Any

Output VAT charged on invoices raised through the Accounts Receivable process should be posted to a separate

dedicated Output VAT suspense account code. These two account codes form the basis of the VAT return, and

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align to the HMRC guidance on the VAT records that need to be kept as shown in VAT Notice 700/21 and (GP 39

All statutory tax returns are drawn from the system, compiled and submitted by due dates).

18. The Output VAT is due to be paid to HMRC. The input VAT (Business and COS) is to be claimed from HMRC but

where the Input VAT figure on the VAT Return is higher than the Output VAT figure, HMRC will make a cash

refund equal to the net sum, to the organisation. This refund is normally held in a separate General Ledger

account code and will represent the balance between the Input VAT and Output VAT account codes.

19. Transaction-level lists should be extracted from the financial General Ledger, the Accounts Payable and Accounts

Receivable systems to allow the validity of the values in the Input and Output VAT account codes to be assessed.

(GP 45 Financial Systems operators develop and make available a common set of related reports). As a minimum

these reports (and therefore the underlying transactions need to hold the appropriate information to populate

them) should cover:

• The amount of Non-Business Input VAT to be recovered; the COS Heading it falls under; identifying

information on the nature of the purchase e.g Procurement Category Code information; and sufficient

information to identify the originator in the case of queries;

• The amount of Business Input VAT to be recovered; identifying information on the nature of the purchase;

sufficient information to identify the originator in the case of queries;

• The amount of Output VAT charged; the Tax Code it falls under; identifying information on the nature of the

income e.g Memo Line information; sufficient information to identify the originator in the case of queries;

• Transactions that relate to purchases from overseas suppliers, differentiating between those from the

European Union (EU) and the rest of the World (RW).

20. Where the procurement/financial system does not hold some of the elements of the VAT treatment as part of the

transaction information (for example, the transaction may be flagged as COS recoverable, but not hold the actual

COS Heading number) automated processes/macros will need to be designed to map on the additional

information to the raw system outputs. Additional reporting products are suggested below where they will support

particular compliance and assurance processes.

Compliance and Assurance

21. Before the information in the reports can be transcribed into the VAT Return and any associated VAT21 COS list,

the content of the reports needs to be quality tested to confirm users have correctly adhered with the

guidance/instructions and any advice given on raising the purchases and generating the invoices within the

system (compliance). Checks are also required to assess the quality of the data provided to ensure it is accurate

and robust (assurance) and where necessary there are clear audit trails for the VAT treatment selected. (GP

62…programme of self-assurance checks to regularly test the quality and accuracy of data underpinning

transactions, statutory returns, submissions and declarations…).

22. The suggestions listed below, brigaded by the area being assured, are intended as good practice guidance, and

need to be tailored to the requirements of your own organisation. They are not an exhaustive list as each

organisation will need to consider their own control environment and the complexities it deals with, and then

establish a compliance and assurance process that mitigates their particular risks of generating incomplete or

incorrect figures for the VAT Return.

23. Organisations which use a Shared Services provider to support the creation of the VAT Return will also need to

agree where the checks will be undertaken. Additionally, some checks, for example around users’ compliance with

routes to purchase (e.g. what type of purchases need to be system-based Purchase Orders, what is acceptable

for manual payments, and where a government procurement card can be used) may be undertaken by different

parts of your own organisation, creating an opportunity for VAT-related checks to be built into their processes to

avoid duplication of effort.

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24. Whilst most of the assurance and compliance checks will be done on the data for the period relating to the VAT

Return, if any significant errors are found there should be a retrospective check of previous periods’ data to

identify if there is any impact on figures which have already been submitted to HMRC.

Input VAT

25. The reports showing VAT charged on goods and services purchased (Input VAT) that has been treated as

recoverable by the procurement and financial system need to be validated before the figures can be used in the

VAT Return. Business Input VAT needs to be identified separately from the Non-Business Input VAT (which is to

be recovered under the COS process). Where checks indicate that VAT recovery is not appropriate the Input VAT

needs to be excluded from the amounts entered on the VAT Return (Annex 1 Box 4) and the values need to be

transferred out of the Input VAT account code and returned to the expenditure account code in the business area

that purchased the service/goods, for example via General Ledger journal corrections.

General checking of the Input VAT figures

26. The identification of transactions for checking, and/or seeking additional information from the originator of the

purchase to establish the validity of the VAT recovery, can be done in a range of ways areas to target are:

• Transactions without procurement category code/VAT coding; system-based exception reports or macros run

on reports by account code etc. should be developed to identify incomplete records, and then the nature of

the supply established and the transaction manually assessed for recovery where appropriate.

• Duplicate payments of supplier invoices; this should be prevented by the purchasing/financial system, but

where more than one payment route (e.g. Purchase Orders and Manual Payments) exists, there is the

potential for transactions to be duplicated. Input VAT should only be recovered once. Data-bases may be

required to identify potential duplicates if the volume of transactions makes spread sheet manipulation

impractical.

• Large invoices without VAT from external suppliers (i.e. not within the same VAT registration group); where

these have been attributed to VAT-recoverable Procurement Codes, the absence of VAT needs to be

challenged. It may be an indicator that the supplier is overseas and not charging UK VAT (see Overseas

transaction section), or may be error on the supplier’s part requiring the original invoice to be cancelled and

replaced with a corrected invoice.

• Transactions for VAT only invoices; after obtaining the rationale for the transaction, examine the underlying

service being received to assess if the Input VAT is recoverable or not.

• Named suppliers where there have been issues historically, to confirm the current purchase order/transaction

has been correctly assessed for VAT-recovery.

• Percentage of VAT compared to the net costs; where this is over 20% it may indicate an overseas supplier

charging non-UK VAT (e.g. Ireland charges 23% - see Overseas transaction section). Values below 20% may

indicate suppliers who are passing on disbursement costs as well as taxable charges for their own services.

(Historically HMRC audit checks have targeted this area)

• High value transactions where errors in recovery would be significant.

• Manual payments where system controls do not prevent a user from incorrectly coding the VAT recoverability

on the transaction; transactions with VAT need to be assessed for potential recovery. System based

transaction reports need to be scrutinised and the nature of the purchase identified.

• The first time a significant spend against a new purchase order appears in the transaction list; the nature of

the supply and therefore VAT recoverability should be established. Where pre-agreement/advice was sought

from the Tax team check the purchaser has complied with the guidance given (e.g. compare it to the log of

queries handled). This provides an early opportunity to rectify any errors, preventing significant impact on the

validity of the VAT Return figures.

• New suppliers; confirm the nature of the supplies and valid VAT recovery where a new supplier is identified:

as above, this provides an early opportunity to rectify any errors.

• known resource / labour suppliers such as Brook Street, Reed, Adecco, Alexander Mann etc

• Random check of transactions flagged recoverable to confirm accuracy.

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27. The checks above are designed to prevent over-recovery of Input VAT, and reduce the risk of HMRC penalties

and requests for repayment; depending on the availability of the data/reports, similar checks can be carried out on

reports of transactions not flagged for recovery to identify potential areas where additional Input VAT may

legitimately be recovered.

28. Checks on aggregate information, from system reports or pivot tables of transaction level lists for example, can

also be valuable in identifying areas for closer inspection:

• Variance analysis on values where there is normally a regular pattern of Input VAT recovery; significant

changes in value need to be explained, as they may relate to new major contracts coming on line that require

checking to confirm VAT recovery is valid, or flag up issues within the system that are erroneously missing

recoverable VAT.

• Trend analysis over a period of time; for example, reducing recovery may be a changing pattern of spend but

could also be indicating a rising pattern of user errors.

• “Deep Dives” or targeted investigations into particular types of expenditure e.g based on COS headings or

spend driven by a particular part of the organisation; this is especially useful when there is a new area of

activity where a tax up-skilling need for purchasers may be indicated.

Contracted out Services non-Business VAT recovery

29. In addition to the general checks, Non-Business transactions flagged as recoverable under the COS regime need

to be tested to confirm that recovery under the COS headings is appropriate, and the purchase meets the

conditions within the COS heading description to which it is attributed. Additional guidance agreed between the

Tax Centre of Excellence and HMRC on complex areas is also available on the TCoE website.

30. Areas to target are:

• Complex COS headings; transactions on COS headings which are particularly complex and easy to

misinterpret should be sampled/validated. Areas like COS52 Professional advice or opinion on departmental

efficiency or policy issues, legal advice or opinion and internal audit, COS21 Estate management services,

COS35 Maintenance, non-structural repair and cleaning of buildings and COS 14 Computer services supplied

to the specification of the recipient should be reviewed, as should any COS headings specific to your

organisation.

• Mismatched or missing coding; additional “exception” reports should be created/run which show transactions

without a full set of relevant coding, for example showing “a COS recoverable” marker but then not holding an

associated COS heading number; investigations are needed to allocate a relevant COS number or to confirm

VAT should not be treated as recoverable.

• Tax Point and out of date transactions; the COS recovery regime requires recovery from HMRC to be done in

the same financial year that the VAT was incurred (with a three month adjustment period at the beginning of

the next tax year) See the HMRC guidance for details. Any transactions with an invoice date/tax point prior to

the current financial year need to be identified and excluded from the VAT Return figures. (Note – transactions

which are correcting an earlier invoice that has already been recovered through a VAT Return within the last 4

financial years can however be accepted.) (GP29 Tax point is based on the date the supply took place, the

payment received or invoice date in line with HMRC or applicable country guidance).

• Suppliers where transactions are appearing on multiple/unrelated COS headings; check to confirm the COS

heading matches the nature of the supplier’s business (e.g. from their webpage descriptions mismatches may

indicate the purchase order has been set up incorrectly and is therefore creating an incorrect VAT treatment.

31. The Input VAT to be recovered against each of the individual COS Headings is entered into the VAT Return on

part 2 of the VAT21 form, as well as going into the VAT Return Box 4 as shown at Annex 1.

Business-related VAT recovery

32. Input VAT incurred in the course of Business-related activity can be recovered in line with the normal VAT

regulations and timeframes (the maximum is usually 4 years) as explained in the HMRC guidance. In general,

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Input VAT incurred in generating an onward supply that is Standard-, Reduced- or Zero-VAT rated can be

recovered, although there are exceptions to this covered in the HMRC guidance.

33. Input VAT incurred in generating an onward supply that is treated as Exempt of VAT cannot be recovered under

the normal VAT regulations, nor can it be recovered under the COS regime as it has not been used for non-

Business Activity. This restriction could be managed through the creation of non-recoverable procurement

category codes to suppress VAT recovery on the incoming costs in the Accounts Payable system; or where the

exact costs to be recharged are not known at the point of purchase, manual adjustments would be needed. The

recharging of shared Accommodations costs to non-Crown bodies as minor occupiers is an Exempt onward

supply which is commonly encountered.

34. When completing the VAT Return, the Business Input VAT recovery amount is entered at Part 1 of the VAT21,

and also goes into Box 4 on the face of the VAT Return.

35. Checks to undertake on the reports (please refer to paragraph 19) showing transactions which are flagged as

recoverable under the standard Business-related VAT guidance rather than the Non-business COS VAT recovery

process. :

• Confirm the status as Business related transaction for VAT purposes;

• Where Business Activity is determined by a cost centre–level flag in the procurement/financial system, confirm

the cost centre has been pre-agreed as undertaking Business related activities only.

o Where Business Activity is determined by the use of a specific business procurement category,

confirm the use of that procurement category code was appropriate.

o Where Business Activity is set at purchase order level (e.g. where the normal mapping of a

procurement category code to COS Non-business recovery has been overridden for a specific

Business-related purchase), confirm this was pre-agreed before the purchase order was set up, and

the selection is not through unwitting user error.

36. Input VAT on transactions flagged as Business activity should have been automatically posted to the Input VAT

account code in the chart of accounts via the procurement/financial system. If the checks above do not confirm the

transaction as relating to Business activity, the correct VAT treatment needs to be established;

• For Input VAT confirmed to relate to Non-Business activity which falls under the COS regime for recovery, the

figures on the VAT Return need to be adjusted to reflect the increase in the COS VAT recovery shown on the

VAT21 against the relevant COS Heading; note the time limit/one year recovery period also needs to be

considered.

• Input VAT confirmed as Non-Business but non-recoverable will need to be excluded from the VAT Return

figures altogether and transferred out of the Input VAT account code back to the expenditure account code in

the relevant business area via General Ledger journals

• Input VAT incurred on services which form part of an exempt onward supply will also need to be suppressed

from input VAT recovery.

37. Organisations who do not have dedicated Business cost centres, or incur Input VAT on services that relate to

mixed Business and non-Business use will need a process to attribute the recovery of the input VAT between the

two. Where the organisation is purely passing on a proportion/share of costs on which it has incurred Input VAT,

and there is no profit element in the charges it makes, the attribution methodology could be based on the amount

of the invoices raised to the customer of the onward service. In this scenario the Input VAT to be recovered under

the Business rules would be equal to the Output VAT charged.

38. Where a supply which was originally treated as Non-Business and COS recoverable is used for Business

purposes the proportion of the VAT attributed to the Business activity needs to be re-classified from the COS

Headings on the VAT21 (reducing COS recovery and increasing Business-related recovery) to show only on the

face of the VAT Return. There is no need for adjustments to the Input VAT account code.

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39. If the supply was originally treated as Non-Business but non-recoverable, its use as part of a taxable supply will

allow the relevant proportion of the Input VAT incurred to be recovered under the VAT Business rules. This Input

VAT will not have originally been automatically posted to the Input VAT account code by the procurement/finance

system, so the relevant amount will need to be moved from the expenditure account code into the Input VAT

account code before it can be reflected on the VAT Return for Business related VAT recovery.

Partial Exemption/Residual Tax Calculation

40. Organisations will incur VAT on most of the supplies they receive. This is only recoverable if it is used to make an

onward taxable business (standard, reduced or zero rated) supply or is a non-business expense that can be

recovered under the non-business COS headings. VAT incurred in generating an exempt onward supply cannot

be recovered. When the VAT incurred is only used to generate exempt supplies, it can be directly attributed to

‘non-recoverable’ and the guidance above applies. However, many of the costs incurred by organisations are

used to provide multiple services which may be a mix of business taxable, business exempt and non-business.

These include cost such as accommodation, IT and HR. As such, the VAT incurred cannot be directly attributed to

one specific onward supply. This is referred to as mixed-use VAT and an apportionment exercise is needed to

ensure that the VAT recovered reflects economic use. Typically, there are two stages to achieve this, a

business/non-business apportionment and then a partial exemption calculation. The partial exemption calculation

should produce a fair and reasonable result and organisations will need to agree a methodology with HMRC. To

assist organisations, HMRC have provided a framework which outlines principles that can be followed to simplify

the approval process. See the framework for government departments here.

41. Where the non-allowable Residual Tax is significant, or is based on a fixed percentage of income or costs,

organisations may wish to include the restriction of the Input VAT in the quarterly/monthly VAT Return, and

undertake a reconciliation and adjustment at year-end. Input VAT identified as non-recoverable within the VAT

Return process should be transferred back to an expenditure account code to maintain the reconciliation between

the VAT Return figures and the general ledger Input VAT account code.

42. Organisations with agreements to make calculations and adjustments just at year end may wish to recover all the

Input VAT in the quarterly/monthly VAT Returns, and put accruals on the financial system throughout the year so

any required repayment of Input VAT already recovered is taken into account in the expenditure forecasts. Year

end adjustments that are paid as a separate assessment would not flow through the VAT Return itself, nor would

the amounts appear in the Input VAT account code (as the repayment would be made from an expenditure

account code).

Output VAT

43. The Accounts Receivable reports should list for every transaction: the net value; the Tax rate applied and the VAT

value; the nature of the supply; the recipient organisation (as VAT treatment can differ depending on the type and

location of the customer); and a way of identifying the originator so queries can be followed up. Where memo lines

are used to automate the Tax coding for the invoice and indicate the Business or Non-business nature of the

supply, this information should also appear in the reports.

44. The Accounts Receivable/financial system should post the Output VAT charged into the Output VAT account code

in the general ledger. This forms the figure that is entered on the VAT Return at Box 1, with the net value of all

sales (excluding VAT) showing at Box 6. Where the Output VAT figure exceeds the amount of Input VAT which

can be recovered this represents a payment due to HMRC.

General checking of the Output VAT figures

45. The identification of transactions for checking, and/or seeking additional information from the originator of the

invoice to establish the validity of the Output VAT charged, can be done in a range of ways; for example, where

combinations of numbers/letters or specific memo lines are used to identify the nature of the supply, excel macros

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or formulas added to the reports can cross check whether the expected/pre-mapped Tax Rate has been applied.

Where volumes of transactions are low, manual scrutiny may be practical.

46. Areas to target include transactions which are:

• Standard-rated or reduced rated tax rates where the VAT amount is not 20%/5% of the net figure shown

(arithmetical errors); or those showing Zero, Exempt or Out of Scope Tax Rate but having a figure in the VAT

field.

• Business Activities that are listed in the Treasury Taxing Directive, but do not have a UK Standard Tax Rate

on the invoices raised; areas such as Secondments and services to other Government departments frequently

generate errors.

• Transactions with an apparently inconsistent Tax Rate when compared to the description given;

• High value transactions, where an error would result in a significant under/overpayment of Output VAT to

HMRC.

• Sales/Services provided to overseas customers; confirm they have the correct Tax Coding and required

information on the invoice to support anything set as Zero-rated or Outside the Scope of UK Tax. Invoices

should carry a note to the customer that they are responsible for the VAT accounting, and the overseas

customer’s VAT registration number should be included in the invoice to confirm their status as a Business

has been checked (links to the HMRC guidance on overseas transactions are in the section below). Intrastat

and EC Sales lists Returns to HMRC may need to be completed for overseas transactions (See the Single

Market VAT Notice 725).

• Onward Taxable supplies which may need the recovery of the Input VAT handling manually (see the Business

Input VAT section).

• Onward Exempt supplies which may need the recovery of the Input VAT manually suppressing (see the

Business Input VAT section). The Exempt onward supply of Accommodation to non-Crown bodies minor

occupiers needs to be clearly differentiated from the supply to Crown bodies under a Memorandum of Terms

of Occupation (MOTO – Outside the scope of VAT) as the implications for the associated Input VAT are

different. Additional guidance is available on the TCoE website.

• Duplicates; comparisons between reporting periods may be needed to identify these. Output VAT should only

be paid once to HMRC.

• Credit notes; these should follow the same VAT treatment as the original invoice to ensure whatever Tax

treatment was originally applied if fully reversed.

• Invoices which relate to transaction types or business areas where errors have previously been identified;

confirmation is needed that any remedial advice given is now being followed.

• New customers; confirm the nature of the supplies and valid Tax Rate is in use where a new (high value)

customer is identified.

• Random check of transactions to confirm accuracy.

47. Checks on aggregate information from system reports or pivot tables of transaction level lists for example, can

also be valuable in identifying areas for closer inspection:

• Variance analysis on values where there is normally a regular pattern of Output VAT charges; significant

changes in value need to be explained, as they may indicate delayed or missed charges being raised, or flag

up issues within the system that are failing to apply the correct Tax Codes/Rates;

• Trend analysis over a period of time; for example, reducing Output VAT may be a changing pattern of

rechargeable services, but could also be indicating a rising pattern of user errors;

• Targeted investigations (Deep Dives) into particular types of onward charging, or income received by a

particular part of the organisation; this is especially useful when there is a new area of activity where an

additional training need for those raising the invoices may be indicated.

48. Remedial action is needed where Output VAT has been incorrectly charged to a customer; credit notes processed

through the Accounts Receivable/financial system should reverse the posting to the Output VAT account code. If

system-based corrections are not possible, then manual adjustments will be needed to reflect a refund to the

customer.

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49. Where VAT has been incorrectly omitted from the invoice there may be a process to cancel and re-issue a

corrected invoice, which will ensure the financial reporting and the Output VAT account code in the general ledger

is correct automatically. If the correction is made by issuing a VAT-only invoice, care is needed to ensure the VAT

amount remains in the VAT field, and does not appear on the net line as manual adjustments may be needed to

ensure the amount appears in the Output VAT account code and thus flows through to the VAT Return.

Purchases from overseas suppliers – the Reverse Charge

50. Transactions with overseas suppliers and customers who are not registered for VAT in the UK follow the

regulations in Place of Supply guidance VAT Notice 741a. (GP7 Import VAT process is in place that allows VAT to

be charged on imports for overseas suppliers who are not UK VAT registered). UK-based organisations receiving

goods and services from overseas have a responsibility to account for the VAT in line with this guidance. This

applies to services from both the European Union (EU) and the Rest of the World (RW), and the Goods from the

EU. Goods from the Rest of the World may have the Import Duty paid at Customs, with the evidence of this

payment allowing the Import Duty to be treated as Input VAT. There are other deferred accounting processes

available where departments have a significant amount of imported goods.

51. The General Rule (see the guidance for exceptions) for transactions between businesses (B2B) is that the VAT is

accounted for where the recipient business belongs; the recipient business calculates and pays to HMRC the

Output VAT that would have been generated had the transaction originated in the UK. The same amount of VAT

is then treated as the organisation’s Input VAT, and can be recovered in line with it’s normal business practices.

This is referred to as the Reverse Charge process.

52. The accounts receivable/financial systems should be set up to identify and report on all overseas purchases,

whether paid in Sterling or foreign currencies. Transactions may be identified via supplier country codes held

within the supplier database; or a combination of codes added at the point of purchase/payment to show the

transaction is with an EU or Rest of the World supplier, along with the expected Tax Rate and VAT-recovery

treatment of the Input VAT element of the Reverse Charge. When identifying relevant transactions, ensure all

payment sources are identified, as transactions going through government procurement cards may need to be

identified from the card supplier’s system rather than the Accounts Payable system.

53. Areas impacting on the VAT Return:

• Foreign VAT cannot be recovered under UK VAT Returns; overseas suppliers should be provided with the

recipient’s VAT Registration number when the service is ordered (prefaced GB) to confirm the organisation is

a business in VAT terms and will be undertaking the Reverse Charge in the UK. The supplier can then issue

the invoice without VAT.

• Overseas invoices received with VAT already added may need to be returned to the supplier for a

replacement with no VAT charged. If an overseas invoice with a VAT charge is paid and a refund cannot be

obtained from the supplier, the Reverse Charge still has to be done, so if the supply is non-recoverable this

will be a double charge to the organisation.

• The calculation of Output VAT for the Reverse Charge process follows the UK VAT rules. If a supply would

have been treated as Outside the Scope of VAT in the UK (for example Membership of Public Interest bodies)

there will be no Output VAT and no Reverse Charge adjustment. Commercial transactions (e.g. Membership

of commercial organisations, supply of IT-related services) would however be Standard rated and would need

a Reverse Charge.

• Some “face-to-face” services that are actually provided overseas, for example Conference attendance, have

their “place of supply” where the service is actually performed, not where the recipient organisation is based

and no Reverse Charge is needed.

• The Output VAT amount and the associated Net Value for EU transactions goes onto the VAT Return at

Boxes 2 & 8 to show its EU origin (Rest of the World Reverse charges are not separately identified from UK

transactions). As the VAT element of the transaction has not flowed through the procurement/financial

system, manual adjustments will be needed to post the VAT amount to the Output VAT account code in the

general ledger. The counter entry posts the corresponding amount to the Input VAT account code.

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• The Input VAT needs to be assessed for recovery under the Business/Non-Business rules as normal (if not

already pre-determined by the tax coding at point of purchase/payment). Where Input VAT on the service

would have been recoverable if purchased in the UK, then it needs to be attributed to Business Input VAT or

the relevant COS Heading number on the VAT21, and included in Boxes 4 and 7 on the VAT Return, with the

net cost of any EU transactions showing in Box 9.

• Input VAT which is not recoverable needs to be removed from the Input VAT account code and transferred to

the expenditure account code in the business area. This effectively means they are paying the same for the

service that they would have done if it had been purchased from the UK. Once removed from the Input VAT

account code the figures do not go onto the VAT Return.

• Naming the journals as “Reverse charge xx Company xx month” allows them to be seen in the general ledger

when reconciling the GL to the VAT Return, and also informs the finance contacts on the receiving cost centre

what costs are being recharged where Input VAT is non-recoverable. Having the company name also makes

it easier to find repeat suppliers to maintain consistency across reporting periods.

Consolidating and reconciling the VAT Return

54. The figures for use in the VAT Return are a consolidation of:

• Input VAT on the acceptable transactions on the Accounts Payable (Business and non-Business COS

recoverable amounts);

• Output VAT from the Accounts Receivable reports;

• Input and Output VAT identified via the Reverse Charge process;

• Restrictions of the recovery of Input VAT identified from the Residual Tax/Partial Exemption process where

these are reported via the periodic VAT Returns;

• manual adjustments identified from the general ledger Input and Output VAT account codes.

55. The figures entered onto the VAT Return must reconcile to the values in the general ledger account codes for

Input and Output VAT, to ensure the VAT Return figures are aligned to the underlying financial information. Any

transactions (e.g. adjustment journals) which are posted to the GL account codes without going through the

Account Payable and Accounts Receivable systems will need to be identified and verified before being included in

the VAT Return figures. Reports or trial balances from the general ledger will support this process.

56. Reconciling items are likely to be:

• Journals showing in the general ledger, correcting errors between expenditure account codes and the Input or

Output VAT account codes identified from the previous period VAT Return activity;

• Journals posted by other business areas creating manual adjustments in recoverable VAT (e.g. an IT invoice

automatically treated as recoverable under COS, but which has had to be adjusted to remove the non-

recoverable voice-capable telephony element);

o agreed naming conventions with the teams posting these journals will remove the need for extensive

investigations within the business when non-identifiable transactions are noted (especially valuable

where a Shared Services provider is involved in the process).

o copies of journals posted to the VAT account codes should be provided to the tax team to track the

adjustments and highlight if any regular journals have been missed.

• Adjustments identified in the current VAT Return period where the journal will appear in the general ledger for

the next period;

• Transactions still under investigation which are being held over until the next VAT Return period;

• Transactions held over from previous VAT Return periods which have now been resolved and the figures

included in the VAT Return;

• Adjustments between non-Business-recoverable VAT and Business-recoverable VAT should also be reflected

on the VAT21 form (both Business VAT at Part 1 and COS Headings figures at Part 2).

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57. Organisations may need to inform their Cash Management Team of large payments due to HMRC, or refunds

expected, so these can be factored in to the cash available for working capital.

Uploading the VAT Return

58. Organisations will need to develop a sign-off process before uploading the VAT Return to ensure the figures

match the content of the audit trails and reconciliation activity. This should include checking the content of the

boxes on the face of the VAT Return, as well as the VAT21 COS Headings listing. The actual process for

uploading the information will depend on any arrangements with Shared Services providers, and in future, the

nature of the software used to transmit the information to HMRC under Making Tax Digital. Deadlines for

submitting the VAT Return and making any payments due to HMRC are set by HMRC and shown at section 5 of

VAT notice 700/12. Where the recoverable Input VAT is greater than the Output VAT, HMRC will make a refund.

59. The underlying data and details of adjustment to the raw figures should be retained in line with HMRC guidance in

VAT Notice 700/21 and will be required if HMRC undertake an audit in line with their Business Risk Review

process. (GP 44 Tax records are maintained and retained in line with legal reporting obligations).

Additional Considerations

60. Guidance allows small value errors (below 1% of net outputs, or below £50,000, whichever is the larger (as

explained in VAT notice 700/45) identified after a VAT Return has been submitted may be adjusted for in

subsequent VAT Returns. Larger scale errors found need to be reported separately to HMRC. Some departments

may have their own arrangements in place with HMRC to report all errors irrespective of value. (GP 33 A process

is in place to report coding errors to relevant parties over thresholds and systems in place to capture all relevant

information).

61. Sales of assets may also impact the Asset register and may have tax implications if Input VAT was originally

recovered under the Business Rules. Liaison with the Fixed Assets team may be necessary when asset sales

invoices are noted in the Output VAT scrutiny. (GP 28 A process is in place to ensure the tax implications of

assets when procuring, selling or transferring assets are considered and checked centrally).

62. Business Continuity plans need to be in place to ensure statutory VAT Returns are made on time (including

Intrastat declarations and EC Sales lists). (GP 58 There are approved Business continuity plans in place to enable

critical activities in the Tax process to continue in the event of a serious incident).

63. Bad Debt Relief may be applicable if sales invoices remain unpaid and are written off in line with guidance in VAT

Notice 700/18. The calculated amount of Output VAT to be recovered flows through the VAT Return as an

addition to the Input VAT Box 4, rather than as a reduction in Output VAT due in Box 1.

If you have any questions on the above, please get in touch with your Tax Centre of Excellence hub contact. For

further guidance: https://taxcentreofexcellence.uk/

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Glossary

Crown Bodies - Government Departments and those bodies determined as part of the Crown by the legislation

which determines their mandate.

Non-crown Public Sector Bodies – Those bodies which have a separate legal status to the Crown; normally a

form of body corporate.

Contracted Out Services Provisions – Those types of activities which are in List 1 of the Treasury Taxing

Direction.

Cabinet Office Global Processes - See here

Business – Activities undertaken by a department which are or have the realistic potential to be in competition

with the private sector.

Non – Business – Activities which are not in competition with the private sector or statute requires the activity to

be complete in a way which is fundamentally different to the private sector.

VAT21 Return – The supplementary VAT return to the VAT100 which allows for VAT recovery under the S41 VAT

Act 1994.

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Annexes

Annex 1 VAT Return form and supporting VAT21

Further Information - How to fill in and submit your VAT Return (VAT Notice 700/12)

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VAT 21 details (Note the descriptions on the form are historic, please consult the up-to-date COS Heading guidance for the current descriptions)

Part 1: Input tax on business activities: £*** Part 2: The information you are entering below relates to refunds claimed on service contracts qualifying as falling under the headings in the Treasury Directions, under Section 41(3) of the Value Added Tax Act 1994: 1 - Accounting & Invoicing: £***

2 - Administration: £***

3 - Admin Of Tolls: £***

4 - Aerial Photo/Surveillance: £***

5 - Agricultural Services: £***

6 - Road Schemes: £***

7 - Broadcast Monitoring Services: £***

8 - Cartographic Services: £***

9 - Cash In Transit Services: £***

10 - Catering: £***

11 - Ceremonial Services: £***

12 - Childcare Services: £***

13 - Collection, Delivery & Distribution: £***

14 - Computer Services: £***

15 - Conference & Exhibition Services: £***

16 - Debt Collection: £***

17 - Staff Records, Payrolls, Including Pensions: £***

18 - Employment Advisory Re Race Relations: £***

19 - Engineering & Related Services: £***

20 - Environmental Research & Protection: £***

21 - Estate Management Services: £***

22 - Export Intelligence Services: £***

23 - Filming, Audio Visual & Production Services: £***

24 - Health Promotion Activities: £***

25 - Hire Of Reprographic Equipment: £***

43 - Static Test Facilities & Test Range Industrial Support:

£***

44 - Operation/Maintenance Of Stores Depot: £***

45 - Operation Of Hospitals & Provision Of Related

Services: £***

46 - Operation Of Prisons, Remand & Detention Centres:

£***

47 - Passenger Transport Services: £***

48 - Pest Control Services: £***

49 - Photographic/Reprographic & Design Services: £***

50 - Preparation & Despatch Of Forms: £***

51 - Press Cutting Services: £***

52 - Professional Services Of Any Expert, Specialist Or

Consultant: £***

53 - Provision Of Accommodation Including Leased/Office:

£***

54 - Publicity Services: £***

55 - Purchasing & Procurement: £***

56 - Radio Services: £***

57 - Recruitment & Relocation Of Staff: £***

58 - Health & Safety Research, Testing & Approval: £***

59 - Scientific Research Re Maff: £***

60 - Security Services: £***

61 - Services Of Printing, Copying , Reproducing Or

Mailing: £***

62 - Share Registry Survey: £***

63 - Storage, Distribution, & Goods Disposal Services: £***

64 - Surveying, Certification & Registration With Ships:

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26 - Hire Of Vehicles Including Repair/Maintnce: £***

27 - Insolvency Services: £***

28 - Interpretation & Translation Services: £***

29 - Issue Of Documents To, & Control Of Bingo

Halls/Bookmakers: £***

30 - Issue Of Docnts Re Wireless & Telegraphy: £***

31 - Laboratory Services: £***

32 - Laundry Services: £***

33 - Library Services: £***

34 - Care Of Livestock/Fauna-Royal Parks: £***

35 - Non-Structural Repair & Cleaning Of Buildings: £***

36 - Maintenance/Repair Of Civil Engineering Works: £***

37 - Cleaning Of Equipment, Plant, Vehicles & Vessels: £***

38 - Repair Of Statues, Monuments & Works Of Art: £***

39 - Medical & Social Surveys: £***

40 - Messenger, Portering & Reception Services: £***

41 - Nursing Services: £***

42 - Office Removals: £***

£***

65 - Training, Tuition Or Education: £***

66 - Transport Research For The Dept Of The Environment:

£***

67 - Travel Services, Excluding Hotel & Fares: £***

68 - Travel & Transport Surveys: £***

69 - Typing, Secretarial, Telephonist & Clerical: £***

70 - Waste Disposal: £***

71 - Welfare Services: £***

72 - Career Guidance For The Jobless Re New Deal: £***

73 - Action Teams For Jobs And Employment Zones: £***

74 - Original Research: £***

75 - Inspection Of Woodland Sites: £***

76 - Probation Services Re Criminal Justice Act: £**

This is the total amount claimed in Section 2: £*** Part 3: Total overall [input tax (Part 1) plus refunds on eligible services (Part 2)]: £*** Declaration Information Full name of person completing the form: Full name of signatory: Position of signatory:

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Annex 2 – Tax Global Design Principles

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